Pensions News Bulletin June 2015
1. Salary Sacrifice Sacrificed
Although not certain, it should be expected that the salary sacrifice arrangement for pension contributions (also called salary exchange) will be abolished in the chancellor’s July 8th Budget. This has been on the cards for some time as it costs the treasury up to £5 billion a year in lost employees and employers national insurance contributions. A figure that would increase as more auto enrolment pension schemes use salary sacrifice for their contributions – as they are often advised to do.
Considering the government’s priority in reducing spending you would have to wonder why they wouldn’t target salary sacrifice. It was never a planned pension policy at all, but a loop hole discovered and exploited many years ago to which HMRC were pretty relaxed.
It would be messy in PR terms to cease salary sacrifice where pension schemes are already utilising it and would result in employers paying additional contributions, where the scheme minimum is paid by this method. However it’s not technically difficult to remove it on current schemes and that would result in the most useful savings. If the change applied to only new schemes, or new usage in current schemes, the saving would be small for years.
If salary sacrifice is to be abolished on existing schemes then it will be particularly important to set out the delivery plan early. We will need to consider the employee communications and to notify people well in advance. The new pension contribution and payment arrangements must be planned and communicated. Liaison with the payroll provider and pension scheme will need to happen in good time and members perhaps given an option of paying less contributions (subject to auto enrolment or contractual minimum). In some cases the employer and employee contributions could be restructured to make the best of the situation. There are many other details to consider such as pension booklets and member websites, but there is only one difficult aspect about this project so long as employers and pension schemes ensure it’s well thought through and delivered properly. The one difficult issue is employee relations and that is easier the earlier the appropriate engagement starts.
2. How Ready is the UK for Retirement (NOT!)?
A report by Aegon published in May illustrates how prepared people feel for a retirement at the standard of living they desire. Although only 16% feel ‘very confident’ about retiring at their target retirement age, just 7% of the population are on track for the retirement they want. Aegon are disappointed with the fact that this hasn’t changed since the previous years report but they shouldn’t be. It takes a long time and particular interventions to change people’s attitudes to something as untrendy and out of mind as long term savings, and being able to assess living as you want decades in the future.
The report found that people’s retirement income expectation was around £42,000 a year on average. Presumably those questioned would have had no idea that this would need an accumulated pension pot of, in the region of £800,000 given the best possible income friendly economic conditions at retirement. Lets say £1m to be on the safe side! Should people know this or not? Employers are in the prime position to provide this engagement through their HR strategy.
There is a behaviour that makes people give up if they believe they have an impossible goal ahead. However on this subject with the right approach a positive behaviour will be introduced which moves people on an alternative path that gets them closer to their goal. And just as importantly allows them to evaluate their choices properly.
Its interesting comparing this report with Barclays 2014 report, ‘Steps Towards a Living Pension’, which found in research with Defined Contribution pension scheme members that a UK living pension would mean an income of about £17,500 a year on average. This research found that people, when engaged in discussion on the subject, had more modest ambitions. This report sets out a series of useful nudges that work with pension scheme members.
Of course the aims of each research project were different and the process and questions were targeted differently. Assessing both gives an insight into the behavioural challenges that must be surmounted, if we are to enable the UK population to put itself into a position where a majority rather than a minority can afford to retire at all.
You can download Aegon’s UK Retirement Readiness Report, called the third UK readiness Report, from their website and request Barclays ‘Steps Towards a Living Pension’ report from Barclays Wealth and Barclays Corporate and Employer Solutions.
3. Investment jargon – introduction to Skewness and Kurtosis
With the increase in frequency of large swings in investment returns that we’ve had over the last few years there has been an increased analysis and commentary of “tail risk”- those extreme financial, political or economic events that have a larger than expected effect on an investment. The measurement of these effects over the regular measures of standard deviation and volatility for normal conditions are “skewness” and “kurtosis”.
These are complex mathematical and statistical concepts but here I’m only attempting to give a layman’s insight, so that we can intuitively understand what’s being said or read and be able to ask a relevant question of the presenter.
Skewness and Kurtosis are statistical descriptions of the distribution of results (e.g. investment returns or asset prices), allowing you to make sense of past results and provide an insight to future risks (assuming everything remaining equal). They are compared relative to the ‘mean’ (average) of the data results.
Skewness is a measure of the lack of symmetry in the data. It measures how unevenly the data is distributed. See Figure 1. Applied to investment returns, if the peak of a distribution chart is to the right, the data distribution is ‘negatively skewed’, illustrating frequent small gains and a few extreme losses. If the peak is to the left the distribution of outcomes is ‘positively skewed’, meaning a few extreme gains and frequent small losses. If the data points produce a symmetrical chart you can expect gains and losses to even out and there is zero skew.
Kurtosis describes the sharpness of the peak in a data distribution chart and is a measure of whether the data results are peaked or flat relative to a normal distribution. See Figure 2. It is said that Kurtosis describes the volatility of volatility. It measures where the volatility comes from in an investment. Is the volatility driven by a few extreme events or is the volatility “spread out” over the full range of a distribution? If looking at historic investment returns the sharper the peak the more likely that future returns will exhibit higher or lower extreme positions – everything else remaining equal. A low or negative Kurtosis expresses the likelihood of no shocks.
Thanks to Investopedia for the charts.
Thank you for reading.