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Defined Contribution vs Defined Benefit

Archive for the ‘Pensions’ Category

Defined Contribution vs Defined Benefit

Wednesday, May 15th, 2019

As defined contribution pension plans overtake defined benefit (in terms of money paid into schemes) for the first time ever, more and more people are taking an interest in how the two differ and the relationship between them. The Office of National Statistics (ONS) has reported that in 2018, employee contributions for defined contribution pension pots reached £4.1bn, compared to the £3.2bn that employees contributed to DB schemes.

With April 2019’s increase to minimum contributions for DC schemes seeing employer contribution hitting 3% and employees contributing 5% towards their pension, the trend of DC contribution increases in relation to DB isn’t set to slow any time soon.

So before DB Pensions become a distant memory, let’s take a look at exactly what they are. A defined benefit pension, which is sometimes referred to as a final salary pension scheme, promises to pay a guaranteed income to the scheme holder, for life, once they reach the age of retirement set by the scheme. Generally, the payout is based on an accrual rate; a fraction of the member’s terminal earnings (or final salary), which is then multiplied by the number of years the employee has been a scheme member.

A DB scheme is different from a DC scheme in that your payout is calculated by the contributions made to it by both yourself and your employer, and is dependent on how those contributions perform as an investment and the decisions you make upon retirement. The fund, made of contributions that the scheme member and their employer make, is usually invested in stocks and shares while the scheme member works. There is a level of risk, as with any investments, but the goal is to see the fund grow.

Upon retirement, the scheme member has a decision to make with how they access their pension. They can take their whole pension as a lump sum, with 25% being free from tax. They can take lump sums from their pension as and when they wish. They can take 25% of their pension tax free, receiving the remainder as regular taxable income for as long as it lasts, or they can take the 25% and convert the rest into an annuity.

One of the reasons for DB schemes becoming more scarce is that higher life expectancies mean employers face higher unpredictability and thus riskier, more expensive pensions. This is a trend that looks likely to continue. If you’re unsure of how to make the most of your pension plan, it’s recommended to consult with a professional.

Auto-Enrolment changes put pressure on SMBs

Wednesday, May 15th, 2019

April 2019 saw the increase of minimum contributions to auto-enrolment pensions from 5 per cent of wages to 8 per cent. With employers now required to contribute 3 per cent, rather than their previous 1 per cent, the Federation for Small Businesses (FSB) has warned that this could put “substantial” pressure on small businesses.

The Institute of Fiscal Studies (IFS) has reported an increase of workplace pension participation amongst small business employees of around 45% as a result of auto-enrolment. That means that businesses who employ between 2 and 29 workers will be seeing a significant extra cost towards pension schemes. These costs aren’t necessarily as daunting for larger businesses, but in the words of Mike Cherry, National Chairman of the FSB, “The costs involved for smaller employers are substantial, in terms of both expenditure and indeed their time, as they have grappled with finding a good provider and setting up whole new systems. Now that the 3 per cent rate has hit, the burden will be greater still.”

But with 70 per cent of UK workers employed by small businesses now on workplace pensions as a direct result of auto-enrolment (first introduced in 2012), employees seem to consider it as an attractive prospect. They too have seen an increase in their minimum contributions, from 3 per cent to 5, and so sacrificing a higher portion of their monthly wages has been accepted as a move that does come with its own benefits. Predictions from investment firm Hargreaves Lansdown state that in real terms, the average employer will see £30 of their monthly wages go towards their pension pot which, on average, results in total pension savings increasing by around £55,000.

Employers, on average, are predicted to now contribute £55 a month to the average employee’s pension pot, an increase from the pre-April figure of £37. These increases aren’t all bad news for employers however; Guy Opperman, Minister of Pensions, sees them as the opposite. “Automatic enrolment has been an extraordinary success, transforming pension saving and improving the retirement prospects of more than 10 million workers already. The increased cost on employers has been phased in over time so firms have had the opportunity to adapt. Pension contributions are a valuable employee benefit which firms use to attract and retain good people. This is true of small and large firms alike.”

