The Rising

Dominic Thomas
October 2023 • 3 min read

The rising

We have all been aware that prices have been rising, some rather more than the officially stated rate of inflation (are they kidding?). You are equally likely to be aware that interest rates on cash deposits have been slowly creeping up, reflecting the Bank of England lending rates. Most of the Banks and Building Societies were shamed into increasing rates by the regulator, the financial cartel has slowly limped to improvement in their offerings. At the time of writing, global equity markets are up about 7.28% over 12 months or 9.96% since the start of 2023.

This has also meant an increase in annuity rates, which are a fair bit higher than 12 months ago. Annuity rates are based on life expectancy and economic conditions, notably interest rates. For example, over the last year, according to Standard Life, annuities are up about 20%. However a little warning about the statement, there is a sense of ‘if only’ about these sorts of things…

If you were quoted for an annuity last year at age 65 (for example) you would be 66 now. As a result your annuity quote would be more anyway due to the fact that you are a year older. The older you are the better the deal, because it’s about your life expectancy (how much is left of it).

If you had bought an annuity last year at the prevailing rates, you may be a little miffed, as most of them do not increase with inflation each year. In simple terms you use a pension fund (usually) to buy a fixed income for life. This is either just in your name or with a spouse benefit (the income will continue at the same level or a lower amount each year). When the annuitant dies, generally the annuity stops, unless there is a spouse benefit or a special guarantee has been bought (so would pay the estate). You can certainly have an increasing annuity, but normally at fixed terms of 3% or 5% at the most. However these are costly and tend to be much lower, typically taking 12 years to catch up before actually paying more each month than a level annuity.

Let’s suppose you have £100,000 and are 65 – a single life, level annuity would provide about £7,462 a year (roughly). If you had been born a year earlier and turned 65 in 2022, you would have an annuity paying around £6,218 a year. This is nothing to do with investments performance, but everything to do with interest rates. Over time, that difference becomes more significant the longer you live.

The other odd thing about annuities is that if you are not in great medical shape, you may well qualify for an enhanced annuity, perhaps 30%-40% more. This is due to the expectation that your life will be shorter than average.

So had you waited you would be able to get a bigger annuity, if your health had worsened you would have a better annuity, if your spouse had died, you would get a better annuity. All pretty grim really. These are all things that we cannot predict, other than that you age. It’s also why we ask you about your health and plans. These are not insignificant issues. Let’s talk about them.

BACK TO ALL BLOGS

The RisingJemima Thomas2023-12-01T12:12:27+00:00

HOW MUCH FOR A HAPPY RETIREMENT?

TODAY’S BLOG

HOW MUCH FOR A HAPPY RETIREMENT?

Doubtless your will have heard of Which? Magazine. They conducted a survey recently in an attempt to understand how much is really enough for people to have a comfortable retirement. They concluded that a two-person household needs an average annual income of £26,000 for a comfortable retirement.

However you have coped with the pandemic, many people have not been able to spend money in the way they normally would. Many have saved the sums that would have been spent on holidays, travel, commuting, work clothes, weekday lunches, meals out and so on. This has given many of us the opportunity to pause for thought and reflect on how much we spend and the lifestyles we lead.

Some people have elected to retire earlier than they had planned, some have had this forced upon them. In practice, the warning signs for higher unemployment have been around for some time. We shall all begin to see the reality of things once the lockdown ends properly and the furlough system comes to an end. I do not see this going well. I implied, no… I stated that the Budget in March worked on the assumption of unemployment rising by 500,000 over the next 2 years with the largest increase in the current 2021/22 tax year.

£26,000 OR £19,000

Anyway, many have been giving thought to how much income they are likely to need when they stop earning. In February, Which? asked around 7,000 retirees about their spending.

The findings can be used as a guide to how much people are likely to spend and how much they might need to save, factoring in the state pension and tax bills. Couples need a pot of around £155,000 alongside their state pension to produce the annual income for a comfortable retirement of £26,000 via pension drawdown – or just over £265,000 through a joint-life annuity. Two-person households would need around £442,000 in a drawdown plan to fund the luxury retirement target (£41,000 per year) – or £589,000 if they’ve taken the full 25% tax-free lump sum available at the outset. If you opt for the guaranteed income provided by a joint-life annuity, you’ll require an initial fund of around £757,000.

For single-person households, achieving a comfortable retirement would mean a pot of around £192,290 alongside the state pension to get to an annual income of £19,000 via pension drawdown, or £305,710 through an annuity. For a retirement at the ‘essential’ level, single-person households would need £77,350 in a pension drawdown or £123,365 to buy an annuity plan to meet an annual target income of £13,000. A couple receiving the current average amount of £155 each per week will get just over £16,000 a year to add to private pensions. Pension drawdown figures are based on the savers withdrawing all of their income over 20 years from the age of 65, with investment growth of 3%, inflation at 1% and charges levied at 0.75%.

