Pension and Retirement Planning

What is your retirement strategy and what income/cash do you want to achieve to meet your objectives on time? Are you on target? Taking retirement planning advice early (around 6-12 months before your intended retirement date) is usually worthwhile.

Financial Planning is key to meeting your objectives, whether you plan to stop work entirely or reduce your workload as you ease into retirement.

Personal Plans, Retirement Annuities, Stakeholder Pensions & SIPP's

Since the introduction of stakeholder pensions in 2001, new pension plans have become more flexible with lower charges. Some of the older type schemes, such as retirement annuities and executive pension plans (EPPs), can have significant advantages such as guaranteed annuity rates and the level of tax free cash available. These need to be checked to understand the significant value that they could offer.

Talk to us about your objectives. You may have undertaken planning in the past and the changes that occurred at Pensions 'A' day in April 2006 may affect your existing plans. (See below)

Occupational Pension Plans, Final Salary & Money Purchase

These have become very topical subjects in recent times, usually for the wrong reasons. Careful advice needs to be sought to ensure that the employee gains the real benefit that was originally offered by the employer and from any Additional Voluntary Contribution (AVC) fund (or FSAVC) they have accumulated, and that the employer controls their costs. We can offer you advice on these plans to meet your individual needs.

Advice can be provided on all types of occupational schemes, such as Small Self Administered schemes (SSAS), Executive Pension Plans (EPPs), Final Salary and Money Purchase arrangements, including AVCs. Other alternatives may include SIPPs.

Keith Churchouse is an authorised adviser to the University Superannuation Scheme (USS pensions) in conjunction with the Personal Finance Society (PFS).

Pensions 'A' Day and its effects/ Tax year 2010/2011

The reform and simplification of pension rules, called Pensions ‘A’ day (April 2006), introduced some radical changes to how pensions are contributed to, invested in and drawn from.

Pension benefits can be taken at any time between ages 55 and 75, and you do not have to retire to take the tax free cash (if available) or taxable income.  From this tax year (04/2010), the minimum pension age has been increased to 55 from 50 (unless ill-health early retirement is permitted).

The new rules also introduced a "Lifetime Allowance" for the maximum amount of all your tax favoured pension savings. This is £1.80m for the tax year 2010-2011 and is now fixed until 2015/2016. Special valuation rules apply to defined benefit (e.g. final salary) schemes. The “Lifetime Allowance” takes into account the value of an individual’s benefits from all pension plans including those taken before 6 April 2006 (Pensions ‘A’ day). This allowance can be utilised in stages or all at once.

Testing of the lifetime allowance will be carried out when you take your benefits. How benefits are secured will have an impact on how they are valued.

If benefits over the Lifetime Allowance are taken, a “Lifetime Allowance charge” will apply i.e. you will have to pay tax on any excess over the £1.80m allowance. Any amount above the lifetime allowance can be paid as a pension benefit or lump sum cash benefit but will be subject to a tax charge, currently 25% if taken as pension income (plus the income will be charged at the individual’s marginal rate of income tax) or 55% if taken as a lump sum.

My recommendation is that all clients pensions benefits (and those that should be funding for retirement!) should review their existing arrangements to ensure that they have made the most of the significant opportunities available to them in the current pension regime. This includes members of occupational pension schemes who really have scope to capitalise on their existing arrangements. Proactive management of your investments is key.

Accumulation

Charges, term, contribution level, investment choice. All these are mixed into your retirement fund to determine its outcome.

Our objective is to provide good quality, low cost plans that perform well.

What we will need to understand from you is the level of risk that you can accept to achieve growth in your plan taking into account the term that you have to retirement, or eventual annuity purchase/alternatively secured pension (ASP), possibly age 75.

We also believe that diversity of investment is important, all eggs in one basket is sometimes not the best answer. Having reviewed you circumstances and needs, recommendations can be made to optimise the accumulation in your plan. We would be happy to liaise with your Accountant/Accountants to improve your overall wealth management and tax position.