House of Lords urges Government to scrap triple lock

Wednesday, May 8th, 2019

The triple lock guarantee currently secures the rise of state pension payments at the beginning of each tax year. However, after an investigation by the Select Committee on Intergenerational Fairness and Provision, a case has been made for the removal of the guarantee.

In its report, Tackling Intergenerational Unfairness, the committee outlined that the maintenance of the guarantee was “unsustainable.” After a consultation, the TaxPayers Alliance told the committee that the current process was “egregiously unfair,” that the state pension was rising rapidly “at a time of spending restrictions on young people” and due to the deficit in public spending, state pension rises were being paid for by future generations. The pressure group then urged the government to put a freeze on state pensions.

The Select Committee conceded that there was in fact a case for spending restraint, although later in the report it stated that “it does not seem fair for people reliant on the state pension to fall behind working people.” It continued: “Nor, on the other hand, is it fair for them to have their incomes lifted at a faster rate than that experienced by working people.”

Another criticism was made by the committee in reference to the National Insurance (NI) system, mentioning that: “The reality of longer working lives should prompt the government to rethink the NI system” as NI contributions do not fund state pensions, despite being used as a criteria for eligibility. The age at which contributions are made was also scrutinised, with the committee stating: “It is not fair that only individuals under the state pension age pay this tax.”

In his summary, the committee chair, Lord True, declared, “both young and older people recognise the contribution the other makes and the challenges they face,” going on to criticise the government, saying that the understanding between generations “could be undermined if the government does not get a grip on key issues such as access to housing, secure employment and fairness in tax and benefits.”

The committee has called upon the government to “take steps to deliver a fairer society” and now awaits a reply from the Treasury.

6 bad habits to avoid during retirement

Wednesday, May 8th, 2019

Planning for retirement can be complicated, as anyone approaching the end of their working life will tell you. However, navigating the myriad of choices, both financially and socially, doesn’t have to be such an enigma. Here are a few tips to help you avoid common bad habits that retirees often fall into:

1. Spending your pension fund money

Yes, that’s right. If you delay spending your pension and spend other available cash and investments first, you could keep your money safe from the taxman. Not spending your pension fund money until you have to may also help the beneficiaries of your estate avoid a large inheritance tax bill.

2. Taking the full brunt of inheritance tax

Inheritance tax can cost your loved ones vast sums if you were to pass away. There are plenty of ways to protect them from losing a large portion of your estate. Strategies such as making gifts or leaving assets to your spouse are an effective way to avoid the tax, among other valuable strategies.

3. Failing to have a plan

Many retirees have multiple avenues of income to provide for them during retirement. Making the most out of those streams of revenue is key to a stress free retirement, as unwise investment or poor planning can lead to unnecessary worries. We recommend contacting a financial adviser in order to set out a plan that’ll let you focus less on worrying about income and more on enjoying your well-earned retirement.

4. Not taking advantage of the discounts

There is an absolute boatload of price slashes available to retirees over a certain age. This ranges from discounts on train fares to reduced prices of cinema tickets. We recommend that all pensioners takes full advantage of these discounts as every penny saved provides more financial security for yourself and your loved ones.

5. Thinking property is the only asset worth having

Property can be a valuable source of retirement revenue, but it’s not the only way to create more income. Property can often incur maintenance expenses for landlords and take up time to resolve that could be spent making the most out of your retirement (though there are many pros and cons to the pension vs property discussion).

6. Buying into scams

When you retire, it seems that all kinds of people come crawling out of the woodwork to give you a “great” investment opportunity or insurance policy. Tactics can include contact out of the blue with promises of high / guaranteed returns and pressure to act quickly. The pensions regulator has a comprehensive pensions scam guide that’s definitely worth a read.

DB pension protection following the British Steel debacle?

