Forget Me Not
17 December 2007 Jason Butler APFS, CFP, IMC
Most senior executives accrue significant pension benefits over their career but fail to appreciate their true value. Jason Butler of Bloomsbury Financial Planning explains the options available.
With some executive's pension benefits valued more than their home, it pays to evaluate the options available to pension scheme members and how they correspond to long-term plans.
Benefit schemes can take two forms: defined benefit and defined contribution.
Defined benefit is where the sponsoring employer underwrites the pension income and any associated lump sum. In this instance, the scheme member doesn't need to worry about investment or longevity risk, but more about whether the scheme is (and will remain) well funded so that it can provide the promised pension benefits.
The trustees are obliged to produce regular reports and financial accounts that set out the financial position of the scheme. The trustees are also obliged to set out the investment strategy adopted by the scheme, as well as the level of funding from the employer. As long as the scheme is well managed, the defined benefit should be provided. However, things can change over the years so it’s worth reviewing the financial health of the scheme regularly.
Defined contribution is where the pension income and associated lump sum are reliant on the level of contributions, net investment returns and annuity rates. There are two types of defined contribution pension plan – occupational and personal.
OCCUPATIONAL AND PERSONAL
Occupational schemes are, in broad terms, employer-sponsored pension arrangements that are overseen by trustees (which usually include a member of the scheme) who are responsible for complying with the legal obligations of the scheme and to ensure members’ interests are protected.
The trustees will also select a range of investment options for members to choose from, representing different asset classes. These typically include equities, fixed interest, cash and property. Some schemes also include other investment options such as hedge funds, but this is not common.
Virtually all schemes offer some form of managed fund option, providing a combination of asset classes actively managed by an external fund manager. Our experience at Bloomsbury Financial Planning has shown that the vast majority of senior executives choose the managed fund option regardless of whether this is appropriate for them, taking into account both their capacity for risk and their personal investment goals. Due to the buying power of the trustees, the charges on the funds are usually (but not always) lower than would be available from retail funds.
Personal schemes are individual plans that may be funded by the employer, employee or both. Unlike occupational schemes, there are no trustees overseeing the operation of the plan, although there will always be a scheme administrator responsible for running the scheme and complying with regulations.
Increasingly, employers are replacing occupational pension schemes (whether defined benefit or defined contribution) with Group Personal Pension Plans. These are essentially a collection of individual personal pensions which benefit from cost and administrative savings, but which absolves the employer from the various obligations and duties associated with occupational schemes. There is usually a range of funds, including a managed fund option.
THE SELF-INVESTED OPTION
A self-invested pension plan is suitable for those senior executives with employers prepared to direct contributions into their own personal pension plan. This is particularly the case where the contributions are large and the executive wishes to have his or her fund managed according to his own needs by a third party investment manager.
Although this option is likely to be more expensive than using a Group Personal Pension Plan arrangement, it does allow the investment strategy to be tailored to the exact needs of the individual. If the portfolio is managed according to an agreed asset allocation strategy using low cost index and pure asset class funds, and the manager absorbs all transaction costs within his or her fee, then the cost differential shouldn't be great.
In addition, the manager can ensure that the asset allocation strategy is in line with the individual’s own capacity for risk, rather than a one size fits all managed fund. This should then enable the pension fund to capture the optimum investment return.
So the message is clear: Don't forget how your pension benefits are invested otherwise you might not enjoy your retirement in the style you have planned.