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FINAL SALARY PENSIONS
TIME TO ABANDON A SINKING SHIP?
THE RICHER RETIREMENT SPECIALISTS
WWW.AVANTISWEALTH.COM
Rod Thomas F...
2
pg 3.	 Introduction
pg 4.	Who else is talking about final
salary schemes?
pg 4.	What are the big changes that have
impac...
3
INTRODUCTION
Over the last generation anyone inside a final salary (also
called a defined benefit) pension scheme was co...
4
WHO ELSE IS TALKING ABOUT FINAL SALARY SCHEMES?
Many people it would seem. In recent months
final salary schemes have hi...
5
HOW DOES A FINAL SALARY SCHEME WORK?
If you are one of the few who understand how a final
salary scheme is designed to w...
6
WHAT’S GONE WRONG?
There are five fundamental problems that have arisen
with final salary schemes that impact the abilit...
7
WHAT ARE THE CONSEQUENCES OF THIS MASSIVE FAILURE?
“Most final salary schemes in the
private sector are in massive defic...
8
BALANCES AND FUNDING RATIO
The final chart shows some important trends over time.
Back in 2007, The total surplus balanc...
9
NO PROTECTION IF YOU ARE NOT RETIRED!
You may believe that contributions you and the
employer have made to the final sal...
10
LIMITATIONS OF THE PENSION PROTECTION FUND (PPF)
Just suppose your company goes out of business or
through a ‘restructu...
11
HOW MUCH WILL YOUR FINAL SALARY SCHEME GROW BETWEEN
NOW AND RETIREMENT?
If your pension is ‘frozen’ because you have le...
12
WHY LEAVE YOUR SPOUSE 50% WHEN IT COULD BE 100%?
Within your final salary scheme there is probably a
provision to pay y...
13
TAKE CONTROL AND MAKE BETTER INVESTMENT DECISIONS
In your final salary scheme, almost all companies make
the investment...
14
MAKING A PENSION TRANSFER TO A DEFINED CONTRIBUTION SCHEME
BRINGS PENSION FREEDOMS, THE RIGHT INVESTMENT STRATEGY CAN
R...
15
REASONS TO KEEP YOUR FINAL SALARY SCHEME
1.	 You are ‘rock solid’ certain that the company will
be able to contribute t...
16
REASONS TO MOVE YOUR FINAL SALARY SCHEME TO A DEFINED
CONTRIBUTION SCHEME?
1.	 You want to take control of your pension...
17
RISK AND REWARD
If you are going to consider transferring a final salary
scheme the issue of risk will be one of the cr...
18
This is where the problems start.
Let’s consider the issues:
Cost
Taking fully regulated financial advice on the pensio...
19
SUMMARY
The whole issue of final salary schemes is hugely
problematic, relatively complicated and extremely
important t...
20
Next Steps
Thank you for reading this
Special Report. I hope you
have found it interesting
and valuable.
Gemini Busines...
21
THE RICHER RETIREMENT SPECIALISTS
DISCLAIMER
Avantis Wealth Ltd is not authorised or regulated by the Financial Conduct...
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Rod thomas investment final salary pensions

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Insightful report looking at Final Salary Pensions by Rod Thomas FCA, Managing Director at http://www.avantiswealth.com

Published in: Investor Relations
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Rod thomas investment final salary pensions

  1. 1. FINAL SALARY PENSIONS TIME TO ABANDON A SINKING SHIP? THE RICHER RETIREMENT SPECIALISTS WWW.AVANTISWEALTH.COM Rod Thomas FCA
  2. 2. 2 pg 3. Introduction pg 4. Who else is talking about final salary schemes? pg 4. What are the big changes that have impacted final salary schemes? pg 5. How does a final salary scheme work? pg 6. What’s gone wrong? pg 7. What are the consequences of this massive failure? pg 7. The deficit and the Pension Protection Fund (PPF) pg 7. How big is the funding deficit? pg 8. Balances and Funding Ratio pg 9. No protection if you are not retired! pg 10. Limitations of the Pension Protection Fund (PPF) pg 11. How much will your final salary scheme grow between now and retirement? pg 12. Why leave your spouse 50% when it could be 100%? pg 12. Why not own your own fund? pg 13. Take control and make better investment decisions pg 14. Making a pension transfer to a defined contribution scheme brings pension freedoms, the right investment strategy can result in a higher fund value and income in retirement pg 15. Reasons to keep your final salary scheme pg 16. Reasons to move your final salary scheme to a defined contribution scheme pg 17. Risk and Reward pg 17. Will you be allowed to transfer even if you choose to? pg 19. Summary pg 20. Next Steps CONTENTS
  3. 3. 3 INTRODUCTION Over the last generation anyone inside a final salary (also called a defined benefit) pension scheme was considered to have a ‘gold plated’ pension. People were universally discouraged by financial advisors from moving to a money purchase (also called defined contribution) scheme, except in the most unusual circumstances. But times change. And the present environment for investment, combined with the momentous changes the Government has made to the pension laws from April 2015 and into 2016, should, in my view, mean that its crucial to take a very close look at any final salary pension scheme that you belong to. “These ‘gold-plated’ schemes are supposed to be guaranteed – but savers are being misled, a top pensions’ official has warned. Alan Rubenstein, head of the Pension Protection Fund, called on companies operating pension schemes that are in jeopardy to be honest with members.” The Daily Telegraph said that these comments represented the most overt warning from a government- backed organisation since the crisis in the early 2000’s, when thousands of workers faced the loss of their pensions as companies collapsed with deficits in their schemes. This special report is primarily to holders of final salary schemes in the private sector, predominantly where you no longer work for the company and have a ‘frozen’ pension. If you still work for a company and benefit from a final salary scheme, there’s also a lot to think about. If you work in the public sector, with an ‘unfunded’ scheme, you are no longer (from April 2015) able to opt out of your existing scheme, and therefore this report doesn’t apply to you. This includes, for example, the NHS, Teachers, Police, Fireman and more. The exception in the public sector is local authority employees who belong to a ‘funded’ scheme and may still transfer out of their pension scheme. As always the views and opinions expressed in this report are my own. And in no way represent advice on moving a pension – which can only be provided by a fully regulated financial advisor. From April 2015, if you are considering moving a final salary pension you will be required by law to have regulated financial advice unless the fund is worth less than £30,000.
