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Raising the roof

This being the start of a new year, I thought it might be useful to review the progress of certain key pension issues.

The issues on which I will concentrate in my next few art-icles are listed in the table below, divided where appropriate between issues relating primarily to defined-benefit schemes, defined-contribution schemes, the state pension and, finally, pension schemes in general. In this first article, I will mostly discuss the first aspect listed under defined-benefit schemes – age discrimination.

I have written several times in these pages about a European directive from about five years ago requiring pension schemes within member states not to discriminate against elderly people simply on grounds of their age. This was widely interpreted by many commentators as meaning that employers would not be able to force employees to retire at a pre-determined age, typically somewhere between 60 and 65, unless it could be demonstrated that the person was unable to perform their duties properly, for example, because of mental or physical restrictions.

As the application of this directive to pensions has been fiercely fought by the UK Government, claiming that other factors should make schemes immune from the abolition of an upper retirement age limit, it continues to amuse me that Government ministers over the last couple of years are claiming credit for “their plans” to permit employees to work beyond normal retirement age.

It has now been announced by the Government that employers will not be able to force employees to retire on the sole ground of age until the employee reaches 70. To my mind, this seems a bizarre compromise as the EU directive places no upper age limit on these anti-discrimination requirements but, as it stands, this amendment is due to come into force on October 1, 2006.

You might be forgiven for wondering why I am devoting time to this issue when its implementation date is a little less than two years away.Anyway, what has it to do with financial planning in general and pension planning in particular? Very briefly, as implementation of this amendment is in around two years time, it immediately affects all employees who are at least two years away from their normal retirement age. I strongly suggest that these people should be made aware that they cannot be forced to retire on the date they had so far anticipated and should reconsider their financial planning strategy if they might want to defer retirement to a later age. In other words, they will have more years to save for retirement.

Members of defined-benefit schemes will usually accrue further years of credit (unless the scheme is closed to further accruals) while those in defined-contribution schemes will be able to accrue bigger funds if retirement is deferred for, say, five years, as well as being able to buy an annuity on more favourable terms due to the higher age at vesting.

Financial advisers who have employers among their clients – small, medium or large – could help those clients by bringing this forthcoming change to their early attention, as many of these employers will currently structure their employment planning strategy on the assumption that a certain number of their workforce will reach retirement age in each year into the future. This assumption will indicate a requirement for a certain additional recruitment strategy.

I cannot immediately think how this assistance could lead directly to any sale of financial services products but fee-based advisers will probably not be too concerned about this and even commission-based advisers should benefit indirectly from increased client goodwill.

Moving from age discrimination to the broadly connected topic of specified minimum and maximum retirement ages, the Finance Act 2004 raised the minimum age at which benefits can be taken from private-sector schemes from 50 to 55 although this will not apply until 2010. Although this is five years away, it should be noted that the measure applies to everyone currently under 45, who will be under 50 at the date of implementation and will not be able to draw benefits until 55.

In my experience, few clients have a realistic hope or expectation of being able to afford to retire as early as 55, let alone 50, so I do not see this change as having any widespread significant impact.

As regards pensions in the public sector, the Green Paper and the tax simplification proposals recommend raising the retirement age from 60 to 65. This would significantly lower the cost of public sector pensions, which are rapidly spiralling out of control at the expense of the taxpayer. Here – more than in any other section of the pension scheme economy – financing costs are escalating fast as the working population is contracting while retirees are living longer.

We are expecting further guidance and proposals on this issue within the next six months and advisers should recognise the importance of any announcements to their public sector clients.

All of us should take a keen interest in developments as any increase in retirement ages will reduce or at least help to restrict increases in our tax bills. Any suggestions to raise the retirement age to 75 rather than 65?Finally, regarding retirement ages, I will turn to state pensions. The Pensions Act 1995 included provisions for enhanced benefits for those deferring taking their basic state pension entitlement beyond state pension age. Currently, an individual’s entitlement is enhanced by around 7.5 per cent for each year he defers entitlement but the Act proposed increasing this to a little under 10.5 per cent – a major incentive which could make sense for the Government were it not for continuing improvements in life expectancy.

The target date for introduction was 2010. However, last year’s Pensions Act brought forward the planned implementation date to April 2005 but reduced the enhancement although more recent announcements have indicated that the enhancement will be at least 2 per cent above bank base rate. Work it out for yourself – at present this comes to almost the same figure as already applies.

The more things change, the more they stay the same, you might think. But the individual will have the option to take the enhancement either as additional pension or – and here it gets interesting – as a lump sum. A bit more about this in Keith Popplewell’s next article.

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