insight word doc text dump feb2018 - thomsons online … · welcome to insight as ever though,...

Insight: Leading on the financial wellness of UK employees

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© Thomsons Online Benefits Ltd. Thomson Online Benefits Ltd. is authorised and regulated by the Financial Conduct Authority. Registered office: Gordon House, 10 Greencoat Place London SW1P 1PH A limited company registered in England with Company Number 5398394

Welcome to Insight Thomsons' Pension Technical Team's quarterly newsletter on trends in UK financial wellbeing programmes.

The fourth quarter of 2017 delivered a number of firsts, from the Catalonia vote for independence to the introduction of different income tax levels in Scotland.

Unsurprisingly Brexit negotiations have taken time to progress, but the introduction of a 2 year transitional deal and an agreement on three key issues (EU and UK Citizen’s rights, the Northern Ireland border and the financial settlement) allowed phase 1 to complete in Q4. Next up is phase 2, which will centre around trade and security.

Philip Hammond’s Autumn budget was relatively uneventful (given that he had little room for manoeuvre) with the most notable points including a break in stamp duty for first time buyers, a promise to build more affordable housing and an additional £2.8bn for the NHS over the next three years.

Pensions though escaped any significant interference, simply with confirmation that the Lifetime Allowance would increase inline with CPI inflation on 6th April 2018 (up from £1m to £1.03m) and that HMRC would be afforded greater powers to register Master Trust schemes.

As ever though, there is plenty going on and in this edition, Andrew Barradell discusses the potential impact of the Scottish income tax changes, Kevin Brendling looks around the corner at the next generation of default fund solutions for DC schemes and Alex Shaw rounds off with some bright thoughts about employee engagement and personalisation.

Luke Harris Pensions Technical Manager

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A nation divided (by taxes)

In the manic month of December, whilst most of us were busy running around getting ready for Christmas or desperately trying to finish all of the outstanding work we had before a break, the Scottish Government announced changes to income tax bands that are due to come into effect from April.

The Government north of the border was given the power to set its own income tax rates and bands in 2016 and the temptation seems to have become too much and they couldn’t resist this newly granted power any longer.

In the budget speech Derek Mackay, the Finance Secretary, stated that the changes would “make Scotland’s tax system even fairer and more progressive.”

He also claimed that "the new 'starter' rate of 19%, combined with the increase in the personal allowance, will ensure that no-one earning less than £33,000 – which is 70% of all taxpayers – will pay any more in tax than they do now for given incomes." We can test this hypothesis later on!

The changes will introduce an extra two tax bands (19% and 21%) whilst also changing the rate for the Higher Rate taxpayers from 40% to 41% and for Additional Rate taxpayers from 45% to 46%.

The full detail of the changes are laid out in the table below (fig 1) :

Current Threshold

Current Rate

Proposed Threshold from April 2018

Proposed rate from April 2018

Up to £11,500 0% Up to £11,851 (A) 0%

£11,151 to £43,000

20% £11,851 (A) to £13,850

19%

£13,851 to £24,000 20%

£24,001 to £44,273 21%

£43,001 to £150,000

40% £44,274 to £150,000 (B)

41%

Over £150,000

45% Over £150,000 (B) 46%

(A). Assumes individuals are in receipt of the standard UK personal Allowance

(B). Those earning more than £100,000 will also see their Personal Allowance reduced by £1 for every £2 earned over £100,000

Andrew Barradell Senior Pension Consultant

Fig 1. Proposed income tax bands in Scotland

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What does all of this have to do with pensions I hear you cry? Well I am glad you asked!

The potential effect of the changes on pensions

Specifically we will look at the impact of Group Personal Pensions, as this is by far the most common scheme type used by clients of Thomsons Online Benefits.

At its heart the taxation of Personal Pension Schemes in the UK is fairly simple (I am choosing to ignore here the additional complexities of the various limits imposed on employees through the various allowances – Annual, Lifetime, Tapered Annual and Money Purchase Annual).

Basically, employees are able to receive tax at their marginal rate for any contributions made into a pension scheme (subject to the various allowances mentioned above). When an employee contributes personally to a Group Personal Pension the provider will automatically increase the contribution by adding back on an amount equal to the Basic Rate of Tax (20%), so where an employee pays in £80 this will be increased up to £100 to be invested. Where an employee has a higher rate of tax (40% or 45%) they would need to claim this additional relief this back though their annual tax return.

Similarly an employee who does not pay tax (due to their earnings being below the level of the personal allowance) would also benefit by this additional 20% even though they have not paid any tax.

