PENSIONS – BEFORE AND AFTER

There are two sides to pensions – saving enough before you retire and making the most of what you have saved when you do retire. The Government is raising state pension age to 65 for women in 2018 then to 66 for men and women in 2020 and to 67 in 2028. Those changes will affect people in their fifties and sixties now. Younger people will have to wait longer – to around 70 for those now in their twenties. As life expectancy increases the government plans to raise state pension age so people spend about two thirds of their adult life paying into the state pension and about a third drawing it.

Of course, state pension age and retirement are not the same thing. More than a third of women and a fifth of men work after state pension age, many through necessity. That figure will probably grow as people stay healthier for longer and are disappointed with the pension they earn at work. Saving more now and using what you have saved sensibly can help you retire earlier and live a better life when you do finally say goodbye to work.

The state pension will be around £7700 a year in present day terms for most of those who reach pension age from 6 April 2016. Some who get a pension related to their salary and were contracted out of SERPS will get rather less as the SERPS part will be paid as part of their pension from work. The state pension is not huge, but it is very valuable. A healthy person aged 65 would need more than £125,000 in their pension pot to buy a pension of £7700 a year – and that would not rise in future. To buy that amount protected against inflation would require a fund of more than £200,000. The average amount in a pension pot is around £30,000 which would buy a healthy person less than £2000 a year without inflation proofing.

A report by the Pensions Policy Institute published last October found that the average rate of contributions to workplace pensions – about 6.5% from the employer and 3% from the employee – was too low to provide an adequate income in retirement. The contributions into the new auto-enrolment pensions will be even less. That tells us that we should be putting every penny we can afford into a pension. Contributions are completely free of income tax. If you pay £100 out of your net income into a pension the Treasury adds another £25 – the income tax you’ve already paid to have £100 left. And if you are a higher rate taxpayer the Treasury adds another £67. Which is why half the tax relief is paid to the better off. Find a scheme with low charges and a boring investment approach such as a fund which tracks the UK stock market. As you get older you may want to consider a genuine cash pension fund but with current rates around 1% few will be attracted to that option (see Saga Magazine December 2012 http://www.paullewis.co.uk/archive/saga/2012/20121201Works.htm). 

RETIRING
At some point the day will come when you want to convert your pension savings into an income to retire on. First check if there are small amounts in old pension schemes that came with a past job? You can check using the free service at www.gov.uk – search for ‘pension tracing’. If your total pension pot is worth no more than £18,000 you can take it as cash – the first quarter is tax-free the rest is taxable in the year you receive it. The value of a pension from a past job counts towards this £18,000 and first has to be converted into a capital amount. Ask the pension scheme administrator how it is converted into a pension pot value – it will be multiplied by up to 20. So a pension of just a few hundred a year can take you above the cashing in level. Even if you are above that level up to two very small pots of up to £2000 each can be cashed in.

If you have too much to take as cash you can take 25% of any pot as a tax-free lump sum. That gives you complete freedom about how to spend at least a quarter of your money. And as you paid in tax-free and can take the cash out tax-free it is even more attractive.

The rest has to be converted into an income. The traditional way is to buy an ‘annuity’ – a pension life. But the complexity and value for money of annuities have been heavily criticised by commentators, most recently by the Consumer Panel which advises the Financial Conduct Authority. In a damning report it says that choosing an annuity is ‘confusing’ ‘complex’ and ‘a lottery’ and it concludes “The chances of mass consumer detriment are…too high to trust current market driven solutions” and it recommends new regulations to control the business.

Any changes to the rules will take time. Meanwhile find a specialist independent financial adviser with financial planning and retirement qualifications. Track one down through www.unbiased.co.uk. The adviser will charge a fee – best to pay it upfront – but it may well be less than you lose in hidden commission with an online service that offers no advice. There are also a very few good specialist advisers who only do annuities – choose one that has been working in the field for a long time and is ‘whole of market’. If your health is poor or you smoke you can get a higher annuity. Online comparison sites will guide you but many are not independent and demand personal details which will be used to pester you with calls and emails. The Money Advice Service is different – its comparison tables cover the whole market and it is not-for-profit. It does ask for some personal details but does not keep the information or sell it on. See www.moneyadviceservice.org.uk

An annuity is a once and for all gamble on how long you will live. You hand over your money, the insurer pays you an income for life and when you die the insurer keeps whatever is left (you can protect it for five years at negligible cost). An alternative is to keep the fund in what is called ‘drawdown’ and take money out of it as you wish. Anything left when you die can be passed to your heirs – minus a hefty tax charge. Drawdown income is taxed and there are annual charges for looking after and investing your fund. Advisers normally say it is not worth doing if you have a pot of less than £50,000.

Normally drawdown income is capped by the Government – currently at around £7000 a year on a £100,000 fund at age 65. But if you have other guaranteed pensions which total at least £20,000 a year – including the state pension, any other annuity, or a company pension – you can draw down as much as you like from your fund as you need it. It is called flexible drawdown and is a good option for those who can do it.

More information
The Pensions Advisory Service gives free and independent advice about all state, work, or personal pensions www.pensionsadvisoryservice.org.uk or call 0845 601 2923.

e-mail Paul Lewis on paul@paullewis.co.uk