Today’s edition of Pensions News (PN) opens with a question; do you, the reader, play or have you played the lottery or something similar?
Not very long ago, a debate took place in PN’s household. The debate related to a lottery in which the main prize was either £1m in cash or an annual income of some £46,000 (net) paid for the remainder of one’s life. PN was asked (by his wife and daughters) which prize he would opt for if he won this particular prize. After stating that he was not likely to win either has he had not entered the competition and did not intend to enter it either, PN said that given the choice, he would opt for a guaranteed annual income. PN’s choice was greeted with snorts and exclamations of derision by his nearest and dearest and you, the reader, may be reacting in much the same way - just make sure that, if you are going to snort, you don’t have a mouthful of coffee which then makes its way onto your neighbour. You may be thinking (as PN’s family did and does) that a lot of cash “now” is better than less cash but often. How one answers the question that PN was asked says a lot about one’s attitude to risk and, ultimately, one’s approach to pensions. Don’t answer the question just yet.
During the domestic debate referred to, PN was told that he, PN had made a grave error in opting for an annuity. A large amount of cash now means one can take advantage of it now. PN answered that, unfortunately, it also means that one can spend/ lose the lot now. PN was attacked with the proposition that, if he elected for the annual income but then went under a bus, the guaranteed income would be useless. PN countered with the observation that a million of our British pounds would be equally useless to the bus-squashed victim. By this time however, the assembled members of PN’s family were busy arguing over how they would spend the lump of cash they had not yet applied to win.
The above debate is analogous with the position that many people have found themselves in when it comes to pensions and retirements. In short; do they want cash now or an income? Up until a few years ago, the question had been answered for them and many individuals resented this. Up until recently then, those who saved for retirement through a personal pension scheme (or a similar money purchase/ defined contribution (DC) arrangement) were required to purchase an income with the bulk of the money they had saved (they could take a quarter of it as a cash lump sum). There were significant problems with this system which included (i) its inflexibility (ii) the fact that insurance companies selling annuities knew they had a captive audience and could influence the price of an income / annuity (iii) linked to (ii), as human beings were living longer, the business of selling an income was more risky therefore the price of purchasing an income in retirement through an annuity became still more expensive. The “old” system was deeply unpopular in some quarters – particularly those who had saved more than (let’s say) an average amount of money.
Those individuals lucky enough to participate in pension schemes which provided benefits on a salary-related or “defined benefit” (DB) basis were unaffected by the system described above since their income in retirement was largely guaranteed by the schemes they were lucky enough to be members of (unless they were unlucky enough to be members of a scheme which wound up in deficit before they had had time to retire). Readers will be aware that, in this country, the number of DB pension schemes has been diminishing steadily over the years and that stories about the decline of some of the larger ones have featured in previous editions of PN and, apparently, the national news on television with “experts” wheeled out to give their groat’s worth of opinion on what was going on. Like all DB schemes, the newsworthy ones had been established on the principle that, once one attained a certain age, one was paid a certain benefit (a pension) which was calculated with reference to the individual’s pay at retirement age and the number of years the individual had been a member of the pension scheme. The pension was payable for life.
As PN has also reported in previous editions, the Government has introduced what have been referred to as “pension freedoms” over the last few years. These so-called freedoms permit, amongst other things, individuals to take the entirety of their pension savings as cash - less tax. Put differently, the cash now or income question was made into a choice by operation of law meaning. The “freedoms” were / have been largely welcomed by those who were frustrated at the rigidity of the previous system. They have also largely been welcomed by Her Majesty’s Revenue and Customs (HMRC). You, the reader, may have paused at this point to wonder at the value of “cash now” to an individual where HMRC has welcomed it as a good idea. It has become clear that the principle of “cash now” through so-called pension freedoms extends beyond the individual to HMRC as the treasury takes its cut of people’s savings where they take the cash.
The advantage of or the problem with (depending on one’s approach to such issues) DB pension schemes is that they are designed to pay a pension meaning that they are not designed to be transposed in their entirety into cash (less tax). This means that a member of a DB scheme who wants cash now (this would include all members of PN’s family but not PN) would need to transfer the value of their DB pension into another pension scheme or arrangement. That arrangement would then permit the individual to take advantage of the so-called pension freedoms.
The so-called freedoms have, predictably, increased the demand for "cash now”. This demand has created an unwanted supply of fraudsters ready to take advantage individuals through the sort of Nigerian Scam Email Mark II in which one is asked to hand over all one’s savings in return for the promise of "cash now" (or at least nearly now). Put differently, the law of unintended consequences has meant that the introduction of the so-called pension freedoms has somehow coincided with an exponential rise in the value and number of pension scams.
Writing in the Financial Times on 30 September/ 1 October, Ms Josephine Cumbo noted that the Work and Pensions select committee has confirmed that it will “examine transfer activity in ….defined benefit pensions, which has mushroomed in recent years….. An estimated £50bn has flowed from company defined benefit schemes over the past two years as savers have been tempted by historically high transfer offers”. Concern has been growing at the proportion of the money being transferred out of DB schemes which is falling into the hands of those behind the scams - leaving savers with no retirement income but a tax bill for taking an unauthorised payment from their pension plans.
Generally speaking (meaning there are exceptions) companies which sponsor DB schemes have not wanted to stand in the way of members wishing to transfer the value of their benefits from a DB scheme. This is because once a member has transferred the value of his/ her benefits out of the DB scheme, the obligation to pay him / her disappears from the scheme itself. This is how or perhaps why relatively generous transfer values have been on offer from some DB pension schemes. The problem (of course) arises where the DB member in question unwittingly transfers the value of his or her rights to a guaranteed income to the sort of arrangement favoured by the writer of Nigerian Email Scam Mark II or, in fact, any email which starts off with the word “congratulations!”.
The select committee is going to look at the “new freedoms” to see if anything should be done in order to protect vulnerable savers from the sort of person who congratulates one for being able to have one’s pension “unlocked”. PN hopes that the committee will decide that something needs to be done because we are, in reality, all vulnerable to the sort of person who offers cash now and, in so doing, queries the value of a regular income. This means that today’s debating point, once you, the reader, have dealt with the choice of tea or coffee for breakfast and then porridge (slow burn energy - makes sense) or an almond croissant from the nearby Italian bakery (tastes better - forget all that nonsense about making sense), is this: given the choice of a guaranteed income for life or a lump of cash, what would you go for? If the latter, watch out for Nigerian Scam Email Mark II and/ or anyone ready to congratulate you on the opportunities your choice has given you. If the former, perhaps a career as a pensions lawyer beckons. Perhaps, like PN, you feel that cash now is not necessarily a good thing – better for someone else to hang onto the cash and pay it to you at regular intervals. Whatever your choice, better keep it to yourself. There is certainly no need for PN to know.
Until next time.…..