  4. 4. 4 WHO ELSE IS TALKING ABOUT FINAL SALARY SCHEMES? Many people it would seem. In recent months final salary schemes have hit the headlines: • “Final salary pension? Your retirement income is at risk” • “Is it worth ditching a final-salary pension for cash?” • “Freedoms spark rush from final salary pensions” • “Why UK Final Salary Schemes Will Move to DC (Defined Contribution)” • “Fears more will exit ‘gold-plated’ pensions to win Budget freedoms - so can it ever pay to give up a final salary scheme?” • “Warning over final salary schemes as combined pension fund deficit grows” WHAT ARE THE BIG CHANGES THAT HAVE IMPACTED FINAL SALARY SCHEME? Here’s a quick bullet point list, which we will explore in more detail in this report. • Poor investment performance • Impact of fees and charges • Inability of companies to fund the pension to the level required • Opportunity to get better investment growth elsewhere • New rules for pension schemes that provide new benefits for defined contribution schemes. • Potential withdrawal of up to 100% of the pension fund, but only after transfer to a defined contribution scheme.
  5. 5. 5 HOW DOES A FINAL SALARY SCHEME WORK? If you are one of the few who understand how a final salary scheme is designed to work, and know how the deficits have arisen, skip this section. Otherwise read on for a quick primer that will set you up to understand the rest of this special report. At its most simple, a final salary pension promises you a set of benefits (e.g. income, cash on retirement, life insurance, widows and maybe children’s pension) which are then funded by the company based on three elements of cash going into the pension: • Contributions from the company • Contributions from that employee • Investment growth over the time The actuary (the professional that does all the pension calculations) has to do two big jobs: 1. Calculate the pension you are likely to qualify for on retirement, taking into account promotions, wage rises, length of service, inflation and more. And then calculate, from the annual pension, what capital sum will be needed to provide that pension. It’s a tricky calculation across maybe thousands of employees on different pay grades and maybe with different pension rights! 2. Calculate how much needs to be contributed to the pension, in the three ways noted above, to ultimately provide the right amount in the fund to pay your pension until you die, and then maybe to your surviving spouse and children. So we have two separate calculations. If all is calculated correctly, and the many assumptions that are made turn out to be reasonably correct, there will be a fund of the right level that can then provide your promised pension for the many years ahead. Only, most probably, there won’t!
  6. 6. 6 WHAT’S GONE WRONG? There are five fundamental problems that have arisen with final salary schemes that impact the ability to pay the promised pension: Problem One: Lack of investment performance If the investment return was expected to be (say) 5% a year, and over a 25 year period it averages 2%, the difference in outcome is extraordinary. Here’s an example with a starting fund of (say) £100,000 and running it for 25 years ahead. • If you achieve 5% a year growth, the fund will be worth £338,000 • If you achieve 2% a year growth, the fund will be worth £164,000 This is roughly 50% less. What this means in real life is that if the planned pension required a fund of £338,000, and the actual fund is only worth £164,000, there is a deficit of £174,000 on your personal fund. If this deficit is not made up by the retirement date what happens? Either you get a smaller pension, or the fund runs out before you die. Problem Two: Low interest rates and low investment performance. Here’s the second big problem. Let’s say the actuarial calculation was that you would be entitled to a pension of £16,900 per year. If the assumed interest rate/investment growth was 5%, then the calculation to work out the fund size needed is simply this: Take the pension of £16,900 and multiply it by 100/5 which gives you, no surprise here, £338,000, which is exactly the same as the fund size we expected to achieve at a growth rate of 5% over 25 years. So all is good, except this is not what happened. The actual growth rate has been 2%, representing rock bottom interest rates and poor investment performance. So now to deliver the promised £16,900 annual pension we need to do a different calculation, viz: £16,900 x 100/2 which gives you a fund size of £845,000. Really! Please check the calculations yourself. But given this scenario, what fund size have we achieved at a 2% growth rate? Refer to the previous paragraphs and you will see that the available fund is not £338,000 but £164,000. The bottom line is that the company has a fund of £164,000 to provide a pension which now requires a fund of £845,000! If you think this is scary, it is. Problem Three: Inability of company to make the required contributions When the actuary completes the calculations one element will be to decide how much the company should contribute. Of course in your contract of employment it probably says how much the company will pay towards your pension. For example, 10% of salary. But suppose 10% of salary isn’t enough to provide the planned benefits? The company needs to contribute more to make up the shortfall. Maybe trading is bad and they just can’t! Or maybe they choose not to! There is no contractual requirement for them to make additional payments to your pension if you are not retired yet (do I hear a gasp of surprise!). The failure of companies to make up pension deficits is the single biggest reason that final salary schemes are in the mess that they are, and there’s little likelihood of it changing anytime soon. Problem Four: Removal of Advance Corporate Tax Credits Do you recall when ex-chancellor Gordon Brown raided the pension funds? His tax change resulted in a reported loss of £5bn annually to pension funds. Problem Five: Life extension We are living longer and therefore final salary schemes have to pay pensions for an increasing number of years. The speed of increase in life expectancy has been greater than the actuarial adjustments, resulting in another requirement for increased funding which wasn’t planned and for the most part can’t be afforded.