There are a couple of complexities/problems caused by these changes:

Higher earners will get a bigger boost to their pensions

As mentioned above, currently across the UK, tax relief is paid on pension savings in line with an individual's tax bracket. That means it costs a 20% Basic Rate taxpayer £80 to save £100 into a pension, and a 40% Higher Rate taxpayer £60. After the changes, in Scotland a higher-rate, 41%, taxpayer would therefore only have to pay £59 to make the same £100 pension contribution. Likewise, a 19% taxpayer would have to pay as much as £81.

Tax relief on pensions costs the government billions of pounds a year. Experts have long argued for redistribution, so higher earners do not receive so much, yet this looks likely to increase that disparity.

How this will work in practice?

It seems the mechanics as to how this would work are unclear. It’s hard to see how the various providers would manage a variable tax rebate at the point of investment. So a flat rate of 20% would likely be applied and Basic Rate taxpayers in the 21% band would need to reclaim the additional 1% through a tax return, which the majority are likely to deem not worth it, a reality perhaps not overlooked by policy makers. This is likely to be in contrast to a higher rate taxpayer who already fills in a tax return, as they will be able to easily claim the additional relief.

Clarity will also be required as to what happens to employees in the 19% bracket, will they continue to receive the full 20% relief, or will they be required to pay something back to the tax man?

In order to manage a variable rate of tax to be applied upon contributions, providers would need to register employees as either Scottish or ‘Rest of the UK’ taxpayers. Pension providers would then have to rely on HMRC to tell them where customers reside via new Scottish or English tax codes, however people who did not contribute to a pension in 2016-17, or are new customers, would not have a code. This will likely mean that thousands of people could receive

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the wrong tax relief. In addition, HMRC will send taxpayer data to providers on an annual basis only, so anyone paying the wrong tax could face a long wait for the issue to be settled.

A postcode lottery

The implications for employers should also not be overlooked. If you have offices in both Scotland and elsewhere in the UK, or in one area but employees who live in the one area also work in the other, then this is likely to be difficult to manage.

You could easily have two employees working side by side, doing the same job for the same salary but one employee’s take home pay will be higher due to where they live.

Maintaining accurate address records will be a huge challenge for HMRC and providers, as currently around 80,000 Britons move into or out of Scotland on an annual basis and there is no requirement to tell HMRC of a change of address.

Testing the hypothesis

You may recall that earlier on we mentioned Derek Mackay’s claim that no one earning less than £33,000 would be worse off under the changes.

The below example (fig 2) looks at an employee earning £32,500, so therefore according to Mr Mackay they should be paying less tax.

2018/19 tax year

Under Current Regime Under new regime

Rate Salary Tax Rate Salary Tax

Personal Allowance

0% £11,851 £0 0% £11851 £0

Basic Rate Tax

20% £20,649 £4,129.80 19% £2,000 £380

20% £10,150 £2,030

21% £8,500 £1,785

Total Tax Due £4,129.80 Total Tax Due £4,195.00

Fig 2. Testing the hypothesis

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Whilst this would at first glance suggest that the figure of £33,000 quoted by Derek MacKay is wrong, it in fact highlights the nature of how politicians often present statements with a deft touch.

What Mr Mackay has failed to mention is that because of the increase to the personal allowance in April 2018 (from £11,500 to £11,851) it is not really a level playing field to compare the tax pre and post April 2018.

In fact, if you look at the figures purely on a Post 2018 basis, the level at which someone has to be earning to pay less tax is £26,000.

It would appear that if you have employees who live in Scotland, life is about to get much more complicated with regards, payroll, communication and pensions.

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Default fund solutions: the next generation?

The introduction of the retirement freedoms legislation in 2015 sparked a revolution in default fund design, which continues to evolve. For those committed to the application of lifestyling, this meant a rethink for the pre-retirement phase. This came at a mutually beneficially time, as the risk of investing predominantly in a single asset class (gilts) in preparation for retirement was becoming increasingly highlighted.

Pre-2015, lifestyling would typically invest members into long-dated gilts (those with a duration of 15 years or more), as these assets help to protect a member’s annuity purchasing power by hedging against movements in annuity costs. However, the actions of central banks following the 2008 financial crisis had caused gilt prices to become very volatile, relative to long-term trends.

The considerable shift in retirement behaviour, with people living longer and phasing more gradually into retirement (as opposed to retiring in full at a fixed date), coupled with the relatively poor value offered by annuities, made it necessary to introduce a more flexible system. In response to the deferral of annuity purchase into the later stages of retirement, members therefore required an appropriate way to supplement their income as they started to reduce their working hours. A new pre-retirement asset structure was now required to accommodate the new retirement model.