TWADDLE – THAT THING ABOUT ASSUMPTIONS

So let me respond by clearly saying “twaddle!” but it’s a helpful guide.That is all it is, there are huge holes in the assumptions and thinking, for starters, assuming a 2 decade retirement. Life rarely happens so “neatly”.

Over the years our processes have evolved with the technology that is available. We stress test your financial plan each week. Considering the likelihood of your life expectancy to the tenth percentile… which means the 1 in 10 chance you live a really long time. We consider sustainable income levels that fluctuate with inflation and changing investment returns based upon historical facts rather than regulatory unicorn utopias.

In any event, why would you care about a survey where your lifestyle is dictated? Surely your financial plan should be about protecting and ensuring that your current lifestyle endures as long as you do…. Or do you want less?

That’s why it is important, no – why its vital to have your own plan, based on sensible assumptions that we review together. Unless you have some mind-blowing news for me, you get one life and the clock is ticking. So have your own plan, know what you want and check with us that you are on track.

Need help? Know someone that does? get in touch... share the truth. It won’t hurt.

Dominic Thomas
Solomons IFA

You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email info@solomonsifa.co.uk

GET IN TOUCH

Solomon’s Independent Financial Advisers
The Old Bakery, 2D Edna Road, Raynes Park, London, SW20 8BT

Email – info@solomonsifa.co.uk
Call – 020 8542 8084

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PRIVACY POLICY | DATA PROTECTION

GET IN TOUCH

Solomon’s Independent Financial Advisers
The Old Bakery, 2D Edna Road, Raynes Park, London, SW20 8BT

Email – info@solomonsifa.co.uk Call – 020 8542 8084

7 QUESTIONS, NO WAFFLE

Are we a good fit for you?

Take Survey

PRIVACY POLICY | DATA PROTECTION

HOW MUCH FOR A HAPPY RETIREMENT?Dominic2023-12-01T12:13:06+00:00

Are Annuity Rates on the Rise?

Solomons-financial-advisor-wimbledon-blogger

Are Annuity Rates on the Rise?

Annuities may be starting to improve again. Why is this relevant to you? Well, if you plan to retire you would be wise to consider an annuity as an option for all or part of your retirement income. If you are already retired and using a Drawdown arrangement, improvement in rates may also be worth your attention.

New Rates

I recently received an email from one of the UKs largest insurance companies advising of change to their annuity rates. In general rates have begun to increase upwards. As an example, a 65 year-old with the maximum single life annuity from £100,000 would now receive £4,944 a year rather than £4,896 a year, an increase of about 1%.

How long is a lifetime of income?

Anyone wanting to build in a spouse’s pension of 50% (i.e. once the “owner” (annuitant) of the annuity dies, income would reduce to 50% for the remainder of the spouse’s life) can expect the same fund to buy an annuity of £4,420 up from £4,375. These are for level annuities (the income remains the same). You could build in a degree of inflation-linking, doing so would reduce the initial income for a joint life annuity £2,818 a year increasing by 3% each year.

The crossover point

The alarming detail is that it would take 17 years (in my example) for the inflation (rising) annuity to match the annual income of the level annuity, at which point it continues to pay out more each year (i.e. a 65-year-old would be 82). It takes a total of 30 years before the total income paid out would exceed that of the level annuity. Remember that this is for someone that started their annuity at age 65.

In truth, there are better annuity rates out in the market. You should also note that if you have any form of health problems, or smoke, you would probably qualify for an enhanced annuity. However most people would look at a pot of £100,000 and think an income of £4,420 is not terribly much and any “bells and whistles” added just make it worse. Hence pension freedoms and the abolition of the requirement to buy an annuity.

However, despite appearances annuities offer a guaranteed lifetime income, no other alternative really does that, but instead relies upon investment returns, which obviously means risk. Since pension freedoms (April 2015) many people have chosen not to buy an annuity and have taken their income from a drawdown pension instead. Unfortunately, according to recent research, many will run their pension pot dry within 12 years. Most people take too much it would seem, or at least an unsustainable amount. Almost everyone under-estimates their life expectancy, which is a crucial discussion to have and one that needs regular reassessment.