  7. 7. 7 WHAT ARE THE CONSEQUENCES OF THIS MASSIVE FAILURE? “Most final salary schemes in the private sector are in massive deficit” • Most final salary schemes in the private sector are in massive deficit (more later). • The only way for companies to make up the enormous deficit is to pay big additional contributions to the pension fund. Most can’t afford it. • When the company goes out of business, the fund can’t get any new money and has to be rescued by the Government Pension Protection Fund (PPF). • Companies are running away from final salary schemes just as fast as they can. THE DEFICIT AND THE PENSION PROTECTION FUND Because of the potential political fallout from major pension schemes going bust the Government created the PPF (Pension Protection Fund). This is designed to provide a level of protection for individual pension holders in schemes that can no longer support their liabilities in the future. The PPF is a great source of data about final salary schemes and it is instructive to see the current situation and extent of the problem. Graphs below courtesy of PPF. HOW BIG IS THE FUNDING DEFICIT? This chart shows that the total ‘surplus’ of all schemes that are in surplus had fallen to about £30bn, whilst the total ‘deficit’ of all schemes in deficit had increased to about £300bn, both by end of December 2014. What this means is that taking all final salary schemes together, there is a net deficit of £270bn and increasing. Given that the Government is trying to find just £30bn of savings on our national expenditure in the next Parliament, what chance is there of this deficit suddenly disappearing? The situation, in real life, is actually far worse than this graph shows. The gap between pension schemes’ investments and the value of actual promises made to pensioners is far higher than the £300bn that would deliver the PPF level of payouts. One independent estimate, by Citigroup, put the real gap at £850bn. “Citygroup estimates the real pensions deficit at £850bn” Even figures from the Pensions Regulator, the body charged with monitoring schemes’ solvency, suggest that if schemes had to pay all their pensions as promised today, they would be 45pc short. This table shows that of the 6,057 private sector final salary schemes, at the end of December 2014, 4,936 are in deficit, up from 3,416 just a year earlier. These numbers are so big that it may be easier to see some actual examples of companies that have large pension deficits. Here’s just a small sample: British Airways £3.3bn Tesco £3.4bn British Telecom £7.0bn Lloyds Bank £31.3bn Dec 2013 Nov 2014 Dec 2014 Number of schemes in deficit 3,416 4,781 4,936 Deficit of schemes in deficit £87.6bn £261.6bn £300.7bn Number of schemes in surplus 2,641 1,276 1,121 Surplus of schemes in surplus £96.4bn £40.4bn £34.3bn
  8. 8. 8 BALANCES AND FUNDING RATIO The final chart shows some important trends over time. Back in 2007, The total surplus balances of all private sector final salary scheme were valued at £160bn. Today they stand at -£270bn. It’s not just the negative number, but the fact that final salary schemes are £430bn worse off than just seven years ago. “Final salary schemes are £430bn worse off than just seven years ago” What do you think happened back in 2007 and before, when final salary schemes realised that they were carrying a substantial surplus balance? A prudent view might have been to put the money aside in case the current positive trend didn’t continue (it didn’t!). Actually most schemes took a contribution holiday and companies stopped contributing as much, or at all, to their pension scheme. Over the same time period from 2007-2014 the funding ratio (what proportion of liabilities can be covered) has fallen from 120% of all liabilities (ie. No net deficit across all schemes), to just about 80% of all liabilities – meaning that on average only 80% of promised pensions can be funded. Of course there’s far worse to come because there is no quick fix to the poor investment performance, low interest rates or lack of companies ability to make up the deficit. Just in case you think I am making this up, here’s a quote from Alan Rubenstein, chief executive of the Pensions Protection Fund (PPF). “Many of the 11 million people with a supposedly guaranteed, inflation-linked pension were being led to believe their pension was safe, when for many that isn’t the case”. “Many of the 11 million people with a supposedly guaranteed, inflation-linked pension were being led to believe their pension was safe, when for many that isn’t the case”
  9. 9. 9 NO PROTECTION IF YOU ARE NOT RETIRED! You may believe that contributions you and the employer have made to the final salary pension, plus the investment growth on your fund, are ‘protected’. If you believe this you are simply wrong. There is no protection in place for people who are not yet retired, when their final salary pension scheme is wound up after employer insolvency. Most people think that their pensions are protected, but they are not - even after the 1995 Pension Act, the introduction of the Minimum Funding Requirement (MFR), the Myners Review and Pickering Report. An employer’s final salary scheme may provide no pension at all for members who have contributed loyally for 30 years or more. “An employer’s final salary scheme may provide no pension at all for members who have contributed loyally for 30 years or more.” The final salary pension is not ‘guaranteed’ by employers at all for those who are still working - people do not generally realise this. If the employer decides to wind up the scheme, or becomes insolvent, they may get much reduced pensions or even no pension at all. Why is your pension at risk? That’s because of the ‘rules’ that say that pensioners who have already retired (and also Directors who have taken early retirement) have priority over deferred pensioners. Those who are still working may not even get their own contributions back if the assets in the scheme are insufficient on wind-up, after having to pay pensioners first. One of the big problems is that the 1995 Pensions Act (which was designed to protect pensions after the Maxwell case) introduced a particular ‘order of priority’ which must be followed, when a scheme’s employer becomes insolvent and there are not enough assets in the fund. This order of priority says that the assets of the fund must be spent on pensions already in payment, plus their full inflation-linked increases, before the pension promises