Newsletter – February 2015


News Bulletin February 2015

Are you ready for staff to cash in their pension from April?

From April the Taxation of Pensions Act 2014 allows employees in DC pension schemes to access their pension fully as a single payment or by a series of ‘cash’ payments and confirms that an annuity need not be taken. Since this was announced in the March 2014 Budget thousands of people have been holding on, not retiring or not starting their pension, in the belief that they can cash out in a few weeks’ time.

Is your business ready for this? Not many are. So as finance or HR practioners (the majority recipients of this newsletter) what will you be saying to staff who want that and ask?

The choice applies directly to DC scheme members and indirectly to DB scheme members. Many schemes have not completed their arrangements to deal with this. Even more have not communicated them. Do you know what your provider is doing? The usual method of avoiding an annuity and going for cash is by the member transferring to another product at significant cost. This was accepted when it applied to the few retirees with large pension pots but this won’t be what the majority of members expect.

Arrangements can be made to offer drawdown within a workplace pension scheme but this can’t happen overnight. Who’s looking at this in your company and speaking to the provider about process, cost and communication?

The employer won’t want disgruntled employees complaining that the chancellor said they can cash their pension but the pension scheme isn’t allowing it or is encouraging high cost transfers to a different product to achieve it.

At the very least appropriate management staff need to be ready and expectations need to be managed.

Another issue is around DB pension scheme members who will want to cash their pension but must transfer to a DC scheme to do so. This can result in overall financial detriment to the employee plus, if many go this route, it could reduce scheme assets significantly setting back funding plans and de-risking arrangements.

The pensions regulator recently published consultation guidance for DB trustees which can be found here:

DB to DC transfers and conversions

Major points include the requirement …

  1. to inform members clearly of the choices available to them.
  2. for the DB scheme member to take regulated financial advice and evidence that to the trustees in applying to transfer. The trustee doesn’t have to know what that advice was or if the member is complying with it.
  3. for the trustee to be aware of the transfer value implications on the scheme and take steps to ensure risks are not heightened – which may mean asking for more time to calculate the transfer value and reducing the amount to be paid.

Further guidance is being published in March.

Post April don’t forget the potential tax implications for employees cashing their pension beyond the 25% traditional tax free amount. They will need to know this or many are in for a big shock. This will be covered in a future newsletter

2. Under 250 employees auto enrolment should be eased.

Auto enrolment has gone okay so far – not as good as you’ve heard, as Myth 1 in the next article explains – but companies going through the process earliest have been the biggest, best financed, and most likely to already have a pension. They have also had the opportunity of paying the lowest mandatory contributions for longest.

The mandatory employer contribution is only 1% until October 2017 when it goes up to 2% and then a year later rises to 3% where it remains unless legislation changes. On the employee side the mandatory contribution moves from 1% to 3% in October 2017 then to 5% from October 2018.

There is a wall of influence pushing to get the combined minimum from the 8% to 12% to improve pension outcomes but the Association of Consulting Actuaries (ACA) suggest in their Smaller Firms Pension Survey that contrary to increasing the contributions the next government should ease the burden on smaller employers. They show in their report that the increases for smaller firms could cause them financial stress and point to a large increase in opting out amongst the generally lower paid who make up a higher proportion of employees in this sector.

The report shows that although over 37,000 larger employers have auto enrolled around 5 million new employees into pensions, there are still over 1 million smaller firms with over 7 million employees to go through the process. As most will not do so until 2016/17 they will very quickly be required to pay the 8% combined contribution rate.

You can read the report here:

The steep path ahead

3. Dispelling 4 Myths.

Over the next four newsletters enjoy these myths exposed.

Myth 1     Auto Enrolment was better than expected in its first year.

The UKs biggest companies started going through the pension auto enrolment process from June 2012. The staging dates are monthly by company size. Largest to the smallest from 2012 to 2018 respectively. Early in 2014 I saw a quote attributed to Steve Webb (Pensions Minister) which said something like .… It was expected that employees opting out of pension saving would average 30% yet after the first year of auto enrolment only 10% have opted out…. this is a sign of auto enrolment’s great success.

Since then this error has been repeated by ministers, pension and financial experts and throughout the media. I suspect it has even driven policy.

What the pensions minister wouldn’t have realised, and no one obviously advised him, was that the 30% average opt-out assumption was the estimate for the complete period of auto enrolment introduction – that is from 2012 to 2017/18. It was estimated (for very good reasons) that the largest companies would likely have an opt-out rate of 10% and the micro companies an opt-out rate of around 50%. In a very rough way we then expected the average overall to be about 30%.

Therefore auto enrolment in the first year went exactly as expected, no better no worse. Interestingly the association of consulting actuaries who gathered information in August 2014 from companies with under 250 employees, who had passed their staging date, reported the median opt-out rate of 11 to 15%. At a guess, now in Q1 2015 I wouldn’t be surprised if opt-out was running at 15 to 20%.

Read the next Myth in March.

4. How to recognise if your fund manager has done a good job.

Most people are pleased if their pension fund has risen in value and upset if it’s gone down. However the fund management industry and investment consultants are more interested in ‘relative performance’ than absolute performance. That is, how the fund has performed compared with how similar funds have performed.

For example, if the fund in question has risen by, say, 7% but in its peer group of similar funds the middle performing fund, or the benchmark index, increased by 9%, your 7% is shown to be a poor result. Even if you were pleased with 7% once you know what a fund of that type should have made you have cause to be disappointed. Questions should be asked of the fund manager or consultant so you can understand why it lagged behind its sector. What are they doing about that for the future?

Conversely if your fund went down by 7% but in its peer group the middle performing fund, or benchmark index, lost 9%, your fund performed better relative to its peers or its benchmark because it lost less.

This is one way that company pension managers and trustees monitor their fund managers and it is part of the decision making process when hiring or firing managers, or changing funds in the scheme’s fund range.

It is very frustrating when your fund has lost money and the investment manager or adviser says they have done well, but what they mean is relative to what similar funds have done over the same period.

There are a number of statistics used in fund management presentations and on fund fact sheets which if understood would help to explain why the funds are performing as they are, and how well the fund manager is contributing to good or bad performance. For a fund rising in value the fund manager may not be adding any of that value if it can be shown all the increase is coming from a rising market. If you were paying active management fees you would not have been receiving value for those fees and you may want to consider switching to a passive fund or identifying if the fund manager can make the improvements you need. This is the knowledge that can be gained by understanding some of the fund management ratios. Here is the first in a series of four of the most useful:


The strange sounding ‘R squared’ is an indication of how closely correlated a fund is to a benchmark. Treated as a percentage it indicates what proportion of a fund’s movements can be attributed to those of the benchmark. Values for R-Squared range between 0 and 1, with 0 indicating no correlation at all, and 1 being a perfect match. Values upwards of 0.7 suggest that the fund’s behaviour is increasingly closely linked to its benchmark, whereas the relevance diminishes as R-Squared descends towards 0.5, and starts to disappear altogether below that.

R-Squared is a key ratio, in that other measures of a fund’s performance will have been calculated by reference to its benchmark so the weaker the R-Squared correlation, the more unsuitable the benchmark is, and the more unreliable these measures will be in assessing the fund.

If you ask your fund manager to provide the R squared you will be able to see if you are really getting performance numbers that mean very much at all!

Thank you for reading. Come back next time for more news and the next in the series of myths and investment ratios.