Digesting the “Alphabetti Spaghetti” of pensions

Gibraltar Magazine – April 2017
Ian Le Breton

It seems that we cannot escape from pensions. I don’t mean in a philosophical sense – that every day of our working lives inevitably takes us closer to the time when we will need to rely on whatever financial provision we have (or have not) made for our future. Rather I mean in the empirical sense. It’s almost impossible to avoid the subject, given the relentless – at times even overwhelming – volume of news stories and articles in the press and online; whether it’s Sir Philip Green’s BHS pensions debacle or, at the time of writing, endless speculation about UK Budget proposals.

In my opinion there is one major issue with pensions: the jargon. Let me take you me back to my childhood. As a child – and this may not come as a surprise to those who know me now – I rarely required any encouragement to eat. I was born into a Jersey family blessed with hearty appetites and there was no need to employ tricks or novelty foods where I was concerned.

Not so one of my fussy school friends, who would eat nothing but Alphabetti Spaghetti. As a result, it became a firm favourite when visiting his house. What wags we were, writing rude words on the plate with our pasta letters and then consuming the evidence. Or so we thought. Today, of course, there are pages online dedicated to this pursuit and somewhere, no doubt, there is probably a Scrabble-style competition for enthusiasts.

And so it was when thumbing through this month’s copy of a pensions industry magazine that I was reminded of these innocent(ish) childhood pleasures. From time to time, I struggle with the plethora of pensions-related acronyms. So perhaps, I thought, it was time to straighten out the pasta a little, even though my tastes have changed a bit these days. Somehow alfabeto pasta (for that is the generic name) doesn’t quite cut it next to Spaghetti con le Vongole or al Nero di Seppia.

To a large extent, increased pension comment in the mainstream press and online is a consequence of the new flexibility that has been given to individuals when it comes to organising their pension affairs. Many of these stories inevitably concentrate on the “scarier” side – doom-laden prophecies that we are not saving enough for our retirement or that the reforms promote irresponsible spending.

Broadly speaking, it has to be a good thing that individuals are allowed greater freedom to deal with their own financial affairs. After all, everyone’s situation is specific, so a “one-size-fits-all” approach will not necessarily offer the right solution. True, some will take a less responsible approach. There are people who may well be tempted to make unwise choices when presented with the freedom to do what they like with their liberated pension pot. But most industry reports show that this is the exception rather than the rule.

Statutory regulation has been put in place to protect individuals. Indeed the pensions business is rightly one of the most regulated sectors in the financial services’ spectrum. As always, there is a lot of professional help available and sometimes the law even requires that financial advice must be received before certain steps can be taken. This is only sensible. While most advisers will have only the clients’ interests at heart, there are – as in every walk of life – also shady characters waiting out there to dupe unsuspecting clients. Luckily these cases are rare and generally well publicised so we can all learn from them.

The increased media coverage around pensions is therefore to be welcomed. Never before has providing for our financial future and for our loved ones when we cease working been so topical. However – and here we get back to the spaghetti – much of the jargon and terminology is still daunting. Worse, many of the more common terms are increasingly “disguised” by seemingly impenetrable acronyms or abbreviations.

In my campaign to make the pension world more accessible, let’s go back to basics. My starting point is to consider two very common abbreviations – “DB” and “DC” – that define at the outset the very essence of the pension being considered. They stand respectively for “defined benefit” and “defined contribution” schemes.

Some of the best-known examples of DB schemes are final salary arrangements set up by companies or governments. These are highly prized by those employees fortunate enough to have one. In such cases, an employee is promised a specified amount, perhaps combining a monthly income with a PCLS (Pension Commencement Lump Sum). In the UK, these types of scheme are becoming increasingly rare. You may also hear them being blamed for the large deficits that are appearing in many pension schemes.

It is far more common these days to encounter the DB’s cousin, the DC. Here a “pot” is built up over a working life – or at least the time during which contributions are made. The pot’s value will determine the benefits that will be paid out in retirement and will be based on several factors. The contributions themselves will of course be critical – how much is paid into the plan by the employee and, where applicable, the employer too. Investment performance will also be vital – hence the necessity to obtain advice at the outset – and the value of any tax relief available must also be taken into account.

It is possible to convert a DB scheme into a DC but extreme care should be exercised. Many of the UK schemes are currently keen to reduce their long-term liabilities. As a result, tempting “transfer values” are being offered. For some, transferring to a DC scheme makes good financial sense: for others, definitely not. Greater flexibility may result and this can be hugely beneficial. But giving up a known, defined benefit that will be for life is not a decision that should be entered into lightly. An AIA (Appropriate Independent Advice) check may also be necessary.

What else do I find in my tin of spaghetti? In past columns I have discussed particular types of pension – QROPS and QNUPS spring to mind. The former will be familiar to many who have left the UK and wish to transfer their UK pension to an overseas arrangement. The latter is a related but altogether different concept and perhaps may be a suitable subject for another day.

While most British expatriates living outside the UK in Gibraltar, or elsewhere, say they won’t return to the UK, the reality is that many do. They might wish to consider another type of scheme – the SIPP (Self Invested Personal Pension). A SIPP is a relatively low cost and highly flexible option. It is also very well regulated by the UK’s Financial Conduct Authority (FCA).

A further type of DC scheme found in the UK is the SSAS (Small Self-Administered Scheme). These are generally established by a company to provide retirement benefits for directors or staff and are normally limited to fewer than a dozen members.

Another popular industry term is FAD – or Flexi-Access Drawdown. This gives a member the freedom to decide how much of the pension pot to take as PCLS (mentioned above) and how benefits are to be taken in the future. Specific factors such as taxation, attitude to risk and income requirements should be taken into account. Individual objectives and the ability to react to health and family issues may affect plans. FAD is therefore to be welcomed – but, once again, great care needs to be taken.

Much of this jargon is of course UK-sourced and will be primarily be of interest to readers who retain connections in the UK. However the pensions’ market in Gibraltar is growing rapidly and at a time when we face the on-going spectre of low interest rates – the saver’s nightmare – preparing for retirement has never been so important. Provided, of course, that the jargon can be understood. Now where is that can of spaghetti?

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