of members who have not yet started drawing their pension can be paid. Even fully solvent employers can decide to wind up their pension scheme. If they do not want to keep running their final salary scheme, it is quite easy for them to just walk away from their liabilities. Employers in the past have generally referred to their schemes as ‘guaranteed’ pensions, but the law currently allows them to just decide to wind up the scheme and leave members short- changed. The law only requires an employer to pay in to their scheme enough to provide pensions for members who have not yet retired at a level specified by what is called the ‘Minimum Funding Requirement’ or ‘MFR’. In fact, at the moment, the funding level will only buy about 40% of the pensions promised to workers under age 45. Even if the employer can well afford to pay in more, the law does not require them to. Until recently, Government rules stopped people from contributing to a private pension if they are in an employer’s scheme. This means most people have had no way of providing any other retirement income for themselves, yet their pension contributions are not properly protected. People can contribute for over 30 years and end up with no pension. This is like encouraging people to put all their money into one share on the stock market. However strong the company is, no-one would ever be advised to do this with their life savings (and their job), but that is what happens when an employee is in their employers final salary scheme.
  10. 10. 10 LIMITATIONS OF THE PENSION PROTECTION FUND (PPF) Just suppose your company goes out of business or through a ‘restructuring’. And the PPF takes over the fund. Don’t relax because you may not get the pension you are expecting! If you have not yet retired, you will only get a maximum of 90% of the planned pension, but with another limitation which could affect you if you are reasonably well paid. There is a cap on the total pension you can receive which varies depending on your age when the employer goes bust, and the age that you start taking your pension. However, most cap’s are between £25,000 and £30,000 pa. Suppose you are age 60, and have a pension due of £75,000 a year as a retiring director. Under the PPF rules this would be capped at circa £25,000 pa. So you would lose two thirds or £50,000 a year of your pension. People with higher paid jobs and therefore significant pensions could find themselves adversely impacted by this cap. Pilot’s pension cut from £47,000 to £26,500 The pension scheme of Monarch Airlines is currently being taken over by the PPF following a restructuring of the company. There was not enough money in the fund to meet all the pension promises made in earlier years. While most staff’s pension will fall below the cap, meaning they will get 90pc of their entitlements, some high-earning pilots will see drastic cuts. “…planned to use his generous promised pension of £47,000 per year to help his children and pay off his mortgage. But he and his wife have been forced to rethink their plans because under the PPF they will get a maximum of £26,500” One Monarch pilot, 51, who did not want to be named, planned to use his generous promised pension of £47,000 per year to help his children and pay off his mortgage. But he and his wife have been forced to rethink their plans because under the PPF they will get a maximum of £26,500. “I’m still in a state of shock,” he said. “It’s like a grieving process. There’s this sense of injustice. My pension is something I’ve paid into over the years and it’s something I was promised. I was paying around £1,000 a month from my salary, excluding the company contribution, and I’ve always regarded my pension as deferred pay. It wouldn’t be so bad if I was in a position to do something about it, but for me the time available is short.” Will the PPF cut benefits even more? Let’s say you have 10 years to retirement. And potentially 25 years to live after that. Your pension fund has to grow for 10 years and then provide for a further 25. Do you really think the PPF can sustain payments at the current level? As deficits grow and the remaining pension funds can no longer increase payments of the ‘levy’ that the PPF demands it will fall to Government to pay the shortfall. I expect that over years to come we will see reductions in the percentage of pension that is guaranteed – from 90%, to 80%, maybe as low as 50%. And also a reduction in the cap, perhaps to £20,000 or less. Nothing is for certain, except that as deficits rise the ability of the Government to fund ‘bust’ private pensions will reach the point where further reductions have to be made. Those already retired will be protected to a greater degree, leaving those in their forties and fifties, who will claim benefits in future years, most at risk.
  11. 11. 11 HOW MUCH WILL YOUR FINAL SALARY SCHEME GROW BETWEEN NOW AND RETIREMENT? If your pension is ‘frozen’ because you have left the company, there is probably a contractual right for it to grow annually according to some definition of inflation. Older schemes might not include this. The definition of ‘increase with inflation’ is very variable. I’ve seen all these possible choices in different schemes: • Increase with RPI • Increase with CPI • Increase at RPI but max 5% • Increase at CPI but max 2.5% • And many more… For your information the average inflation over the last 25 years is 2.73% with the Government target for inflation at 2.0%. We’ve just hit the lowest inflation rate since records began at 0.0%! The bottom line is that your final salary pension, between now and retirement, is not going to grow in real terms at all. At best it will keep pace with inflation. “The bottom line is that your final salary pension, between now and retirement, is not going to grow in real terms at all. At best it will keep pace with inflation.” The longer you have before you retire, the more this matters. Suppose you have the opportunity to place your fund elsewhere with investments that can do far better? (Talk to Avantis Wealth about this). Example Existing fund growth – 2.5% annually Alternative fund growth – 8% annually Value of fund now - £100,000 Years to retirement – 15 years Existing fund would be worth - £144,800 Alternative fund would be worth £317,216 (more than twice as much) The benefit is through moving your pension to a place that performs far better. No advantage in just moving your final salary scheme if the new scheme only matches inflation!
