Tuesday, 22 May 2018

    Five misconceptions savers make and what schemes can do to help

    From property to parlance Sara Benwell explores how schemes can help their members overcome five common pensions misconceptions

    engaged investor cover story questions

    1) “My pension is my property”

    The competition between ISAs, buy-to-let properties and pensions products has never been fiercer. In fact, the latest ONS data shows that almost 45% of us see a property as the best retirement investment, followed by a quarter who think it’s a pension.

    Some people plan to use buy-to-let properties to fund their retirement as an alternative to saving towards a traditional pension pot. More worrying is the trend towards people hoping to ‘cash out’ their pensions to invest in property in the hopes of generating enough income to fund retirement.

    What should schemes do?

    Fortunately for those trying to convince members to take a balanced view of property as an alternative to pensions, the Chancellor is busy making buy-to let investments less attractive.

    In the past year he’s removed wear and tear allowance, tax relief landlords receive on mortgage interest payments has been cut from 40% or 45% to 20% and then he added 3% extra Stamp Duty to  buy-to-let purchases.

    Jonathan Watts-Lay, Director, WEALTH at work says: “It is clear the Chancellor has targeted the buy-to-let market and is reducing the previous tax breaks. These changes may put off new entrants to the market who were relying on the tax breaks to make the investment viable.

    “Although there are other considerations to take into account, I believe there are other more tax efficient and flexible methods of saving for retirement.”

    Schemes should advise members to maximise their pension savings and highlight the valuable tax reliefs that are available.

    Kate Smith, regulatory strategy manager at Aegon said: “[The] news that buy-to-let properties will incur additional stamp duty will reduce its attractiveness for retirement planning.

    “The announcement highlights how all investments come with costs and as with so many things in life, it’s better not to put all your eggs in one basket.

    “While many people will have done very well from their property if you look at the figures a typical pension fund has returned 2308% since 1983 while residential property has returned 644%.”

    Highlighting statistics like these and making sure members are aware of employer contributions – essentially giving a 100% return on their money before investment - can help members understand the value of pensions savings.

    Alistair Byrne, senior DC strategist at State Street Global Advisors said: “Good returns have been earned from property and members value the familiarity of the asset class. However, in terms of retirement income provision, I don’t think enough attention is paid to concentration risk, illiquidity, and maintenance and management costs.

    “Schemes need to continue to stress the benefits of a well-managed, low cost pension portfolio.”

    2) “I’m a risk averse person”

    Research from State Street Global Advisors suggested that women are often too conservative in their risk-taking and men are too confident.

    Meanwhile many pension investments rely on a single evaluation of ‘risk attitudes’, which flies in the face of evidence that the risk taken in a portfolio should be high when a member is young and become more conservative over time.

    In fact, it is often riskier for a younger member to be invested in conservative assets as they may not see the returns they need when they still have time to ride out the volatility.

    What should schemes do?

    David Deidun, a partner at Quantum Advisory, believes that education of members is crucial.

    “Once again this goes back to education with the need to educate savers to perhaps meet in the middle.

    “Having said that, history here would prove as difficult to change for the future as men are, on average, more ‘gung ho’ than women.”

    Malcolm McLean, a consultant at Barnett Waddingham, suggests that we need to re-characterise risk. Helping people to better understand what their risk profile should look like and at what age.

    “Young people can and perhaps should be encouraged to take more risk with their investments but those people older and closer to retirement should not. That would seem to me a more sensible divide when it comes to risk aversion.”

    Lydia Fearn, head of DC & financial well-being at Redington, agrees that the emphasis should be on getting savers through the door younger.

    She explains: “Immediate pressures, such as paying or saving for a mortgage and other debts often sidetrack savers from thinking about their retirement goals.

    “However, the problem with this is that the money saved earlier works harder thanks to the phenomenon of compound interest – essentially the interest paid on interest.”

    Schemes should look to communicate with younger members stressing the difference that saving even a little extra can make to an end retirement fund. Easily accessible online calculator tools can help people visualise this.

    3) “Use it or lose it”

    Evidence suggests that most savers are champing at the bit to get access to their tax-free cash. For those who have debts which need to be paid off this can make sense, but for others taking the cash out is often a mistake.

    McLean explains: “There’s absolutely no point whatsoever in taking out the money and putting it in the bank rather than leaving it where it is because you’re getting 25% of the total put in a DC arrangement and if that pot is going to grow in value then the value of 25% will also grow.

    “They basically start to lose out from day one as the pot starts to accumulate in value.”

