Many staff face losing cash as companies fight to ease funding pressures, reports Jeff Salway
Workers in final salary schemes have been warned to tread carefully when offered incentives to transfer into less generous pensions despite a new ban on cash bribes.
Thousands of employees have agreed to sacrifice gold-plated pensions for alternatives that could leave them with an income shortfall in retirement. Many more pension scheme members are being targeted by firms desperate to ease funding pressures.
The government last week acted on fears over the tactics used by employers to entice workers out of their final salary schemes when it announced a ban on cash bribes.
Employers have redoubled their efforts to shift workers out of final salary schemes in recent years as the funding of the pensions has come under growing pressure.
The vast majority of private sector companies have closed their final salary pensions to new staff and most have closed them to existing members as the cost of providing the benefits has become untenable.
Now those firms are focusing on ways to lure workers out of final salary pensions, under which employers promise to pay an income throughout retirement that keeps pace with inflation.
They want to shift final salary scheme members into defined contribution (DC, also known as money purchase) pensions, where the outcome depends largely on the amount they pay in and investment performance.
The inducements offered to workers are part of “enhanced transfer value” packages designed to tempt them into agreeing a deal that may be against their long-term interests.
Some employers also offer “pension increase exchanges”, where retired employees are encouraged to give up annual inflation-linked increases to their pension in return for a non-increasing pension that starts off significantly higher.
More than eight in ten of those incentives involve a cash payment, according to the Department of Work and Pensions (DWP).
It last week launched a voluntary code of conduct featuring a ban on such cash bribes.
Fraser Smart, Edinburgh-based managing director of Buck Consultants, welcomed the ban.
“The cash incentives have often unduly influenced member decisions to their potential longer-term detriment,” he said.
The ban follows a warning from the Financial Services Authority (FSA) last year that some companies were using increasingly underhand tactics to get members out of final salary schemes.
Members were given too little advice and too little time in which to decide, according to the City regulator. It also accused employers of using complex transfer-out proposals that stack the odds heavily against the individual.
Only in a minority of cases do individuals benefit from incentivised transfers, according to the FSA.
But while the inducements are rarely worth accepting, the way they are promoted means many people take up the offer at the risk of leaving themselves at risk of lower incomes in retirement.
Last year the Pensions Regulator urged employers to ease the pressure on people being made offers and said they should pay for members to have financial advice while considering their offer.
So what should you look out for if your employer offers you incentives to leave its final salary scheme?
The first question to ask is, what’s in it for the employer; while the offer may seem attractive, the long-term costs are far harder to measure.
The problem is that in agreeing to move out of a final salary scheme, you’re waving goodbye to the certainty of a defined pension income.
With cash bribes banned, the decision will now be based largely on the enhanced transfer value (ETV), where the pension being transferred is increased.
If the ETV is chosen, then the pension becomes more flexible, but there’s also a lot more risk around the amount of pension you can expect in retirement. Crucially, however, that risk isn’t factored into the transfer value.
In leaving a final salary scheme you lose all future benefits, including guaranteed annuity rates that are becoming even more gold-plated as annuities plunge to new record lows.
Instead, you take on the risk previously borne by your employer and, post-transfer, will be at the mercy of investment markets.
“The main risks for the members taking transfer values is whether investments in the future do not perform as well as expected prior to retirement and, secondly, if annuity rates are expensive at the time of retiring,” Smart explained.
“Increased investment market volatility in recent years could be seen as increasing these risks.”
It also means having to take far more decisions over your pension – another factor that is not always made clear.
“Following a transfer the member will have to make choices on future investments, the timing of conversion of the fund into a pension as well as the style of pension at retirement,” said Smart.
To match the pension benefits being surrendered, you may find you need annual investment growth of 6 or 7 per cent a year. Some transfer proposals suggest this is a realistic expectation – but in the current environment it may well involve taking on extra investment risk with which you may not be comfortable.
The offer can be worth accepting in some cases, however, albeit a small minority.
For example, if you want to take control over your company pension, a DC scheme provides the flexibility to select your own investments.
There may also be a chance that you’re better off transferring out if you’re in ill health or have a lifestyle that qualifies you for an enhanced annuity. These pay out a bigger income than conventional annuities to those whose life expectancy is likely to be compromised. In some cases, this could provide a bigger income than the final salary scheme, but those instances are relatively rare.
So while there’s no guarantee that you’ll be worse off by accepting an offer to move out of your company’s final salary scheme, the chances are that you will be.
That’s why financial advice is considered absolutely essential in weighing up the pros and cons, said Smart.
“Having provided information to the adviser it is quite likely that if they recommend not transferring, then this is sound advice to be followed.”
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