  12. 12. 12 WHY LEAVE YOUR SPOUSE 50% WHEN IT COULD BE 100%? Within your final salary scheme there is probably a provision to pay your spouse a ‘widow’s pension after your death. That’s been, in the past, another big benefit of a final salary scheme. However, if you were to enter a drawdown arrangement, possible with a defined contribution pension and some other occupational pensions, then you could ensure that all your pension was passed to the surviving spouse. Oh, and when your spouse dies, the pension isn’t lost but passes again to further beneficiaries (children perhaps?). So is a final salary scheme better in this aspect of provision? I don’t think so. WHY NOT OWN YOUR OWN FUND? When you move into drawdown, through a defined contribution scheme, you own your own pension fund. This is critical to understand. “When you move into drawdown, through a defined contribution scheme, you own your own pension fund.” Let’s say that by the time you retire your final salary scheme promises a pension of £10,000, and has a notional fund value of £300,000. I say ‘notional’, because if you stay with the scheme you’ll never be entitled to it. Maybe a tax free cash sum up to 25% of the value, but that would be the maximum. Within a drawdown scheme, you own your fund. That £300,000, assuming you transfer to another scheme, is yours. And with the new pension freedoms that means lots of choices: • You can withdraw 25% tax free • You can withdraw as much of the remaining balance as you wish, either in one go or across the years, subject to tax at your marginal rate • You can live from the income of your investments, never taking the capital sum, and leave it as a legacy to your family or other beneficiaries • You can keep it as ‘rainy day’ money, knowing you have reserves to fall back on should the need arise • You can keep it as ‘luxury expenditure’ money, ready to use for the things you always wanted to do but never could afford • You can use it as supplementary income, adding to the income generated by your capital should the need arise • You can use your pension as a tax planning tool, leaving your fund as a legacy that is not subject to inheritance tax. (but income and capital withdrawals will be subject to tax in the hands of your beneficiaries). Or you can stay with a final salary scheme and after the potential 25% cash lump sum, never have access to any of these things!
  13. 13. 13 TAKE CONTROL AND MAKE BETTER INVESTMENT DECISIONS In your final salary scheme, almost all companies make the investment choices for you. No options at all. Why? Because they have contracted to provide certain benefits. How they get there is up to them. “..history over the last 15 years shows that current investment strategies are not delivering” All well and good, but history over the last 15 years shows that current investment strategies are not delivering. This is a very big topic, dealt with in detail in my Special Report ‘Property As Your Pension’, available for download by Gold Members (free registration) on the Avantis Wealth website at www.avantiswealth.com. The key point is this. I have a favourite saying: If you keep doing the same things, you’ll keep getting the same result. And the results of your final salary scheme are simply terrible. You might not be an expert at investment, but there are strategies and asset classes which can make a significant difference to the growth of your pension fund before retirement, and to the level of income you can draw after retirement. Investments offered by Avantis Wealth generally offer returns of 7% to 15% net annually. Of course with control comes responsibility, so a willingness to get involved in investment decisions is a pre-requisite for even considering an alternative option for your final salary pension. As is a willingness to take a higher level of investment risk in return for a higher level of reward. It’s worth pointing out that from what you’ve already read, having a final salary pension could be considered hugely risky given the enormous deficits and the potential loss of income if the company goes bust and the PPF takes over! What difference might better investment decisions make? Let’s continue our exploration of alternative investment options started in the section called ‘How much will your final salary scheme grow between now and retirement’… In that example we discussed how improving the rate of growth could potentially, dramatically, change the outcome for a fund valued at £100,000 with another 15 years to retirement. We showed that by increasing the rate of growth from 2.5% a year (assumed inflationary rises) to 8% (achievable with a different investment strategy) then the fund value on retirement could be around £317,000 instead of £145,000. A dramatic improvement, but that’s only part of the story. Assume that you retire now. And your existing final salary scheme is actually able to pay the scheme pension calculated by the actuary (this is a big question mark in itself!). That pension is likely to be in the order of £4,350 a year, or £362 a month. This is based on a comparison with an annuity purchase for a 65 year old man, inflation proofed, 50% spouse pension and increasing with inflation. Note that there are sometimes special provisions and guarantees in your final salary scheme which entitle you to more than this, it’s a matter for your professional advisor to consider and discuss. However, for the moment this is the best assumption we can make. On the other hand, if you had achieved greater growth through moving to a defined contribution scheme and investing in high performance assets, your fund is now worth £317,000. The benefit doesn’t stop when you retire, because now you can take the income instead of leaving it behind for the fund to grow. So you have 8% a year income to ‘play with’. Let’s assume you leave 2.5% behind in the fund, therefore allowing it to grow with inflation. You can draw 5.5%. On your new fund of £317,000 this is an annual income of £17,435, or a monthly income of £1,452. Let’s summarize the position At the risk of being boring, on the basis of the assumptions we have made, you have the option of: A) Staying with your existing scheme – having a pension of £362 monthly and NIL fund B) Move to a high performing Defined Contribution scheme – having a pension of £1,452 and a fund of £317,000! I couldn’t make it more clearly than this. Just looking at the financial impact of owning your fund and improving investment performance makes a dramatic, even life changing, difference! Option Stay with final salary scheme Move to defined contribution scheme Starting fund size £100,000 £100,000 Years to retirement 15 15 Growth 2.5% 8% Fund at retirement £145,000 £317,000 Monthly income £362 £1,452 Fund you ‘own’ NIL £317,000
