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Calendars and Tripods
April saw the biggest, and by far the most popular, changes to pensions ever. Any requirement to buy an annuity – hugely disliked due to the poor levels of income they offer – has been abolished with savers now free to do whatever they like with their pension pots after the age of 55. But to take full advantage of the changes it’s important that you prepare properly, understand your wealth calendar (more on this later) and discuss with us your needs and wants.
There has been a huge amount written by our industry on these changes, most of it overly complicated, in fact at the start of the year (5th January) Guardian Money prepared a 10-point action plan, aimed not just at individuals on the point of retirement, but at all savers from their 40s upwards who are putting money away regularly to finance a pension.
However a 10-point action plan, is in my opinion, 7 points too many.
Good things come in threes!
The rule of three ‘omne tium perfectum’ principle suggests that things that come in threes are inherently more humorous, satisfying and effective than any other number of things. This is definitely the case in Wealth Planning where the 3 components that create the foundation are
- A Financial Plan
- An Investment Strategy
- A Taxation Plan
This foundation, a tripod if you like, helps manage your goals, helps you achieve your targets by managing market movements and puts you in the best possible position by maximising your tax position when you need it most.
So with your tripod providing a strong foundation and your wealth calendar - a simple concept - detailing and highlighting all of the important events that will affect your finances in 2015 and the more you understand these the better. So expect to hear more about these as we go through the year.
The pensions changes, what are they and how are you affected?
It’s now that the changes are normally complicated with language such as Defined Benefit pensions, Pension Commencement Lump Sums and Phased Income Drawdown.
Of course this language has a place but really pensions are either about Saving or Spending. The good news about the changes that happened in April are that regardless of whether you are Saving or Spending there are benefits for all.
Summary of Changes
1. Complete Flexibility:
Over 55s can take their monies how and when they want to.
2. Tax Free:
25% of the funds still free of tax when taking an income.
3. Tax Reductions:
Rules on taxes on death have changed considerably, with an ability to pass your pension fund onto named beneficiaries in some circumstances tax free.
4. Tax Relief:
Savers continue to benefit with tax relief on their savings.
The changes that the chancellor announced last March only affect defined contribution pensions, that’s a pension that you save into and when you choose to retire you use the value of your fund to provide an income.
If you are lucky enough to have a final salary-style scheme (Defined Benefit pension) then the changes won’t apply to you. The final salary pension is exactly that an income based upon a percentage of your final salary, generally considered a great benefit.
This leads us to the first point in my 3 point plan
1. Know what you have and keep it in one place if appropriate.
Did you work for a number of employers before settling on your career path? What type of pension was it? What is it’s current value? Where is it invested? How much is your State Pension worth?
Long-forgotten pension plans can end up wasting away in expensive, poorly performing funds, with the paperwork alone enough to put you off becoming more proactive, so perhaps you should transfer them and keep them under one roof? There are advantages to switching your pensions, but also pitfalls – such as charges (called exit penalties) of up to 15% to transfer a few old-style pensions before the stated retirement date.
2. Consider the tax consequences.
Amid all the hype and rhetoric about the new pension freedoms, hidden away in government documents was an estimate that they will raise nearly £4bn extra in tax from the reforms. Why? Because all those people who cash in their pension pot immediately will have the money treated as income for that tax year.
Someone with a pension fund of £300,000 is eligible for 25% tax-free, but the remaining £225,000 is taxable – potentially landing them with a £121,127 tax bill unless it’s effectively managed. Generally, it’s best to manage the drawdown of your pension money while keeping below the threshold for 40% tax.
3. If you’re under 55, pile money in, if in your 60s consider boosting your State Pension.
Under 55s, paying in as much as you can afford, can be among the best financial decisions you can make, especially now you are free to do what you like with the money after the age of 55. For a 40%-band taxpayer, that means you effectively pay in 60p to get a pound out (£1 minus the tax relief). It’s a no-brainer. Of course the government have introduced rules that limit how much you can pay in annually once you have started to take an income, so ensure that you maximise payments before starting to take an income.
If you are in your late 60s and set to retire you are able to buy up to £25 a week of extra state pension under a scheme which is particularly beneficial to many women who went part-time and/or took a career break to raise a family when they were younger, and also to the self-employed.
For example, to obtain an extra £1 of pension a week (£52 a year) for life, will cost a 65-year-old around £890, while to get the maximum extra £25 a week (£1,300 a year) of state pension, someone aged 65 would need to pay more than £21,000. As you get older, the cost comes down. There is a full calculator at gov.uk/state-pension-topup.
If you are still working in your late 60s, you can choose to defer taking your state pension and, in return, the government pays you more in later years. But it’s a finely balanced calculation. If you reach state pension age before April 2016, it’s very good value; defer it by one year and you’ll get an extra £611 a year on top of the current £5,881.20 a year. But it’s bad news if you’re retiring after that, as the government has halved the value of deferrals for people retiring beyond April 2016.
So the 2015 Pension - Freedom and Choice changes are indeed momentous and the changes outlined underline the importance of planning and maintaining your plan cannot be under estimated.
At Principal and Prosper we are here to help and we know having as many options as possible to maximise the tax efficiency of your income is part of any good financial plan, therefore your adviser will discuss the variety of options available that best suit your circumstances.
This is based on our understanding of current HMRC rules and regulations which may be subject to change.
Darren Scoon (Strategic Business Manager)
"A 10-point action plan, is in my opinion, 7 points too many."
Darren Scoon (Strategic Business Manager)