State pension forecasts can be showing more income than the individual will receive, since it will include contracted out savings even though if these are cashed out by the individual.
This is dubbed by pension specialists as a very complex area, to which advisers should pay particular attention.
In 2016, Baroness Ros Altmann introduced the Contracted Out Protected Earnings (COPE) element in the state pension forecast, designed to explain to the public that they might not be getting a full flat rate pension, due to the fact that there was some other pension arrangement in place.
Between 1978 and 1997, employers sponsoring defined benefit (DB) pension schemes could contract their employees out of the additional state pension, as long as the scheme paid a comparable guaranteed minimum pension (GMP).
The GMP is payable for life at age 60 for women and 65 for men, and a survivor benefit is payable to a spouse or living partner.
The benefit of contracting out was that both employer and worker had a reduction in their National Insurance contribution.
However, with the introduction of pension freedoms in 2015, savers are now allowed to cash out their final salary savings. In these cases, the state pension forecast provided by the Department for Work and Pensions (DWP) will still show the COPE, even though that pension pot no longer exists as a benefit.
According to Andrew Tully, pensions technical director at Retirement Advantage, “this is a complicated area of the state pension system and consumers do not necessarily understand what the COPE element is or how it relates to their overall pension savings”.
He said: “Someone using the pension freedoms could spend the COPE element of their pension and yet the DWP will continue to report it as additional income, though the state pension forecasts as systems do not tie these things together.”
“This is an area where advisers will clearly help their clients but if consumers do not have an adviser relationship it is easy to see how retirement plans can go awry.”
Chris Tagg, partner at Barnett Waddingham, told FTAdviser that this loophole should be make clear by the adviser to their clients when processing a pension transfer.
However, he said: “I don’t think this is a consideration at all [for advisers], they only look at critical yields.”
Alan Chan, director and chartered financial planner at London-based IFS Wealth & Pensions, claimed that it is still technically correct for the state pension forecast to show the pension pot as a COPE, even if it was cached out, since that is the reason why the individual pension is lower.
He said: “Without this info, it’s like a missing piece of a puzzle and the individual would be querying why his/her state pension is less that the headline amount.
“We normally ask the clients to obtain a forecast wherever possible, so that we can factor in the correct state pension amounts into our planning.”