The pensions reforms that have just come into effect are wide-ranging, and employers need to be on top of the changes to help their staff make the right decisions, writes Peter Crush
Here’s a question: how much would an average employee – one earning £25,000 per year – have to pay in tax if they decided to withdraw their entire £50,000 pension pot in one go?
“You can’t say ‘I don’t know’,” says Jonathan Watts-Lay, director, WEALTH at work. However, if your answer really is ‘I don’t know’ then as an employer you could be seriously remiss.
An Aegon poll, taken on the eve of what has been described the largest changes in pension rules for a generation (freedom to take the entire sum, rather than be forced to buy an annuity), has revealed that a third of employees have no idea of the tax implications. This means they will almost certainly be turning to their employer for information about their choices.
Although the generalities of the pension changes have been widely publicised, it’s the reality of facing very specific questions like this that employers need to prepare for – and quickly (the answer, by the way, is a hefty £11,523 in tax).
For while changes to the pensions landscape open up the opportunity for staff to have more control of their savings, the nuances they need to consider expand dramatically.
Choose to take that same pension pot in three separate chunks in successive years for example, and the tax bill shrinks by £7,500.
“In the past employers could facilitate discussions down a very specific annuities track, but now people need to know much more about their new choices – which can be much more complex,” says Neil Hawkins, Friends Life’s financial education director.
“The range of issues that need covering now include discussing attitudes to sudden wealth and spending, the rates their new income is taxed at or even whether to take an invest-and-drawdown option.”
In the employers’ defence, the annuities only market meant they only needed to offer very broad advice. That used to mean that to have a good retirement income (defined as 67% of final salary, according to MGM Advantage) employees needed to save around 15% of their salary over the course of their careers.
The new landscape changes this, but according to experts, there is some good news. It’s illegal to give ‘advice’, but it’s actually very easy for employers to build up scenario-based information of how pension costs and outcomes change if different paths are followed.
To the employee with a £100,000 pension pot, for instance, finding out that they would have to give £43,643 to the taxman might be a sufficient deterrent against cashing in all their savings at once.
Reward knows this information isn’t always easily to hand, or in easily digestible form. That’s why we asked Aviva to draw up real pensions outcomes, based on real scenarios that employers can use to help both current and new pensions savers.
We asked them to compare different contribution levels, started at different ages. We then asked what annuity this might buy.
Compiling the data was Aviva’s head of policy John Lawson. “Always, the message is that you get out what you put in, while minimal contributions won’t do.”
He adds: “We can also see how contributions might have an impact on choices. With small pots – anything from the 3% contribution level data – the annuity would be so small, employees might well consider cashing it in all at once.”
According to Lawson, the rough cost of taking £215,000, £130,000 and £67,000 pots as a lump sum would be around 40%, 35% and 30% of the total. He says the ‘tipping point’ pot size where staff should consider doing something other than cashing it in is around £50,000.
“Anything less and it’s not worth eking out; anything more than this and there are choices that need considering,” he says.
Expressed in tabular form, employers can quickly show trends – for instance that the myth that it’s not worth older employees starting a pension is unjustified.
A 40-year-old saving 12% can build up a larger annuity (should they choose this option), than a 20-year-old saving just 3%. Start just 10 years earlier, and they could double the size of their pensions pot.
One big worry, of course, is that beyond offering the sort of data provided here, there is a question about who pays for this. But Lawson says clued-up employers shouldn’t need to concern themselves.
“Employers can claim £150 per employee for financial education as a tax deductible expense, and even for small companies this should easily be enough to pay for financial education done in groups of employees at once.”
He adds: “There is a fear from employers that even if they provide ‘education’, they might be held liable for the decisions staff members actually take, but this is another myth. All advisers know it is they who are responsible for any information they impart, not the employer.”
He argues that data like Reward’s contribution levels/annuity income chart can go a long way to providing staff with what the industry calls the ‘first line of defence’ – the ‘did you know..?’ set of initial Q&As that start the financial education ball rolling.
Armed with some simple facts, this means communicating the outcomes that pensions choices entail doesn’t have to be difficult.
Pensions freedoms, choices and outcomes will be key topics THIS WEEK at Reward Live. For the full programme, please CLICK HERE.