Early discussions with their employer can make employees’ transition towards retirement a smooth and rewarding journey.
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- The number of workers over the state pension age is increasing.
- Early discussions about retirement will enable employees to be better prepared when the time comes.
- Age discrimination rules mean communicating with staff about retirement must be done with care.
- Ensuring staff get the right annuity product is crucial to their future financial wellbeing.
The mechanics of transitioning staff from work to retirement have changed beyond recognition in the past 30 years. A generation ago, employers had to do little more than put employees in contact with the trustees of their final salary pension and arrange the office collection. These days, HR professionals face the challenge of navigating older staff, many of whom have inadequate defined contribution (DC) benefits, through the tricky waters of age discrimination legislation and on into the next phase of their life.
For employees in DC schemes, managing that process in the most efficient way can have a big impact of the level of pension they end up receiving.
Longer lifespans are stretching the ages to which workers are able, and want to, remain economically productive. Meanwhile, low levels of pension provision across the UK are forcing employees to stay in their jobs later in life. These two factors, combined with legislation prohibiting age discrimination and promoting phased retirement, where individuals move from full-time to part-time work before full retirement, have had the effect of increasing the number of older workers.
This transformation of what ‘retirement’ actually means has led to a situation where 12% of people are working beyond the state pension age, compared with just 7.6% in 1993, according to the Office for National Statistics. Many employers find the expertise and experience of older employers valuable. But longer working lives can also create challenges for organisations when it comes to succession planning.
Also, many employees are looking forward to hanging up their boots, and want the process managed well. So speaking to employees early about their retirement plans benefits both organisations and individuals. Retirement planning experts recommend speaking to staff five or 10 years ahead of the time they expect to retire.
Jamie Jenkins, head of corporate strategy and propositions at pension provider Standard Life, says: “Interest in retirement workshops really starts to peak five years out from retirement. At that time, seminars with employees can talk about the sort of retirement each employee envisages.”
Discussions will focus on the age at which retirement will happen, how the employee’s projected income will meet their needs, and consideration of winding down through part-time work.
Key to these early discussions is helping employees to think about when they plan to retire, not least because, for DC pension plans, the retirement age they have notified to the scheme will have a big influence on the investment strategy their fund follows. This is because most default funds in DC plans operate a ‘lifestyle’ procedure, which gradually switches the employee’s assets from riskier equities into more cautious bonds and gilts as they approach retirement.
This lifestyle process generally starts between fi ve and 10 years before the retirement age selected. But if an employee in a scheme with a fi ve-year lifestyle programme has selected a retirement age of 65 but now plans to retire at 60, he or she will be in very risky assets right up to that planned retirement date. Should the markets fall 30% in the months before their retirement, as they did in 2008, the employee’s pension could be 30% less than expected.
Lifestyle default pension funds have come in for some criticism in recent years, and newer schemes may offer ‘target date’ funds, which manage the switch to more cautious assets by a specified year in the future. For example, someone aged 45 today may be in a fund targeting retirement in 2032, when they will be 65. As retirement approaches, that employee will still need to review whether 2032 remains their target retirement year.
Early discussions about retirement will also give the employee a realistic picture of when they are likely to be able to afford to stop working.
Steve Herbert, head of benefits strategy at Jelf Employee Benefits, says: “Engaging with staff 10 or five years out from retirement gives them the time to start putting more into their pension pots. People approaching retirement have often cleared their mortgage and may have more ready cash to put away, so maximising the tax relief available is an efficient strategy.”
But employers must tread carefully when it comes to discussing retirement planning with older staff if they are to avoid accusations of age discrimination. Walking up to a member of staff in their early sixties and asking them if they want to see a financial adviser about retirement planning could find the employer in breach of the Equality Act 2010, which sets out a general principle forbidding age discrimination.
Ed Goodwyn, partner at law firm Pinsent Masons, says: “In this situation, the employee would be able to argue a breach by the employer of the implied duty of trust and confidence, saying ‘you have given up on me because I am old’. The employee could claim constructive dismissal there and then, or, more likely, would save it for if they find themselves dismissed in future and bring out the accusation then.
“If the employee succeeds, damages for loss of earnings would be very substantial because the individual would be able to argue that his or her age makes it harder to get another job.”
The Equality Act effectively abolished default retirement ages in April 2011 in most situations. But court cases since then have set precedents suggesting that a default or ‘normal’ retirement age can be set provided it is objectively justifiable. For the minority of employers that are confident they have a robust, justifiable normal retirement age in place, there should be no problem in approaching staff about retirement planning. But for the majority that do not, more care must be taken in the way a pre-retirement conversation is approached.