Thursday, April 25th, 2019

The treasury has made a promise that since the mismanagement of private pension transfers from the British Steel Pension Scheme (BSPS), the FCA will make an effort to “stamp out bad practice.” So what exactly happened, and what comes next?

Members of the (Defined Benefit) BSPS were given the choice to transfer to a new scheme, sponsored by Tata Steel UK but with lower indexation, or to go into the Pension Protection Fund (PPF), the UK’s pension lifeboat fund which cuts benefits by 10% for those who are yet to retire. 83,000 of the scheme’s 122,000 members opted to transfer to the new BSPS with reduced benefits (but higher payments than those that transferred to the PPF) but roughly 2,600 members requested a transfer from the (DB) BSPS to private arrangements.

The advice that these 2,600 people received is under fire for being unsuitable, with several firms subsequently being barred from undertaking pension transfer business. In fact, the regulator found only 48.1% of the advice that it investigated could be considered suitable.

That’s where the FCA comes in. The Financial Conduct Authority is a financial regulatory body operating independently of the UK Government. It’s financed by charging fees to members of the financial services industry. Specifically, it regulates financial firms (both retail and wholesale) which provide services to consumers and thereby maintains the integrity of the financial markets in the United Kingdom.

Officially, its role includes: “protecting consumers, keeping the industry stable, and promoting healthy competition between financial service providers.” But what’s changed to help curb the chances of this happening again? In the words of John Glen, the Economic Secretary to HM Treasury; “The new rules on pension transfers provide advisers with a framework to better enable them to give good quality advice, so that consumers can make better informed decisions”

As for your pension, most DB schemes, as well as the defined portion of hybrid pension schemes based in the UK, are eligible for protection, however there are some exceptions. If you’re unsure about your scheme, the Pension Protection Fund provides a full list of qualifiers and conditions at https://www.ppf.co.uk/your-scheme-eligible.

Time to cut out the jargon from pensions

Wednesday, April 3rd, 2019

People simply aren’t saving enough into their pension funds. Despite the relative success of the auto-enrolment rollout and the increase of minimum contributions from 5% to 8%, there’s still a culture of misunderstanding surrounding pensions. With a reported 51% of the public believing that the minimum contributions are in line with the recommended rate of saving, this is unfortunately not the case. With experts generally recommending a figure closer to 13%, something needs to change for people to have a real understanding of their pensions.

IFA firm Portafina conducted research in February 2019 on a sample of over 2,000 people between the ages of 18 and 70, designed to find out how much we know and, more commonly, don’t know about the world of pensions. The figures paint a pretty clear picture that something needs to be done. With less than 1 in 5 (19%) knowing exactly what a pension is, 72% not knowing when they would be able to withdraw money from a private pension and 31% having no idea when their pension would be taxed (and a further 40% thinking they knew, but being wrong) clearly there is an issue to be addressed.

So why is it that we don’t understand? It might be because of all the technical jargon. In fact, 85% of those surveyed in the Portafina report said that if they received clearer information about their pension in plain language and direct, coherent graphics, they would be able to make more informed decisions. When confronted with 7 common examples of pension related terms, only 37% knew what some of them meant, with a quarter not understanding any of them at all. Perhaps this is just a symptom of a larger problem regarding the lack of financial education available.

According to the Government guidance, since the introduction of financial education to the national curriculum in 2014, pupils at key stage 4 should be taught about “income and expenditure, credit and debt, insurance, savings and pensions, financial products and services, and how public money is raised and spent.” Despite this, estimates put the figure of schools actually delivering this education at around 40%, as although it’s compulsory for secondary schools, academies and free schools are not bound by the official curriculum.

It’s a shame that so many people are missing out on the benefits and later life income available through proper pensions practice. If you, like many others, feel that you need the jargon done away with and pension information delivered in an understandable and accessible way, please do ask for advice from a professional.

What does a pensions dashboard mean for you?