Cue a raft of new lifestyle strategy monikers, with ‘drawdown’, ‘flexible’ and ‘universal’ glide-paths peppering the market. In reality though, they all aim to do

similar things, which is primarily to prepare members for a more flexible retirement journey.

A reduction in volatility is still imperative, due to sequencing risk (the risk that downward volatility in the early years of withdrawals has an especially negative impact on a member’s pot size), and therefore a reduction of investment in growth assets is required. However, it is also necessary to support income withdrawals from the plan and therefore an appropriate balance must be struck between growth and non-growth assets.

The current model of growth phase and de-risking to prepare members for making withdrawals is something of a halfway-house, borne out of the need to support DC members who wish to take their 25% tax-free cash entitlement or full encashment.

However, most providers are yet to sufficiently address the ‘in retirement’ phase of the member journey, merely focusing on the initial needs. In part this missing part of the jigsaw has been driven by commercials, as most DC savers hold the majority of their pension savings within a DB arrangement and therefore relatively small DC pots are encashed. However, this position will change over time and members will need greater support, both in terms of the provision of appropriate options but also in how to make the right decision(s).

Furthermore, applying a wider spread of assets to underpin the best strategy can be relatively expensive and difficult to achieve within the well-intentioned, but ultimately stifling, charging cap. Achieving the optimal asset allocation requires scale (for the provider) and requires the market to continue to develop.

For example, it can be prohibitively expensive to gain access to certain private equity and infrastructure assets within the cap. As a result, the tail-end of an all-encompassing default strategy may be considerably more expensive than the growth phase and costs may have to be distributed to meet the cap. This

Kevin Brendling Senior Technical Pensions Consultant

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means that those invested in the growth phase would be supplementing retirees, which is not ideal. It is unfortunate that the cap is not more accommodating and does not focus more on value, but this is unlikely to change, at least in the short-term.

The Full Monty

So, what should a fully comprehensive solution look like and how could it deliver a better retirement journey for members? The most critical aspect of what providers now need to deliver is a solution for those moving deeper into retirement. Whilst we know that annuities are relatively poor value for members in their late 50s and 60s, value improves as members enter their 70, 80s and 90s as mortality gain (the increased factor premium for reduced life expectancy) starts to work in their favour. At this point the ability to obtain secured income for the remainder of their life will become their highest retirement priority.

Therefore, whilst it is appropriate to initially de-risk members into a flexible income strategy (under a lifestyle approach), it will later become appropriate to accommodate the transition into secured income.

There are three key distinctions to be made here, relative to traditional annuity-targeting strategies:

• Members should not be invested 100% in gilt assets. Instead a range of appropriate assets should be used, including different bond durations.

• Members should be supported in making the right decisions at the right time. Technology can assist here with options including online chat, online case studies, modelling and robo-advice.

• Ideally, members should be able to better tailor their investment to their needs.

The first point is a lesson from the past, that even when a seemingly appropriate asset class is utilised for a specific purpose, diversification through negatively correlated assets is still required to help protect members from a sudden fall in value.

The remaining two points can only be successfully driven by technology, given the scale of the need to deliver appropriate information to members at the right time, in-line with their requirements. Whilst there are justifiable concerns about the use of robo-advice, this may be a prime example of where a competent delivery could be a tremendous help to members, assisting them to select the most appropriate lifestyle option for their needs.

This approach could be taken a critical step forward, but would require considerable tech investment by the provider. It is therefore only likely to be developed by the largest providers/ asset managers. However, there is great incentive for them to do so – unless they make their default fund solutions a compelling reason to stay invested, members can simply transfer away when they retire.

The recent merger and acquisition activity with Aviva & Friends Life, Standard Life & Aberdeen Asset Management and Scottish Widows & Zurich is testament to the value of not just growing assets under management but also retaining these assets.

One way to do this is to enable members to tailor a lifestyle strategy to meet their individual needs. This would be most critical in the final phases where a member may wish to move from a flexible income approach to a secured income approach or may wish to extend their time in the flexible income phase.

An appropriate set of questions could be constructed to identify the member’s retirement funding position, income needs and attitude to risk. Their personal glidepath could then be adjusted to deliver greater growth potential to support

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higher income withdrawals, or to reduce growth potential and therefore volatility to help protect capital. Or a member may decide they may only require flexible income for another two years and will then wish to purchase an annuity with the remainder of their pot.

The use of multi-plan modelling tools along with risk profiling tools, require development to meet the evolving needs of pension members. Happily such tools already exist within DarwinTM (with new features due for roll-out in 2018) but the next step forwards will require platform investment from providers to increase the functionality of their tools and to link up with the investment and asset management systems.