    What should schemes do?

    Suggesting that members call Pension Wise or even take financial advice could help them better understand all the options available when it comes to freedom and choice.

    Byrne thinks schemes could also help educate members themselves.

    He explains: “The 25% tax free cash allowance is well-known and ingrained in people’s thinking about accessing their savings.

    “Pensions managers can stress that the tax free amount can be spread over a number of withdrawals over time, but I suspect the ‘use it or lose it’ perception will persist.”

    Deidun believes that schemes can rethink some of the language they use and use software tools to demonstrate the different options to members.

    He explains: “Since the pensions freedoms were announced many savers have struggled to understand the options available to them and because of this there has become a greater need to educate savers.

    “This can be done by using simple language and easy to use software projections. Encashing may not always be in the member’s best interest especially as many are now living longer “than the average” as this can lead to being pension poor in later years, even when buying an annuity.”

    4) “I don’t need advice!”

    Many people think that they either don’t need or can’t afford independent financial advice; a problem that has been exacerbated by confusion between guidance and regulated advice.

    Byrne explains: “Regulatory distinctions between information, guidance and advice mean practically nothing to the typical member. Advice is anything that helps them work out what they should do, and there will be frustration in cases where the experts running pension schemes are reluctant to answer the question “so what should I do?”

    “Given the blur between advice and guidance it is also not surprising to find reluctance from members to pay the costs of regulated advice, even though that can give them the specific recommendations they desire.”

    However research from Unbiased.co.uk shows that taking financial advice on savings can add £48,279 to an average retirement pot.

    Furthermore the new pensions freedoms have left many members paralysed by choice unsure of the right route to take. Fearn explains:  “There is so much choice!  - cash ISAs, Stock and Shares ISAs, Help-to-Buy ISAs, SIPPs, defined contributions plans, the state pension.

    “One of the key barriers to creating a successful pension savings plan is understanding the sheer volume of options available and how they can assist you in saving for the short, medium and long term. A pension is likely to be only part of the picture.

    “Being able to put together the different building blocks of saving into a long-term plan with defined objectives is crucial.”

    What should schemes do?

    Members can’t be made to take advice, but consistent and clear messaging on the benefits of advice could help.

    Deidun explains: “A consistent message included in all correspondence would go some way towards it. A need to discuss, not necessarily advise, could be one route to greater understanding. An alternative would be a legal requirement to seek out advice but we feel this could be going too far.”

    McLean agrees that schemes must do more to push people towards at the very least taking some guidance. “I think we really need to push this to make sure that people do understand they’ve nothing to lose by speaking to an ‘expert’ and getting help.”

    Byrne suggests that some schemes may want to go further by putting advice in place for members or by having an adviser available: “Ideally, schemes can signpost where members can get individual advice, and negotiate attractive fees for their members,” he explains.

    5) “Je ne parle pas pensions!”

    One of the biggest communications issues for pensions is that people approaching retirement are often reading the same information expressed differently in a variety of different places.

    McLean explains: “I think people approaching retirement are getting bombarding with this stuff which comes from providers and trustees and sadly it’s not always as good as it should be.

    “They may also be receiving communications from the employer and they’ve got stuff coming at them from the regulator and from TPAS and I can well understand people getting totally confused about what it all means.”

    Fearn is concerned that confusing communications could lead to members pulling further away from pensions. “As Roz Watson points out in the Age of Responsibility report, it’s all very well offering a market-leading pension scheme, but if the employee doesn’t understand how it works or what they need to do to make the most from it, they’re less likely to join in, sign up and make the most of this opportunity to save for a more secure future.”

    What should schemes do?

    McLean thinks the answer lies in the pensions industry as a whole working together to develop a consistent lexicon. He says: “It’s not a set of language that people should use, we need a set of language to avoid.”

    Byrne agrees but also thinks schemes need to look at their own communications as well: “Our research with members suggests confusing terminology and conflicting advice is a major barrier to effective decision making at retirement.

    “It would be great if the industry can develop a consistent lexicon that can be used across schemes, but in the meantime the first step is for providers and schemes to make sure their own literature is clear and consistent.”

    Readers' comments (1)

    • The historical growth figures for pensions returns vs residential property are misleading, in that property investment includes a large element of gearing i.e. 644% return using borrowed money is worth more than 2308% return on just your own money.

      This certainly doesn't mean that future property investment is better. There is a lot of scope for property prices to fall, which would be catastrophic for many smaller landlords.

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