Wednesday, February 20th, 2019

The development of an online pensions dashboard has been given endorsement from the government and looks as though it will get official approval in 2019. So what is a pensions dashboard? Keeping track of your pensions can be a real challenge, in fact there is currently over £5 billion worth of unclaimed pensions, sitting untouched. The idea of the pensions dashboard is to provide people with a one-stop-shop to access information about multiple schemes and see how much they have available to them. Ultimately, the more informed we are about our pension situations, the better the decisions we can make regarding our retirement.

This isn’t the first time somebody’s had this idea. In fact, the plan to introduce some form of pensions dashboard has been around for a while, but there have just been logistical issues in making it happen.The Financial Conduct Authority first approached the government in 2016 and issued the challenge to make a pensions dashboard available to consumers by 2019. With so much data to collect and so many different organisations involved, it’s not been an easy thing to implement but the end is in sight.

Pensions expert Ros Altmann welcomed the news that the Prime Minister has given official endorsement of the the development of pensions dashboard, stating that it will “help people keep track of all their pensions in one place,” and calling it an “invaluable tool in planning for later life.”

She also acknowledged, however, that there were still some hurdles to overcome. As older legacy pensions are not currently recorded electronically, the task of uploading all of that data will take a considerable amount of time and money. The auto-enrolment pension records, which only began in 2012, could be transferred to a central database relatively easily. This would provide a dashboard for younger workers, with legacy records being gradually updated at a later date.

An incomplete dashboard, however, may come with its own challenges entirely. Tom Selby, senior analyst at AJ Bell, voices his concerns. “The biggest danger is that people make poor decisions based on incomplete information – this situation must be avoided or the long-term damage to individuals and trust in pensions generally could be huge.”

Selby suggested that an incomplete dashboard could be a danger to the dashboard itself. “In the age of instant online banking, people rightly have high expectations of financial companies. A half-baked dashboard risks being discredited from the start.”

There will be a non-commercial dashboard hosted by the Single Finance Guidance Body, although financial services companies will also be permitted to host their own dashboards.

In the meantime, if you think you might have pension pots that have fallen by the wayside, there’s an easy tool to track them down at no cost. All you need to do is get in touch with the government’s Pension Tracing Service – you can find their details at https://www.gov.uk/find-pension-contact-details. If you have any other questions on this topic, do get in touch with us directly.

What is a partial transfer?

Thursday, February 14th, 2019

You may have a defined benefit pension and be aware of pension transfers but not have heard of partial transfers.

A partial transfer is a pension option that allows you to cash in a portion of your retirement fund, while still retaining the rest as a guaranteed income. They are a way of accessing your defined benefit cash without taking on the risk of a full transfer and, for those with very large pensions, they can prevent you from exceeding your lifetime allowance.

Yet the vast majority of pension trustees do not offer these transfers. According to a report by The FTAdviser in March 2018, only 15% of schemes offered partial transfers.

Some trustees may be put off due to the complex administration involved. Helen Ross, actuary and investment consultant at XPS Pensions Group, however, sees no reason why offering partial transfers shouldn’t be the norm. “People are given binary options between either security or flexibility and there is nothing in between. Providing partial transfers is beneficial for businesses too, as it makes things simpler for consumers and it’s cheaper to do in the long run.”

With the reforms to the pensions market that we’ve seen in recent years, the doors have been opened to great freedom and choice for consumers accessing their pension pots. That comes with lots of opportunities but also bears the risk of people running out of money earlier than planned – particularly when performing a full defined benefit transfer. Mary Stewart, head of corporate solutions at LV, says, “we strongly believe there is a role for partial transfers to allow DB scheme members flexibility over their retirement options, while maintaining the certainty and security of a regular income.”

Members of pension schemes need to have access to the options and information to make good decisions about their retirement and personal finances. For some, a partial transfer may be what’s needed. If you think that may be the case for you, ask your scheme administrator if it’s a viable option and discuss it with your financial adviser.