So now you know that:

There are different and better (higher) annuities available in the market
Health issues might provide a better (enhanced) annuity
Drawdown pensions carry risk
Life expectancy is a key factor
Most people are expected to run out of money
Review, review, review – especially if you have a Drawdown pension

Dominic Thomas
Solomons IFA

Email me to get in touch

Are Annuity Rates on the Rise?Dominic2023-12-01T12:18:18+00:00

Taxing Reforms for Pensions

Taxing reforms for pensions

There has been considerable “chatter” about the prospect of pensions being reformed even further. In particular, the tax of pensions is very much up for debate, making the prospect of tax reforms for pensions a genuine possibility.

In brief the Chancellor has already made huge changes to the pension system, enabling a pension to be taken as a lump sum or as income without any requirement to buy an annuity. In addition, a pension can now be easily passed on to beneficiaries of your estate, rather than ceasing when you do.

Tax Overpayments

The new freedoms have already and will continue to mean that some people don’t do their sums properly and end up paying too much tax – unnecessarily, which of course is a good thing if you run HM Treasury… every little helps and all that.

In very simple terms, most people will currently find that whatever the size of their pension pot, they can take 25% of it as tax-free cash (these days “we” call it a pension commencement lump sum – or PCLS). The rest is taxed as income.

Reforming tax relief

At the moment, anyone that pays into a pension gets tax relief – either at 20%, 40% or even 45% depending on your rate of tax. Everyone gets 20% (from age 0 to 75). So an investment of £1000 actually costs £800 if you are a nil rate or basic rate taxpayer. If you pay more than 20% tax, you get to claim the balance back via your tax returns.

The Chancellor is reviewing this, because it costs the country a lot of money. The main problem being that employers make most of pension contributions each year and do so in part because it is treated as a deductible cost. If this were considerably altered, then most employers are likely to reduce or even stop (bar the minimum requirements of auto enrolment) their contributions. This would result in smaller pensions in retirement…

So he could simply reduce tax relief to a lower amount, in essence he has done this already for anyone earning over £150,00, who have their annual allowance restricted to just £10,000 (less than an ISA) if they earn over £250,000.

Tax relief provided in 2013/14 amounted to £34.3bn, whereas the tax on pensions generated £13.1bn a “cost” to the UK of £21.2bn. Most of which (2/3rds) is reclaimed by higher rate taxpayers… those paying 40% or more.

Shrinking the Pot

He has also reduced the amount that can be held in a pension (the Lifetime Allowance) which is set to reduce again from £1.25m to £1m next April. Anything above this will be subject to an excess tax charge of 55% as things stand at present. That’s what I call easy money for the Treasury and there isn’t that much that you can do about it, other than applying for protection where relevant.

Changing the Sweetener

Another option would be to make pensions tax-free in retirement instead of taxable. Whilst this sounds all well and good, the reality is that who would honestly trust any future Government not to change the rules later, when they realise that they need the income to be taxed.

Simplicity Seems Dead

I am of the opinion that pensions are going to change, how much and when, we simply do not know. However the Government wants to be seen not to help the “rich” which seems to include people paying 40% tax and everyone paying 45% tax. It would include anyone in the State Sector that has built up a long career – doctors, teachers, police, civil servants – all of whom seem to be the current “cat to kick”. It certainly includes anyone that has pension funds worth £1m or more. Though I would argue that £1m in a pension pot isn’t that huge (yes I know its relative) but in practice that provides at £40,000 a year income… not enough to pay higher rate tax. The worst case to my mind would be to create a “before and after” system – which we have had before, which only makes life more complicated.

If I were Chancellor?

People need an incentive to save for the long-term. I would abolish the Lifetime Allowance making all current and previous protections irrelevant. I would restrict tax relief to a % of salary, perhaps providing it directly as a 5% tax cut, say 20% tax becoming 15% if payments are made to a pension. That way HM Treasury collect taxes, people are incentivized to save and earn. I would scrap rules that enable people to pay into pensions for children, which is essentially something that only the wealthy can do, so that pensions are only for those aged 18. However I would continue to tax pension income as income…

Sadly, for younger generations the prospects of good pensions looks fragile… of course there is the prospect of the solution as outlined in Logan’s Run….. there’s just one catch..

Dominic Thomas
Solomons IFA

Taxing Reforms for PensionsDominic2023-12-01T12:20:08+00:00

Pensions: Are you an Equitable Life policyholder?

Are you an Equitable Life policyholder?