  14. 14. 14 MAKING A PENSION TRANSFER TO A DEFINED CONTRIBUTION SCHEME BRINGS PENSION FREEDOMS, THE RIGHT INVESTMENT STRATEGY CAN RESULT IN A HIGHER FUND VALUE AND INCOME IN RETIREMENT I’ve covered a lot of ground about the challenges facing final salary schemes and the new pension freedoms available to people with defined contribution schemes. Moving your pension from one to the other may resolve many of the issues and provide new options and benefits not available to you within your final salary pension. That’s only half the story. If you do switch, you will be faced with making the right investment choices going forward. By ‘right’, I mean those that match your current age and planned retirement date, attitude to risk and expectation of return and more. This report is not the place for a detailed discussion about investment options. My views are expressed clearly in my Special Report “Property As You Pension”, which not surprisingly champions property (within strict guidelines) as a key component of a long term investment strategy. “We expect investments available within our portfolio to deliver 6% to 12% net annual income/growth – consistently year after year” We expect investments available within our portfolio to deliver 6% to 12% net annual income/growth – consistently year after year. Compared to the historic uncertainty of returns from shares and the exceptionally low income from fixed interest securities using property as an investment strategy can be transformational. The key element in this report is to understand that if you want to make the very best of your retirement, and you are in a final salary scheme, there are two elements to consider: a) Transfer of fund, and b) Selection of the right investment strategy To learn more, please request ‘Property As Your Pension’. Register at www.avantiswealth.com as an ‘Access All Areas’ Member (free of charge) and you will have access to all our Special Reports and more.
  15. 15. 15 REASONS TO KEEP YOUR FINAL SALARY SCHEME 1. You are ‘rock solid’ certain that the company will be able to contribute to and then pay your pension maybe 20, 30 or 40 years in the future. You are confident that it provides a level of certainty above that of defined contribution schemes. 2. You don’t have beneficiaries who you wish to provide for, but are solely focused on your own income. 3. You don’t want to take any interest in, or responsibility for, your pension investments. 4. You don’t believe you can beat inflation with a different investment strategy, then one of the biggest benefits of a defined contribution scheme is neutralised. 5. You have such a large pension fund that achieving better growth is simply not important. 6. It’s not important to you that you have access to your pension fund above the tax free cash lump sum. 7. You are close to retirement and there aren’t many years left to improve the investment performance of the fund (but you would still benefit from owning the fund within a defined contribution scheme and maybe improving your pension with what you have). 8. You consider that the risk of choosing a more adventurous investment strategy outweighs the possible benefits of improved income. 9. You have been told by your employer there is a substantial reduction in fund value by transferring out and the benefits of doing so are not strong enough to outweigh this. CASE STUDY One client works for an airline as a highly paid pilot. The airline pension scheme was hugely in deficit (more than 50% shortfall) and there was serious potential for it to go out of business. The pension protection fund would not have paid anything like the actual pension that was due, because of the ‘cap’ on total payments. The shortfall could have been more than half the anticipated pension. The pilot was offered a pension transfer fund value of 60% below the calculated value. But the transfer was still considered worthwhile because it secured the future of at least part of the fund. And with the years to go to retirement, an aggressive growth strategy for the fund meant there was a good chance of rebuilding the ‘lost’ fund value in coming years. This is an exceptional story, but played out in less extreme circumstances every day as people consider what are relatively complex options, where nothing may be perfect.
  16. 16. 16 REASONS TO MOVE YOUR FINAL SALARY SCHEME TO A DEFINED CONTRIBUTION SCHEME? 1. You want to take control of your pension and have a say in investment choices and how your pension is structured. 2. You are concerned that with the increasing deficits in final salary schemes, your employer may not be able to support the pension scheme perhaps for the next 30-50 years! 3. You are concerned that if the employer defaults and the pension protection fund takes over the scheme, the benefits due to you may be further restricted in the future. 4. You want to withdraw a greater part of your fund, or even all of it, above the tax free lump sum. 5. You believe you can achieve better than inflation growth through different investment strategies (for example, with property-backed assets that typically return 7%-15% pa). 6. You want to provide a legacy for your children, family or other beneficiaries. If you die before the age of 75 this would be tax free! 7. You want your spouse to receive the full benefit of the pension on your death, rather than the 50% ‘widows’ pension sometimes offered by final salary schemes. 8. You want to take ownership of the pension fund for the future, whether you choose to withdraw it, use it for luxury items, keep it as a rainy day fund, use it to ‘top up’ income from time to time or leave it as a legacy. 9. You like the idea of protecting part of your estate from inheritance tax. 10. You want more flexibility of when and how much income you choose to take. 11. In the future you may consider moving abroad, and an offshore pension may be appropriate for consideration now. 12. You have a lifestyle or medical condition that may mean you have a shorter life expectancy than average. If this is the case it may be very beneficial to move because your beneficiaries would inherit your total fund. Within a defined benefit scheme the full value will be lost on your death. 13. You haven’t retired yet, your pension is ‘frozen’. And you understand the laws which means that in a failure the pensions in payment (for people already retired) get first call on ALL the money in the fund, including that allocated to you. Wow! Scary stuff. More about this in the next section. 14. You live with a partner but are not married. Your partner will not benefit from a spouse’s pension which is payable under the final salary scheme, but could be made a beneficiary under the defined contribution scheme. 15. You may be offered an ‘enhanced value’ by your employer to move. Many employers are desperate to get existing members moved out of the final salary scheme and will provide fund transfer values in excess of the actuarial calculation. 16. Of all the times to consider moving, now is excellent. Why? Excuse me if this explanation is a bit technical but it is important. a. The value of your final salary lump sum is theoretical. It is calculated as the capital sum needed to provide the assumed pension you are entitled to receive at the point of leaving the scheme. b. Because interest rates are so low and investment performance so poor in the mainstream pension sector, the capital sum needed to provide your benefits is at an all-time high! c. The capital sum is calculated as a multiple of the pension it has to provide. Everyone calculates it differently, but it wouldn’t be surprising for the multiple to be 30X, or even 40X on occasions. In ‘real life’ that means if you are entitled to a pension of (say) £5,000 a year, your fund value could be as much as £150,000 or even £200,000. d. And with this fund, invested in high performance assets, you could be achieving an immediate higher income of double or more what your final salary scheme will offer! e. One word of warning. Schemes in deficit (most of them!) often have the right to reduce the value of your fund on transfer. So it is possible you may face a penalty if you did decide to transfer. Depending on the level of penalty, it may still be worth moving.
