Pensions World

Andrew Hoddinott, PricewaterhouseCoopers, explains the consequences for workplace pensions of the removal of the default retirement age.

Since 1 October 2011, employers have not been permitted to force employees to retire at age 65 (or any other age for that matter) unless this can be “objectively justified as a proportionate means of achieving a legitimate aim”.

Examples of “legitimate aims” outlined by the courts and tribunals so far include workforce planning and promoting recruitment and retention of younger employers, but until further case law develops it will be difficult to predict what retirement practices will be deemed objectively justifiable. To complicate matters, there are differences in approach between the UK courts and the European Court of Justice. What is clear is that retirement practices will be subject to greater scrutiny and employers will need to be prepared to justify them.

Some employers accept their approach to retirement needs to change and are investigating the implications. Recruitment, maintaining a workforce that can meet the business’s needs and succession planning for key employees could all be affected. In the short term, employers need a plan to deal with increasing numbers of requests for flexible working or changes of role from older employees.

With all this to grapple with, some employers may see pensions as a secondary issue. But the loosening of control over retirements that the removal of the default retirement age (DRA) will bring has significant implications here, too.

Changing retirement patterns

The number of people in the UK working at older ages was increasing rapidly well before the DRA was removed. According to Office for National Statistics figures, the employment rate for 65+ males has nearly doubled over the last ten years or so (around 7% in 2001 and now around 12%). Will this trend continue?

Continuing enjoyment of work, family circumstances, health, aspirations for retirement and many other factors will all continue to influence employees’ decisions about whether to work longer and for how much longer. But pension issues will continue to be one of the most important and the way things are going they are providing significant additional impetus to work later:

• Increasing state pension age means later access to an important element of retirement income for some employees. Even though employees may have a need to keep earning only for a year or so after 65 to balance income levels, they may find that continuing to work suits them and decide to work for longer. The Pensions Act 2011 accelerates the rise in state pension age and the government indicated in September that there will be still further rises – it could reach 67 as soon as 2027.
• Recent tax changes give people valuable flexibility to vary the level of their retirement income to fit their circumstances without being penalised by HM Revenue & Customs. With more control over the level of their combined employment and pension income, some people may decide to work longer, drawing a low retirement income initially, and defer annuitising most of their savings until later (this can now take place after age 75).
• Heightened awareness of savings shortfalls and longer lifespans is making people of all ages realise that the need to work for longer and accumulate greater savings is hard reality not just an ideal. There is also more consciousness of the need to keep savings in reserve to meet the costs of long term care in the later stages of retirement – this is high in people’s awareness following prominent media coverage of the Dilnot Report this spring.
• The economic environment is inevitably influencing current retirement decisions. Those with defined contribution (DC) pensions may be deferring retirement in the hope of riding out the cut in their retirement income caused by recent stock market falls and continuing low annuity rates.

The removal of the DRA could open the floodgates. Even if only small numbers of people take advantage of their right to work later initially, there could be a cumulative effect over the coming years as awareness increases and people see friends and colleagues deferring their retirement.

Careful consideration

Some people will wish to start drawing their pension at the age they had originally planned but to continue working. Some will wish to defer drawing pension until they finally stop working. Others may wish to draw a low pension initially and increase it in stages. Employers will need to give some thought to how these courses of action can take place under existing employment contracts and pension scheme rules.

Employers should also consider carefully whether their current pension scheme design may inadvertently work against them by discouraging employees from phasing in their retirement (and so continuing in full time employment for longer than the company would like) or by providing late retirement terms that increase costs.

Pensions already built up These will generally commence at a “normal retirement age” set out in the pension scheme rules. For defined benefits (DB), it is necessary to decide how to increase the level of pensions if they are deferred to a later age. Should they be determined from salary at normal retirement date and increased for interest and to reflect a shorter period of payment; or should they be determined from salary at later date of retirement from employment? For the latter, what is the best way to allow fairly for the impact on salary of any reduction of hours or change of role or job scope?

Most schemes will already have rules for late retirement, but it may be wise to review them (particularly if there is some element of discretion in rules/terms), given that they may be used for more and more people. There could be a risk of financial strain for the pension scheme (and cost for the company) if the existing rules are used. For example, the existing terms may be intended only for short periods of deferment or may have been set with more focus on ease of administration than on cost in the expectation that take up would remain low and within the company’s control.

For DC pensions, later retirement is less problematic. Instead, it provides an opportunity to ask whether their current pension scheme design could be improved. Companies seeking to embrace later working (and indeed those that just see it as inevitable but still want to support their older employees) should check whether their pension scheme is still fit for purpose. Could drawdown options be added to help employees take full advantage of more flexible income and annuitisation rules? Should investment options be reviewed so that any automatic switching of investments from equities to bonds in the run up to retirement continues to be dealt with sensibly as the concept of a single pre-determined retirement date disappears?

Build up of pension from age 65 To make sure pension terms are not perceived as age discriminatory, it will be necessary to allow for pension contributions for employees working beyond 65. Companies will need to assess how many employees they expect to continue working, and for how much longer, to understand and budget for the additional cost. New contribution scales may need to be developed and meshed in with existing age related scales. It is worth bearing in mind that when auto-enrolment arrives, it may be necessary to do this anyway as auto-enrolment applies to workers aged up to state pension age which is set to increase beyond 65. Additionally, it may be necessary to check that payroll and administration procedures can cope.

Other benefits Benefits provided using insurance, such as life insurance for death in service, can be withdrawn from people over 65 without giving rise to age discrimination (this is provided for explicitly in the legislation that removes the DRA). However, companies will have to consider whether this would be consistent with their own employment terms and objectives.

Plan with pensions in mind

Employers who are reviewing their retirement policies following the removal of the DRA should make sure that pensions enter their thinking at the earliest stage. Certainly, a change in retirement policy may need changes to pension terms. But more importantly, thoughtful pension scheme design can help regain control over retirements. Do not let the tail wag the dog.