As a parent, could you be missing out on your state pension?

Thursday, February 14th, 2019

There’s no reason why being a parent, and particularly being a non-earning parent with commitments to their children, should put you at risk of decreasing your state pension entitlement. Currently, however, there are potentially hundreds of thousands of people in this exact position – although thankfully, there are steps to take so that it can be avoided.

In order to be entitled to the full new state pension, you will generally require 35 years of national insurance contributions to qualify. Those years of contributions can be difficult to accumulate if you’re out of work for whatever reason. If you don’t already pay national insurance contributions, perhaps because you’re staying at home to look after children, you are able to build up your state pension entitlement by registering for child benefits, as long as you’re a parent of children under 12.

Figures supplied to the Treasury by HMRC suggest that there could be around 200,000 households missing out on these pension boosting entitlements. If the child benefits are being claimed by the household’s highest earner, and not the the lower earner or non-earner, these potential national insurance contributions can fall by the wayside. Treasury select committee chairman and MP Nicky Morgan says; “The Treasury committee has long-warned the government of the risk that for families with one earner and one non-earner, if the sole-earner claims child benefit, the non-earner, with childcare commitments forgoes National Insurance credits and potentially, therefore, their entitlement to a full future state pension.”

With 7.9 million UK households currently receiving child benefits, there is potential for a large number of people to be affected. Thanks to data from the Department for Work and Pensions, it’s suspected that around 3% of those (around 200,000) may be in this situation. It’s worth noting that the family resources survey covered 19,000 UK households and as the estimate is sample-based, there is some uncertainty on the exact numbers of those at risk. Nicky Morgan continues, “Now that we have an idea of the scale of this problem, the Government needs to pull its finger out and make sure that people are aware of the issue and know how to put it right.”

The fight against pension scammers

Wednesday, January 23rd, 2019

For those who want to stay safe from the efforts of pension scammers, help is out there. It’s just as well because such help is in high demand. Between August and October alone last year, the Financial Conduct Authority’s (FCA) ScamSmart website had over 173,000 unique visitors. That’s around 3,145 people per day on average, or one person every 27 seconds.

The FCA and The Pensions Regulator founded their pension fraud awareness campaign in the summer and since its launch, the number of visitors has rocketed. The website highlights common red flags to watch out for, as well as offering a form for reporting suspected fraudsters.

The scams are becoming more and more sophisticated and there’s big money involved. In 2018, pensioners reported being conned out of £23m, up from £9.2m in 2017 – that’s an average of £91,000 each. Once the fraudsters have the money, it’s very unlikely that it will be recovered, so the key to protecting yourself lies in prevention. The Head of Enforcement at the FCA, Mark Steward, has said: “Pension scams are very difficult to spot. [Scammers] try to make the victim feel afraid or uncertain, worried their money is better off somewhere else. [They] will target people from all walks of life and with any size pension.”

There are practical steps you can take to cover yourself and the Get Safe Online website offers six great tips for avoiding fraudsters:

  1. Never reveal your personal or financial data, including usernames, passwords, PINs or ID numbers.
  2. If you must supply payment information to people or organisations, make sure they are genuine and never reveal your passwords.
  3. Remember that a bank, or any other reputable organisation, will never ask you for your password via email or phone call.
  4. Do not open email attachments from unknown or untrusted sources.
  5. Do not readily click on links in emails from unknown or untrusted sources. By rolling your mouse pointer over the link, you can reveal its true destination which will be displayed in the bottom left corner of your screen.
  6. If this destination is different from what is displayed in the text of the link in the email, beware – only click through if you are certain it is safe.

The best thing you can do is stay vigilant and get in touch with a watchdog or trusted resource if you’re unsure. FCA research shows that more than 10 million British adults are likely to receive an unsolicited pension offer a year. Thankfully, this number should reduce as new regulations from the Treasury banning pension cold calling will have recently come into effect.