Most law firms leave it to partners to make plans for their retirement, but they are often too busy to spend time on their own financial planning and fail to take the adequate steps. Mike Fosberry explains the difficulties this can create and why encouraging partners to make arrangements is a more prudent approach.
The major asset for most law firms is the partners working in the business. It is therefore surprising that, when it comes to providing retirement income, most firms take the view that it is the individual partner's responsibility to organise this and make the appropriate arrangements.
However, unless law firms actively encourage – or even oblige – partners to make full provisions for their retirement, this could make succession planning difficult. Partners who have not made adequate retirement provision could end up in a situation where they cannot afford to retire. The Leslie Seldon case highlights some of the problems around this issue and the difficulties for all parties.
Smith & Williamson recently carried out a survey in which 119 firms took part, including 54 from the UK's top 100. The results give an interesting insight into what are typically private arrangements that have relied on the partner taking personal responsibility.
Responsibility
Of the firms that took part, only 14% said that, while it is the partner's responsibility to get advice, the firm pays for it. This approach tends to be more common among larger firms.
The remaining 86% confirmed that it is the responsibility of individual partners to make provisions for their own retirement. Yet nearly two-thirds of firms fail to specify this in their partnership agreements.
Allowing partners to make their own retirement choices – without any senior management oversight of the arrangements in place – could have serious implications for the future management of the partnership. Partners are often too busy to spend too much time on their own financial planning – the analogy of the cobbler's own shoes springs to mind.
Partners who have not made adequate retirement provisions could end up unable to afford to retire, making succession planning more difficult. However, even though partnership agreements may include a fixed retirement age, it may not actually be enforceable under the Equality Act. In many cases, a review of the partnership agreement regarding retirement provision would be wise.
Education
The key is educating partners to plan for retirement. Partners should be encouraged to fund their retirement without the need for firms to adopt a 'big brother' approach. But are formal pension arrangements necessarily the only answer?
Pension contributions offer a cocktail of tax reliefs – especially for higher-rate taxpayers – that clearly make them attractive. It is difficult to see how this, or any future, Government could take away higher-rate reliefs for pension contributions as those in employment could maintain this relief by simply taking reduced remuneration. The employer could then make a contribution, equivalent to the sacrificed remuneration, to their pension fund.
In his 2012 Autumn Statement, Chancellor George Osborne announced a cut in the annual contribution allowance from £50,000 to £40,000 from the 2014-15 tax year. He seems to see pensions as a relatively soft target and so there could even be further reductions if his growth forecasts are not met. The message must be to take advantage of the higher allowances while you can.
While pension investment is highly effective in building a retirement fund, annuity rates are particularly low at the moment, as has been widely reported. These low rates reflect the level of long- term gilt yields and increasing longevity. In the short term, there seems little prospect of a rise in interest rates as the UK economy is showing little sign of growth. But most commentators believe that continued quantitative easing will result in higher inflation, which could fuel a rise in interest rates.
However, many with larger pension funds are unlikely to ever buy an annuity with their pension fund as the flexibility of income drawdown in retirement will appeal.
How much is needed in retirement?
An accrued pension fund of £1.25m (the reduced rate of standard lifetime allowance that will apply from 2014-15) would purchase a pension of £24,750 (based on quotes as at 18 March 2013, via the Avelo portal for a 65-year-old male) on a fully index-linked basis for a 65-year-old.
In the event of the individual's death, it would continue on unabated to their spouse (assumed to be three years younger). If the spouse's pension reduces to 50% of the main pension, then the initial starting level will increase to £28,400 at current rates.
It is unlikely that partners would consider it palatable to retire on these sums given that this is the pre-tax gross pension. The basic state pension will provide a slight top-up but, for many, this will be a negligible amount and not payable until they are possibly 68 years old.
Against this backdrop, some partners will need to consider taking action – the sooner, the better. Given that pensions now seem to be seen as a soft target – evidenced by the number of pension changes in recent years, all of which have sought to erode the tax benefits – securing the current reliefs for pension savings becomes ever-more important. Our survey indicates that many partnerships are not focused on this issue at all.
For most partners, the best starting point is to look at what they might need in terms of income at retirement and then to plan how they will accumulate sufficient capital to finance it. It is important to consider a range of investments for retirement planning, such as individual savings accounts (ISAs), which can allow husbands and wives to build up substantial capital sums over several years by maximising their annual ISA allowances.
Bearing in mind the long-term issues for the partnership itself, it is prudent to give partners every encouragement to start this process as early as possible. Many will not take any action unless they are encouraged to do so. Action such as setting aside pension contributions as a first call on a partner's drawings can help reinforce this message.
Protecting profits and dependants
When it comes to the issue of the untimely death of a partner, nearly half (46%) of the firms in our survey do not have insurance cover to protect their profits. This figure increases to 68% in firms with 100 partners or more.
Larger firms tend not to have insurance cover to protect profitability, as the loss of a single partner is unlikely to impact significantly on profitability in the same way it might for smaller firms.
However, for smaller practices, where the loss of a key partner could prove disastrous, there is little excuse for not taking action to protect their most valuable assets. Providing funds in these circumstances to cover both loss of profits and payments of partnership capital to the deceased's estate should be good business practice. Do not forget about the issues that could arise from the long-term disability of a partner.
Overall, firms seem to be better at protecting partners' dependants, with 70% providing insurance cover for this in the event of an untimely death. Larger firms tend to be better at protecting dependants. Smaller firms need to consider this option as part of their partnership planning. If they do not have the resources to manage this in-house, it may be worth outsourcing the establishment and ongoing administration of this important benefit – perhaps alongside life assurance cover for their staff.
The larger the number of people covered, the more likely it is that there will be reductions in premium rates and free cover levels before underwriting is required, which helps reduce cost and administration.
Partnerships that do not manage these risks are effectively transferring the risk to their balance sheet, which seems unwise when taking a more pragmatic approach will resolve the problem.
Originally published in Legal Week
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