As always, you need to know that the value of your investment can go down as well as up and that past performance is not a guarantee of future performance.

Drawing Pension Benefits

We live in unprecedented times in most aspects and areas of financial planning. But for those who had planned to retire in 2009, there are some difficult decisions to be made in light of the current economic climate. With fund values and annuity rates having fallen and the real rates of costs increasing (CPI 3.5% March 2009) it is an anxious time for many.

In my view, taking financial planning advice has never been so important for retirees and potential retirees in this climate. Starting the advice process early is vital, years in advance, to ensure that retirement is as comfortable as was anticipated when the client first started saving all those years ago.

So why start planning so early? In my view, this is because of the many options that are available for retirement benefits and that fact that each client is different, with different expectations, anticipations and assets available to meet these requirements.

Taking this a stage further, we need to consider what options are available for retirement income and, in the current climate these may, or may not be, beneficial. I have listed examples below:

1. Defer retirement until later.
2. State pension benefits.
3. Need for tax free cash.
4. Buying annuity benefits, taking into account the clients requirements and circumstances, such as health, smoker status, spouses benefit, tax position and protection against inflation.
5. Phased retirement, including short term annuities.
6. Income Drawdown.

Deferring retirement, State Pension & Need for tax free cash

Deferring state pension is an option at this time, especially for those who may not have planned to take pension benefits now. These may include those being made redundant at a later stage in their working career. Dependent on the circumstances, using other savings (or a redundancy payment) to subsidise income in the shorter term may be a real option if the pension fund value has fallen and needs to recover. However, a cautionary note needs to be added here. The minimum retirement age is increasing from 50 to 55 from 2010 and some may fall into a trap of having access to their funds one year and having this withdrawn the next. To reiterate, it is the advice at this stage after careful consideration of the situation that will guide a client appropriately. If someone continues to work past their state retirement age, they can also defer their state pension. The advantage of this is that this pension increases by 1% for every 5 weeks deferred. This amounts to about 10.4% for a full year and this can be valuable in the right situation.

Normal pension benefits have to be drawn by the age of 75. However, in the budget of June 2010, it was announced that a review and consultation of this option is now underway with its results to be revealed in April 2011. Also, notes on the transitional measures state that pending implementation of the necessary changes, legislation will be introduced in Finance Bill 2010 to increase to 77 the age by which members of registered pension schemes have to buy an annuity or otherwise secure a pension income.

As always, advice should be sought on this issue before taking pension benefits.

In an ideal world, I would like to see a client enter retirement debt free and with 3-6 months income on easily accessible deposit in case of an emergency. This may not always be possible, but the ability to take tax free cash at the time retirement benefits are drawn may be used for this issue. Tax free cash can now also be taken from funds accumulated by Protected Rights or Safeguarded Rights, which are Protected Rights transferred under a pension sharing order. Therefore, care needs to be taken, especially if the benefits are being drawn from a final salary scheme or policy with a guaranteed annuity rate as the cash gained may be at the loss of an annuity rate that cannot be replicated elsewhere.

Retirement Options

You can choose the type of income you take.  This could be in the following formats (or a combination of them):  

1. To purchase an annuity, including short term annuities.
2. To phase your retirement by purchasing annuities/taking income on a year by year basis with segments of the overall fund while leaving the remaining fund invested.
3. To take income from the invested fund on a year by year basis (‘income drawdown’)

Annuity purchase   

Historically, the most common way to take retirement benefits under pension plans is to purchase an annuity. An annuity is a level or increasing income for the rest of your life and is taxed in the same way as salary.

An annuity gives you payments at stated intervals until your death. You give your pension fund either to the insurance company that you have built up your funds with or to another on the open market to purchase as large an income as possible for the rest of your life. There are a number of types of annuity, which include Guaranteed, Unit Linked, With Profits and Impaired Life/Smoker Annuities.

