Taking charge of your own finances

Retirement will be no fun without enough money to enjoy it. Unfortunately most of us are being kicked out of our company's defined benefit funds, can't rely too much on the government for help, don't understand the defined contribution funds we've been put into and are not saving enough anyway. To make matters worse we are being ripped off by a savings and retirement industry that is skimming of the top of our investment returns while giving us very little good advice or value.
This blog contains some of my thoughts on taking control of retirement and pension savings. It will look at ways of cutting costs by using cheap online stockbrokers and share dealing combined with cheap index funds and Exchange Traded Funds (ETFs) to build diversified portfolios. This is a work in progress so I welcome your thoughts.

Thursday, December 10, 2009

The transfer incentive scam: Why leaving a defined benefit pension is a bad idea

In the last couple of years the experience of those saving for pensions and retirements have been polarized into two distinct worlds: those with Defined Benefit plans (DB) and those in Defined Contribution plans (DC).
Investment risk
Both have their advantages and drawbacks but the main difference between the two is that people in DC plans have no guarantees of anything. In a DC plan you and your employer contribute set amounts to your pension pot every month and what happens to that pot is your problem and yours alone. You may invest it all in cash and earn a return so paltry that you struggle to have enough money to retire. Or you may invest it all in shares taking a gamble that you will either hit the jackpot and be made for life or perhaps end up trying to retire on less than you saved in the first place. There are a million variations in between, but in short, what happens with your pot of money is in your hands and you have to live with the consequences.

In a Defined Benefit plan, the company takes that investment risk. It promises to pay you a retirement, and how it gets there is its problem. This is not entirely risk free for a saver as you have to worry about the company going bust, but in general the certainty that a DB plan gives is worth a lot. One measure of this is the price that companies have to pay insurers to take over their DB plans. Before life insurance companies will agree to promise to pay retirees the same pension that they are already getting from companies, they will typically ask for a premium of up to 30% to the assets in the existing fund. In other words the certainty that is offered by having your payments guaranteed (and not subject to the fluctuations of the market) is worth at least 30% of your assets. And that assumes you are already retired.
Trying to buy a similar annuity from a life insurer while you are still working is almost impossible because few insurers will want to take on the risk of what might happen to stock and bond markets 30-40 years from now.

Longevity risk
Another risk that has to be taken into account is the question of how long you will live. A long, healthy life should be a blessing. But if you are in a defined contribution fund there is nothing to protect your savings from the fact that the longer you live in retirement, the more money you will need to avoid running out of catnip. This doesn't just affect retirees. Although I'm in my late 30s, the average life expectancy of people retiring now is increasing by as much as a few months every year. By the time I hit retirement age I can, with luck (and on average) look forward to many years of walking the dog. The downside is that by the time I get to that age, the price of buying an annuity with my savings will have increased to reflect that.
Employees in DB funds don't have to worry about such things. Rising longevity is a problem for the fund and their employer, which has to top up the retirement fund if it starts running short of money.. So it is not surprising that most big companies have now closed their DB plans to new members and are also trying to get existing members of these plans to switch out. The way they are doing it is by offering incentives.

The transfer incentive scam
All of which brings me to a talk by David Norgrove, the chairman of Britain's official Pensions Regulator on transfer incentives being offered by companies and some of the "worrying tactics" they are using to encourage people to leave Defined Benefit plans. These include putting excessive pressure on people (calling and coming to their houses), misinforming them by suggesting the DB fund is not safe and using high pressure sales tactics such as telling them they only have a limited time to act. But that trustees of pension funds should:

...start from the presumption that such exercises and transfers are not in member interests.

Many members are likely to be strongly influenced in their decision to transfer by the immediate prospect of receiving an attractive amount of cash - or by an offer which contrasts an 'enhanced' transfer value with a pension from an under-funded scheme.

...If a company is willing to encourage the transfer, the company's gain is likely to be the member's loss.
 In other words "if they want me to have it, then I probably don't" - which would seem to be a fair starting point for skeptically assessing all offers in the snake oil world of savings, investment and retirement.

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