  17. 17. 17 RISK AND REWARD If you are going to consider transferring a final salary scheme the issue of risk will be one of the critical factors. If you consider risk in the established sense, then for clients not willing to consider any risk at all, the return in recent years has been… wait for it.. below zero! Why so bad? Because the only investments that are considered to be approaching ‘risk free’ are fixed interest deposits guaranteed by the Government, and Government Bonds, both of which have returned an income of below inflation. So the inflation adjusted return for risk free investments has been less than zero. I don’t know about you, but in saving for retirement this is simply not an acceptable solution. The reality is that you will have to go up the risk ladder, if you expect to achieve a positive return. “The reality is that you will have to go up the risk ladder, if you expect to achieve a positive return.” When I talk to clients I find out, most of the time, that their understanding of risk is rather sketchy. In many cases their view is very black and white. Either something is risky or it is not. This view just doesn’t reflect the complexity of the real world. For example, there is a widely held view that to achieve great returns, you have to take great risks. At Avantis Wealth we don’t necessarily agree with that. We think that the risk-return relationship can be changed, in the investor’s favour, by bringing into the equation such factors as proper security over the investment, contractual income returns and more. In the special report ‘Property As You Pension’, I cover the issue of risk and risk mitigation extensively and I recommend you read the relevant chapter as it will help inform you about the key issue related to risk management. In the meantime, the starting point for risk assessment is to consider your existing final salary scheme and consider what risks you run by staying where you are. These risks are of two kinds: 1. Intrinsic risks in the pension scheme itself, like a future inability to pay the full pension, or in extremis, nothing at all! 2. Risks of losing a better return or more flexibility or a legacy for your loved ones, by not benefitting from the possibilities within a defined contribution scheme. Whatever you might want to happen, the reality is that life itself is a risk, and pension schemes also contain risk. How you understand and manage those risks is what matters. If you are like most of the population you have never considered your pension scheme in much detail, and the information in this Special Report may be shocking to you. Equally shocking may be the fact that pensions are a risky business! However, now you have the ability to learn, understand and make good decisions about risk, reward and the achievement of your goals. WILL YOU BE ALLOWED TO TRANSFER EVEN IF YOU CHOOSE TO? You may think this is a strange question. The Government has introduced new freedoms that enable you to take up to 100% of your fund from a defined contribution pension. You have a statutory right to transfer your fund from a final salary to a defined contribution pension. Problem solved. “You have a statutory right to transfer your fund from a final salary to a defined contribution pension.” Only it isn’t. And this is where I get extremely concerned and upset. At the same time as allowing these new pension freedoms, the Government is naturally concerned that people – that’s you – make sensible decisions. And because pensions can be complex, we can’t be trusted to make decisions by ourselves. So whilst providing these new pension freedoms it will be a legal requirement from April 2015 that any pension transfers from final salary to defined contributions, with a fund value of more than £30,000 (almost all of them!) will require fully regulated financial advice prior to transfer.