I believe that in the past, the smoker and impaired life options have not been utilised as much as they might have been. With the introduction of postcode annuities (where rates may be higher dependent on where you live), I feel that these options are going to be a growth area.

All too often a final and binding decision has to be made about private and company pension benefits. This affects the rest of your life and need not be so with careful planning in advance. Many annuitants do not know that they can use their Open Market Option (OMO) to increase income from their fund and although our industry has improved communication of this option, it still has work to do.

Phasing

This option certainly has mileage in the current climate. Many clients have a few pension plans rather than just one. You can select which plan to draw, rather than using all of them, to provide some income and tax free cash now, whilst keeping the balance invested with the aim of recovering (although this cannot be guaranteed) from any falls that they may have suffered in the recession. Also, some pension policies offer the benefit of segmentation, where parts of the policy can be used, rather than the total plan, allowing greater flexibility in how benefits are deployed.

These options have been attractive to many clients in the last 6-12 months.

Many would also argue that the introduction of shorter term annuities (up to 5 years, introduced at pensions ‘A’ day is a form of phasing and can work well for some. Personally, I would like to see this market mature further before giving final judgement.

Personal Pension Income Drawdown

The benefits and flexibility that these types of plans can offer have to be placed carefully in context with the additional risks that they attract. I would normally expect to see a minimum pension fund value after tax free cash of around £120-£150,000.

The main advantage is that you do not need to buy an annuity at the moment, although under current legislation, an annuity or an alternatively secured pension (ASP) would eventually have to be purchased by age 75. Initially you could take the maximum tax free cash and the residual fund would be used to provide an income, if you choose.

Income drawdown is suitable for some clients who already have income or capital from other sources and do not need to maximise the income from their pension funds.

When you start an income drawdown contract, the maximum level of income is calculated and this is based on 15-year gilt yields and uses a formula given by the Governments Actuaries Department. This then gives you the maximum income you can take initially which equates to around 120% of the annuity income detailed above and there is also a minimum level, which (due to changes at ‘A’ day) has now reduced to nil. It is not normally recommended to take the maximum income. The maximum and minimum income levels are recalculated every five years and income can be varied within this period as long as the maximum and minimum figures are not exceeded. Any income provided will be taxed at your highest marginal rate.

Death Benefits

One of the main advantages that income drawdown has is the superior death benefits.

If you buy an annuity, then if it is simply on your joint lives and there would be no return at all to your estate on your death beyond the guaranteed period that might be written into the contract. With income drawdown, the residual fund is available. If you die whilst taking income drawdown, your dependants will be able to receive the value of the remaining fund as cash less a tax charge of 35%. Any residual fund should fall outside your estate for inheritance tax purposes.

Risks

There are therefore risks involved in income drawdown. The fund may not grow as hoped and this could lead to an eventual shortfall in income in later years. Annuity rates may fall further in the future and the annuity that is eventually purchased could be lower than if one were purchased now. There are also other risks and issues to take into account such as charges (higher under this type of contract than an annuity) and mortality drag.

Investment diversification

However, for a client that has enjoyed investment diversification during their working life, retirement does not mean that they have to avoid asset allocation. The growth in SIPP contracts in recent years has been a testament to investment diversification with sophisticated asset allocation tools being employed to help with pension growth. If someone has been planning for retirement, then they may well have their allocation of funds in place before retirement, allowancing tax free cash and income to be available when needed.

Summary

I do not believe that taking retirement benefits now is a poor option, although it may require a little more careful planning and lateral thinking to make the outcome as effective as possible. There are pitfalls if advice is not taken. As ever, the ability to take independent advice is more important then ever.  

We are qualified to provide bespoke advice on all areas of retirement planning, both for private and occupational pension schemes. We would be pleased to guide you with the objective of achieving greater value either through better terms or reduced taxation.

Please note that this is for guidance only and that the information outlined in this document is not intended as personalised investment advice and may not be suitable for everyone. You should seek independent financial advice before proceeding further. The Financial Services Authority does not regulate taxation and trust advice.