Pension savers miss out on £720 million

Research recently published by Unbiased has revealed that UK pension savers are missing out on £720 Million in tax relief by failing to top-up their employers' pension schemes. Higher rate tax payers who make additional contributions are entitled to tax relief at up to 40% on contributions, which they make to improve their retirement income. These can be to the employer's scheme or to a private arrangement.

With many schemes under pressure and reducing the rate at which future benefits build up, or even ceasing to provide future benefits, it has never been more important for people to take personal responsibility for their retirement planning. Tax breaks are available for pension contributions as well as for other forms of saving. Unbiased have provided a tax waste calculator to help you find out whether you are making full use of the relief available to you. Find out how much tax you are wasting here

Half of all UK adults are making no retirement savings

A recent survey commissioned by the BBC suggests that half of all UK adults have made no pension savings. Only 36% of under 30's make any contributions and only 45% of 41 to 65 year olds contribute. Most cite lack of affordability but others expressed concerns about pensions given recent stock market falls and the well publicised failure of companies such as Equitable Life.

This is not as straight forward as it seems. For many on low earnings it is arguable that they are quite right in not making private pension contributions as this is simply likely to tip them over the threshold for state benefits of far greater value than the pension which they will receive. The UK government has tried to remedy this effect by introducing Pension Credits. You can find our more about Pension Credits here If you know what your expected private and state pensions are, you can can obtain an estimate of your entitlement, if any. It would be sensible for anyone on low earnings who is considering making private contributions to check whether they will actually be better off.

The FSA consumer website Moneymadeclear also provides a great deal of useful information, not only on pensions but other aspects of financial planning.

Whilst I recognise only too well that younger people can only afford very limited contributions, it is worthwhile mentioning that if an early start can be made with retirement planning a respectable level of retirement income can be built up at an affordable contribution rate. The opposite is also true. If contributions are left too late, it will be nearly impossible to make them up. In this table the FSA have shown estimates of the levels of pension which can be expected given different levels of contributions and starting ages.

For example, a 20 year old contributing £50 per month could expect a pension of £238 per month when they retire at 65. They would need to live just under 8 1/2 years after retirement (i.e. to age 72 1/2) which is within most people's life expectancy, i.e. they are likely to get their money back.

Of course, other assets can be used such as properties and business sale proceeds. These need to be factored into retirement planning. The key word here is 'Planning'. In order to ensure that you are able to achieve the level of income in retirement which is needed to maintain your standard of living, you need to have a plan which is updated regularly. The plan should be based on cash flow modelling as this is the only effective means of analysing the impact of different types of assets as well as changing levels of requirement.

Accessing cash in hard times

Many commentators are predicting that we are about to enter into a recession, as a consequence of which unemployment is likely to rise. With the housing market still in decline and credit being in short supply alternative sources of funds need to be found.

For the over 50’s there is a source of funds in the form of the tax free cash sum from accumulated pension funds. Most private pensions allow policyholders to draw a lump sum of up to 25% of the value of the fund. This can currently be taken from age 50 although from 5th April 2010 the minimum age will rise to 55.

It is not always necessary to draw a pension at the time when the tax free cash lump sum is taken. Instead the remainder of the fund can be allowed to continue to be invested according to the level of risk that the policyholder wishes to take. If an income is required this can be taken from the fund subject an upper limit, which is reviewed every five years, or in the form of an annuity which can provide a guaranteed income for life. The income is normally paid net of UK tax although expats can arrange for it to be paid without deduction of UK taxes but subject to tax where they reside. If the policyholder is trying to maximise the amount of cash in the short term they could take their entire first year’s entitlement to income from the fund as a single payment at the beginning of the year.

Potential funds from which benefits may be taken early include personal pensions, stakeholder pensions, retirement annuities, final salary (defined benefit) schemes and additional voluntary contributions (AVCs and FSAVs). In the case of final salary schemes and AVCs the policyholder needs to have left the service of the employer with which they built up the benefits. The proceeds from several different pensions of all varieties can be brought together in a single arrangement in order to allow the withdrawal of tax free cash.

Take a case where funds of say £80,000 have been accumulated in a variety of plans. Once they have been transferred, £20,000 can be paid out as a tax free lump sum. In addition a further £3880 gross (£3104 net of basic rate tax) could be paid as an upfront income payment from the fund.

This facility is not just useful to help clear debts. The capital released in this way can be used towards new business ventures or even as a deposit for people wanting to take advantage of the drop in house prices by investing in properties which they will rent out.

This article, of necessity, has been abbreviated in order to keep things simple. One should not forget that the primary purpose of pension funds is to provide an income when the policyholder or member no longer works. If benefits are taken early this will be at the expense of later income in retirement. Some private pensions provide guaranteed annuities, which can be forfeited if the policy is transferred elsewhere. Where benefits are transferred from a final salary pension scheme this could result in a smaller longer term retirement income and guarantees could be lost. These are just some of the issues that may need to be considered. Due to the complexities involved it is most important that advice is sought from a properly qualified pensions specialist before entering into any transactions.

Shop Around when you retire

BBC Breakfast on Saturday 21st June featured a piece on the importance of shopping around to ensure that you get the highest possible income when you retire.

This applies to those of you with private investment linked pensions. These operate on the basis that you make contributions during your working life to create a pot which you use to support yourself in retirement. At that point, you can typically take 25% as a tax free cash sum and the rest must be used to provide an income in one of a variety of ways. For most people of relatively modest means the most appropriate option is likely to be an annuity.

Annuities come in all sorts of shapes and sizes. They can be paid monthly, quarterly, half yearly and yearly, in advance or arrears. Payments in arrears tend to be greater than in advance. For example a pension yearly in arrears will be better than a pension monthly in advance. They can be level or escalating and can include various levels of provision for spouses and dependents. They can also include a degree of capital protection so that the fund is not all lost should you die shortly after retiring. Enhanced annuity rates are available to smokers as well as to people in poor health.

A key aspect of annuities is that once you have made your choice and the annuity has been put into force, you cannot change your mind. It is therefore critically important that you carefully consider your requirements – and those of your dependents- before you commit yourself. If you suspect that your health may qualify you for a better rate check out enhanced rates.

The Financial Services Authority, the body which regulates the financial services industry, has produced a useful booklet which summarises your choices on retirement. You can access it here

The thrust of the BBC piece was that a large number of people do not appreciate that when they retire they do not need to buy an annuity from the company with which they built up the pension fund. All pension providers are required to offer what is known as the ‘Open Market Option’, which is the facility to take the fund to another company where an improved annuity can be provided. As a consequence they are losing a substantial amount of money.

The importance of checking out the Open Market Option cannot be overstated. Most pension companies do not offer good annuity rates. Prior to retirement they issue a pack of information containing a range of options and this will mention the open market option. However too many people ignore this to their cost.

So how do you find out more about the Open Market Option? See an independent financial adviser. They will not only be able to shop around for you but they will also be able to advise you on which on the other benefits you should include such as a spouses/dependents pension, escalation etc. They will also be able to liaise with the various companies involved to ensure that your pension comes into payment with a minimum of delay.

As a practitioner I can assure you that this is not merely a theoretical exercise. Barely a month goes by when I don’t help someone shop around for the best rates. Most recently this has resulted in a pensioner increasing their income by some £3000 per year.



Chris Wicks CFP
I help you achieve your lifetime goals for reasons that are important to you