  18. 18. 18 This is where the problems start. Let’s consider the issues: Cost Taking fully regulated financial advice on the pension transfer is likely to cost a minimum of £1,000 and most probably more. Plus the advisor may wish to charge an on-going annual fee for ‘advice’. You may not wish to incur these costs. Willingness to act Advising on a pension transfer requires a special level of competence according to the Financial Conduct Authority. There are about 20,000 regulated IFA’s in the UK but only a small number are qualified to provide pension advice. Just finding one isn’t easy. It’s not just that there aren’t many. For years IFA’s have been trained to believe that Final Salary pensions are the ‘gold standard’ and not to be touched. Even the analysis tools they use to compare a final salary scheme with a defined contribution scheme are skewed in favour of a final salary scheme. So many of the qualified advisors will simply not want to get involved. They face big risks if they give advice which years later turns out to be wrong, for what they see as a relatively small reward. Problems with investment strategy I’ve discussed above the importance of not just transferring to a defined contribution scheme but looking at investment strategies that can deliver higher returns. In my world this means property backed assets that meet specific criteria. Hardly any IFA’s know, understand and are willing to advise on property investments. In fact their PI (professional indemnity) cover may preclude them from doing so. What happens when they say ‘no’? Let’s assume you’ve overcome all the hurdles above, found an IFA who is willing to advise on the pension transfer and your investment strategy which now includes property. They do a detailed fact-find, and present the findings. Their recommendation is not to move, and they will have some very clever reasons why not. Based on their own set of criteria for risk management, which you don’t agree with. Now what happens? This is where the Government and the financial services industry go head-to-head. The Government says that you have the RIGHT to the transfer. If you have taken financial advice and you choose to ignore it, that’s your right. But the pension schemes, by-and-large, won’t accept a transfer where the advisor has said ‘no’. Stalemate! In the past this situation has been dealt with by the clients writing an ‘insistent client letter’ to the advisor thanking them for their advice and insisting that they go ahead with the transfer. But the current professional press is full of feedback from irate financial advisors who say they are simply going to refuse to act on insistent client letters, and will refuse to support your transfer case if their conclusions are negative. This is where I get very angry and upset. Financial advisors are not omnipotent, applying their own judgements about the situation to OUR lives. As a Chartered Accountant I question many of the beliefs they hold about risk and reward. For example, I believe that investments backed by property as security is inherently less risky than share investments. That view is not shared by most financial advisors. The bottom line is that you may find, after a lot of thought and a decision to transfer your fund, that making it happen is not at all easy. My company, Avantis Wealth, can refer you to appropriate advisors who understand the full range of investment options and can advise in a holistic way. “You are likely to need to be determined, focused and single minded to make a transfer happen in the current climate” You are likely to need to be determined, focused and single minded to make a transfer happen in the current climate that has pitched the Government and our basic rights against the established views of the financial services establishment.
  19. 19. 19 SUMMARY The whole issue of final salary schemes is hugely problematic, relatively complicated and extremely important to understand. No longer are final salary schemes the ‘gold standard’ of old. They have numerous risks attached and the lack of flexibility and choices means that most people in a final salary scheme can’t benefit from the new pension freedoms. If you are in a final salary scheme it is in your interest to consider what you should do. This report, as mentioned at the beginning, is absolutely not advice to take any specific course of action, which can only be decided in consultation with a fully regulated advisor. Hopefully I’ve covered all the major issues surrounding final salary schemes, the problems and the opportunities. So you are now better equipped to decide what is best for your own future. “For many people, a good starting point is to request a pension review.” For many people, a good starting point is to request a pension review. You’ll find out all the essential information about your pension, current values, predicted outcome and much more. My company can organise a complimentary review that will be carried out by our preferred IFA. As always I’m welcome feedback and/or your questions. Email rod@avantiswealth.com and you’ll get a personal reply.
  20. 20. 20 Next Steps Thank you for reading this Special Report. I hope you have found it interesting and valuable. Gemini Business Centre 136-140 Old Shoreham Rd Hove BN3 7BD United Kingdom 01273 447 299 0800 612 0880 invest@avantiswealth.com www.avantiswealth.com Contact details If you have any questions about your final salary pension please email me: Rod Thomas, rod@avantiswealth.com I will always reply personally. If you have understood and find resonance with the concepts and ideas shared in this Special Report, it’s time to take action. This is what my company, Avantis Wealth, can offer you: Do you have a frozen or underperforming final salary or other pension? Then request a complimentary pension review. This will show you: • Value of your fund • Performance over the last 5-8 years • Fees and charges you are incurring • Expected income in retirement Armed with this information you can explore options to do better. CALL OR EMAIL US NOW! Want to build your fund for the future, achieving maximum growth? Whether you wish to invest directly or through a pension scheme, our investment portfolio offers a wide choice of investment type, location and timescale: • Investments typically from 1 to 5 years • Returning up to 12% annually, or 60% over 5 years • Investment starts at £10,000 CALL OR EMAIL US NOW! Want to invest for income now? Do you have poorly performing investments and need to generate the best possible income right now? Then consider investments within our portfolio which offer: • Up to 12% annual income • Payable quarterly, six monthly or annually • Investment starts at £10,000 CALL OR EMAIL US NOW!
  21. 21. 21 THE RICHER RETIREMENT SPECIALISTS DISCLAIMER Avantis Wealth Ltd is not authorised or regulated by the Financial Conduct Authority (FCA). Avantis Wealth Ltd does not provide any financial or investment advice. We provide a referral to a regulated advisor who will offer appropriate advice, or to the company offering an investment who will determine your suitability for the investment prior to any offer being made. We strongly recommend that you seek appropriate professional advice before entering into any contract. The value of any investments can go down as well as up and you might not get back what you put in. You may have difficulty selling any investment at a reasonable price and in some circumstances it might be difficult to sell at any price. Do not invest unless you have carefully thought about whether you can afford it and whether it is right for you and if necessary consult with a professional adviser in accordance with the Financial Services and Markets Act 2000. These products are not regulated by the FCA or covered by the Financial Services Compensation Scheme and you will not have access to the financial ombudsman service. Information is provided as a guide only, is subject to change without prior notice and doesn’t constitute an offer of investment. Some investments may be restricted to persons who are high net worth, sophisticated or professional investors or who take independent advice from an authorised independent financial advisor.

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