In the meantime, providers must continue to develop their retirement investment strategies with a more comprehensive approach. The chart (fig 3) is a broad peek around the corner of what future strategies may look like, with the notable differences being a longer glidepath and much greater diversification of assets throughout the journey.

Coming Soon?

The development of new glidepaths is not a quick process and where new underlying funds are being developed, they will need time in order to build up a sufficient track record with which to make them a viable solution. Our own Investment Committee requires a minimum three years of track record before a fund or profile can be considered for access to our panel.

However, some providers (e.g. Legal & General) are ahead of the curve with a comprehensive and diversified retirement glidepath (‘pathway’) already available and we eagerly await the introduction of Aviva’s new offering, which looks to deliver much greater diversification, coupled with a market leading digital solution.

In the world of default fund design, these are exciting times but providers have a real challenge to deliver better outcomes within the constraints of the charge cap.

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14

Asse

t Hol

ding

%

Retirement Journey (0 to -15 is withdrawal phase)

Cash

Absolute Return Bonds

EM Debt

Global Corp. Bonds

UK Corp. Bonds

Index Linked Gilts

Gilts (Mixed Duration)

Property

HY Bond

Infrastructure (equities)

UK Equity (incl private equity)

EM Equity

Global Equity (incl Smart Beta)

Fig 3. Example of a more comprehensive default investment solution

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Fundamentals of pension engagement: my view

What does engagement matter?

Pension engagement represents the emotional commitment an employee has to save for their life after work. It means that person wants to save and takes informed actions throughout their working life to do so. Engagement develops over time- it’s not an overnight job. To be successful you must employ a range of media and channels, create a number of different strategies and do this repeatedly over time.

Long gone are the days when employees would stay with one employer for life, secure in the knowledge that they would be able to live comfortably in retirement on the income they accumulated in their defined benefit pension. With DC (defined contribution) plans now the norm, employees bear more responsibility for their own financial outcome at retirement. This results in a duty of care for employers, their advisers and pension providers to support employees in making good financial provisions for their future.

A large proportion of the UK’s working population today have been automatically enrolled into their pension, with contributions automatically deducted and invested on their behalf. Auto-enrolment (AE) has been very

successful at harnessing inertia to rapidly increase pension membership across the UK. However, in spite of this success, AE alone is not sufficient to guarantee optimal outcomes at retirement.

Employees now need to be actively engaged with the topic of pensions, as early as possible, to ensure that they can have a comfortable retirement. Or to even be in a position to retire at all.

A well designed and communicated company pension scheme can also play a vital role in both the recruitment and retention of key talent.

Three out of four employee worries can be contributed to financial issues, which can result in less concentration at work, lower job satisfaction, reduced productivity and increased absenteeism. So good levels of pension engagement can help to produce a healthier, happier and ultimately more productive workforce.

Most people are aware that saving is essential, but more needs to be done collectively to turn that awareness into action and to get them actively doing it to ensure they have an income after their working life. Employers need employees to take individual ownership of their pension. Do this and not only will they be taking the right steps to secure better income in retirement income, they will also value their pension more.

Setting out the challenge

Industry jargon and constant Government tinkering of pension rules has left many people feeling confused and disengaged. In some cases the word ‘pension’ has become tarnished with negative connotations and even just mentioning the word itself can have the tendency to switch people off.

Alex Shaw Senior Pension Development Consultant

https://www.employeebenefits.co.uk/pensions-reforms/

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Pension communications need to cater for a broad audience, ranging from new graduates often saddled with student debt, right through to older employees approaching retirement. With four to five different generations within the same workforce, a ‘one-size-fits-all’ approach will not work, so more thought must be put into the targeting of messages.

The company pension scheme is also increasingly part of a wider financial landscape. Over the past few years, pension education has evolved and now needs to incorporate wider financial support to remain engaging and relevant to a modern audience. Having to add more financial topics to the list of communication needs makes the task of employee engagement even more complex for employers than it once was.

Recent technological advancements have changed the way people now interact and react to messages, compared to a decade ago. Why should pension communication be any different? On average we each receive over 2000 information messages a day, across a variety of media, so more creativity is required to overcome the background noise.

By utilising behavioural science, technology and a variety of communication channels, we can provide employees with collateral in a medium they find appealing and which they will consume.

Embracing the challenge of pension engagement can unlock a great opportunity to change employees’ financial behaviour and make a real difference to their future.

Fail to prepare, prepare to fail

The first step to developing a pensions engagement strategy is to take a step back and define the problem you are wanting to solve, the activity you are trying

to promote, and how success will be measured. Ultimately, what behaviours are you trying to change?