Sarah Ozanne, partner at solicitors CMS Cameron McKenna, says: “Companies without a default retirement age must make preretirement communications part of the general information available to all staff, and is not targeted at someone on grounds of their age.”
Pinsent Masons’ Goodwyn adds: “As long as the discussion is in terms of helping the employee with retirement generally, whenever that may be, that is acceptable. But if the employer says ‘these sessions are only available to those aged 64’, it will be in trouble.”
Once employees in DC schemes get within touching distance of retirement, they face one of the biggest financial decisions of their life: how to use the pension pot they have built up.
For those with big funds, income drawdown will be an option. But for the majority, it will mean buying an annuity. But annuities vary widely, both in terms of the value they offer and the benefits they deliver.
Smokers and those with medical conditions can get more because of their shorter life expectancy, but even healthy people can usually do better by shopping around rather than staying with the pension provider with whom they built up their savings.
Buying an annuity is irreversible and getting it wrong can ruin years of good pension saving, leaving pensioners up to 30 worse off.
From March 2013, pension providers will be required to comply with a new code compelling them to highlight prominently the much higher income that enhanced annuities can give and direct individuals to places where they can get advice and information.
Those with large funds will be able to afford to see a financial adviser, but not everyone will. David Still, managing director of retirement income at Friends Life, says: “A lot of people with fund values of £20,000 or so should have an enhanced annuity on account of their lifestyle, but are not getting it, in part because they cannot afford financial advice.”
But there are ways employers can ensure their staff get a good deal.
Debbie Harrison, senior visiting fellow of the Pensions Institute at Cass Business School, says: “Currently, for many of those with smaller funds, an employer or trustee directs the member to a website run by an annuity specialist and leaves them to it. The problem with this is that the member may get good value, but the wrong type of annuity.
“A preferred option that is increasingly being adopted is for the employer or trustee to embed a generic advice process in the scheme by appointing a specialist adviser, such as Annuity Direct, The Open Market Annuity Service (Tomas) or The Annuity Bureau.
“That specialist adviser contacts the member and takes them through the annuity process. There is usually a cap on the amount of commission the adviser will take, and the deal is that the adviser has to take the smallest pots as well as the large ones”.
Checklist: What staff need to know to prepare for retirement
- Find out what money they will have coming in and how their pension will change.
- The Money Advice Service has an online budget planner. Individuals can get a state pension forecast and forecasts for personal pensions through the Direct Gov website.
- Get in touch with all their pension providers. For any lost pension, they should contact the Pensions Service through the Direct Gov website.
- Work out how much mortgage they have left to pay. They may be able to clear this with their tax-free cash lump sum.
- Claim the state pension, or consider deferring it in return for an increased pension/lump sum at a later date if they plan to retire later.
- Notify their tax offi ce. Pension coding form P161 should be completed to make sure the right amount of tax is paid.
- Check whether they are entitled to other state benefits.
At-retirement decisions: Role of the employer
The at-retirement decision-making process is a key element of retirement saving. The range of choices available and the decisions made will have a bigger impact on a member’s income than an employer’s efforts to reduce charges.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “Any employer that doesn’t ensure staff get a suitable at-retirement shoppingaround system might just as well pick their provider armed with a blindfold and a pin.
“There is no point in triple-bolting the front door of the pension scheme, diligently selecting a low-cost provider with low charges and a good default fund, if you then leave the back door wide open.”
Nigel Barlow, director of product development marketing at Partnership, says: “Such a service can provide a wide choice of providers, the ability to compare rates for individual circumstances, take advantage of medical and lifestyle factors and tailor and compare different benefi ts and their effect on the pension.”
Roger Breeden, a principal at Mercer, says that having paid signifi cant amounts into a pension, it would be ironic not to take the key final step of helping the member to ensure they maximise their income.
“The annuity market is rapidly evolving and the competitive position of annuity providers varies on a daily basis,” he says. Members need assistance to ensure they make the right decision: one that will be with them for the rest of their life.”
But when purchasing an annuity, rate is not the only factor to consider, says Matt Trott, head of annuities at LV=. “With alternative products such as fixed-term annuities, which can offer fl exibility in retirement, now available, it is crucial that customers are aware of all their options to ensure they purchase the solution that best suits their needs.”