Understanding your audience, and what makes them tick, takes time and thought. Employees are all individuals, with different priorities, different ages, incomes, debts and resources.

By using segmentation we can group members or employees according to a range of variables which determine their characteristics and tendencies. The pension governance process and the use of benefit surveys/ questionnaires can be a useful aid to gaining insight on your employee population, to support the segmentation and targeting process.

Taking time to ensure that different groups receive the right messages at the right time takes careful planning to avoid ‘communication overload'. Special care also needs to be taken to make sure that employees get relevant messages, at a time they are likely to look at them, and in a position to take action. Give a message at the wrong time, and you'll lose them.

Personal milestones, such as passing a probation period, or receiving a pay rise/ bonus, or celebrating a significant birthday, can help to shine a spotlight on pension saving at a time when staff might be more open to reviewing, and potentially making changes to, their level of involvement with the pension scheme.

Good engagement practice should be strategically planned, not ‘ad hoc’ or reactive in its approach. Most communication programmes will only work if employers keep at it and persevere.

Including pensions in a wider financial wellbeing strategy can enable staff to better visualise the impact current pensions engagement can have on their

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future lifestyles. Rather than focus on pensions, employers can teach concepts such as regular savings and stock market investment, as part of a broader financial education programme.

Putting your plan into action

A key decision is deciding how best to use the various communication channels at our disposal to maximise engagement. Getting senior leadership involved in promoting and taking part in campaigns can have a positive impact on this goal. Communication options which can be used include:

• One to one meetings

• Workshops/ presentations/ internal ‘town hall’ meetings

• Targeted messaging based on context

• Factsheet

• Campaigns

• Financial education/ pension month initiative

Choosing the right channel for the right message is not an exact science, and there are no hard and fast guarantees that one method will be more efficient than any other. An exception to this is face-to-face communications which is considered the strongest form, but can be financially and logistically challenging to provide in practice.

Tone of voice is also important to increase the effectiveness of communication. Pension communications needs to work harder than most to get results. It’s worth taking a step back and thinking about your business’ tone of voice, making a call on whether it is something that should, or shouldn’t flow through to your pension communications. Companies need to ditch the jargon and keep

communications as light and simple as possible. Employee feedback can help to develop an effective communication style.

Thinking about the ideal media format for your target market, and the information you are trying to communicate, can also make a difference. Short online videos can be an ideal engagement tool for younger people but, for older employees where the messaging can be more complex, it may be more useful to create a newsletter or brochure.

With an increasingly youthful and tech-savvy generation entering the workplace, digital methods of communication are frequently embedding themselves into the fabric of our working lives. This trend ought to be embraced by employers hoping to achieve engagement in pensions. Millennials in particular, are increasingly in search of employers with corporate values to which they can relate and connect. Pensions and savings related benefits are probably not on their list, but they should be.

Gamification of pensions (creating a game, quiz, or digital ‘story’) works because it combines the motivating and fun aspects of games with creativity and behavioural science. A good example of this is Scottish Widows’ “Age Me” game which looks at the employee’s pension situation today and ages a photo of them to the point when they’ll have enough to retire.

Digital communication has huge potential to improve employee pension engagement, but it’s fair to say that there is a long way to go before its potential is fully realised in the pensions space.

Thomsons and Mercer are keen to embrace new technology where it has the potential to effect behavioural change. To this effect we have developed personalised videos to visually engage viewers on a one-to-one basis. On average 65% of individuals viewed their personalised video, with 45% clicking

https://www.employeebenefits.co.uk/pensions-2/

https://www.employeebenefits.co.uk/financial-education/

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to take action at the end of the 90 second clip. You can see a demo of this type of video on this link.

Digital and social media are a powerful set of tools, but they're not a silver bullet. If you haven't got a pension engagement strategy in place, it does not matter if what you do is online or offline, paper or tablet.

Engaging employees with pensions can seem like a daunting task, but it needn’t be. At Thomsons we are passionate about helping our clients to develop a market leading financial education strategy—please speak to your Thomsons Pension Consultant to find out more.

45%

55%

65%

Fig 4. Personalised video responses

35%

https://www.uk.mercer.com/what-we-do/wealth-and-investments/personalised-pension-videos.html

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Pensions Insight Team

E: [email protected] W: thomsons.com @ThomsonsOnline thomsons-online-benefits

Contact us

Luke Harris Pensions Technical Manager

Andrew Barradell Senior Pension Consultant

Kevin Brendling Senior Technical Pensions Consultant

Alex Shaw Senior Pension Development Consultant

insight word doc text dump feb2018 - thomsons online … · welcome to insight as ever though,...

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