Protest by EMAG October 2012

One of the larger financial messes in the last 20 years has been the failure of Equitable Life. This was a company that essentially said they didn’t deal with “middlemen” (meaning IFAs) which in practice enabled them to also say that they did not pay commission to independent financial advisers, so despite being nothing more than a product manufacturer, managed to persuade many people that this was somehow better than an IFA being able to select from the entire market and select an appropriate arrangement. As a mutual society, they could also claim not to have shareholders (who require returns). Of course in practice, like any organisation, mutual or Plc, they have operating costs – their staff and advisers who sold, sorry “arranged” policies. It was evident to some in the mid-1990’s that Equitable simply wasn’t a sustainable business. As you may imagine there were not many IFAs that couldn’t control the sniggers once Equitable was forced to close to new business in December 2000. As yet I haven’t met a single adviser that doesn’t believe that the demise of Equitable Life has had a significant impact on the degree of mistrust of financial institutions. This seems to have been compounded by the delays in appropriate compensation to policyholders. Despite failure, the company survives to service its estimated 500,000 policyholders with around £8bn of funds being managed (Equitable has been around for 253 years).

The Big Broken Promise

However the demise was nothing to do with product charges, commission (or lack of it). In practice it was triggered by failing to keep a simple but expensive promise of guaranteed annuity rates, on which it reneged and was subsequently brought to book, which then resulted in the collapse as the annuity rates were rather more than “over generous” at the time. Anyway, long sad story short, the time to apply for compensation due to the “government maladministration which ocurred in the the regulation of Equitable Life” which was established in 2010 is drawing to a close. Despite paying very large sums, there are still many people that haven’t claimed and should do so as a matter of priority. This is relevant to people that bought policies between 1992 and the end of 2000 when Equitable closed. Call the helpline on 0300 0200 150 and checkout the supporting website. Also dont forget the EMAG site as well.

Space travel has significant risks

Looking at old Equitable adverts now is a reminder that assurances about the future were somewhat misplaced. Saying something with confidence does not make it true. Even this 1998 advert with Buzz Aldrin suggests that retirement activities might include a space trip by 2028… well who knows, but certainly the belief that you can get something for nothing is definitely thinking from a different planet and those policyholders that have not yet had compensation, probably feel that their pension shouldn’t really be rocket science, but something much more down to earth.

Dominic Thomas

Pensions: Are you an Equitable Life policyholder?Dominic2023-12-01T12:40:12+00:00

Dispatches: How to Blow Your Pension

Last night Channel 4 showed a 30 minute programme called “How to Blow Your Pension”. The premise being that the new pension rules might result in thousands of “pensioners” cashing in their pension pots, blowing the lot only to run out of money. You can see the show on the 4OD website should you wish to. The intention was good, but the execution rather miserable and once again missing the opportunity to educate people and whilst Michael Buerk had a good reputation as a BBC newsreader, clearly he doesn’t appreciate that a document from a pension provider is not actually advice – but information about options. Frankly it isn’t that much of a jungle out there, but you will need proper advice, this is not the time to become a DIY internet “expert” it has to work and last. Just because someone has teeth that they care for, doesn’t mean that they should do their own dentistry. Just because you earn, handle and spend money does not make you best placed to do a proper job of planning and generating income for the rest of your life… So I thought I’d have a go at explaining the issues.

New Pension Rules – Simple

Pension rules are changing, from April 6th 2015 anyone aged 55 will be able to access their entire investment based pension pot should they wish to. There will be no compulsion to buy an annuity (an income for life). The principles have not changed – in that 25% of the pot is treated as tax free and the remainder is treated as income when you take it, however you take it – and so subject to income tax at your relevant rate of tax. You can still buy annuities should you want to. That’s it.

Running out of Money

The difficulty is that for most people their pension needs to last as long as they do…. ideally a bit longer if they have a spouse that outlives them too. So in practice you need to be careful about how much you take, its got to last and once its gone, its gone. So you have to guess how long you and your spouse might live (clue – actuaries do this for a living and designed annuities).

Make a Plan

So you will also need to reflect on how much income you need, what plans you have and it would be sensible to allow for some unexpected costs. You may need to pay for your own care or medical treatment – if you wish to choose how this is provided to you. You will also need to reflect on the impact of inflation, which at the moment is at record lows – but do the things you pay for really have such a low rate of inflation? and making a guess now for the next 20, 30 or perhpas 40 years of retirement needs some proper thought. If you don’t buy an annuity (which for many will be a very sensible option) the fund will need to grow (just to stand still and keep pace with inflation at the very least) – so how much investment risk is appropriate? what returns do you really need? what happens if these aren’t achieved? how will the portfolio be looked after? … and so on.

Review the Plan

As a result of these new “freedoms” (which some already enjoy anyway) you have a plethora of choices and the truth is that these need to be reviewed – in fact thats the beauty of it all, you get to alter your decisions (unlike simply buying an annuity and having to live with the consequences for the remainder of your life). The ability to access the money means that the crooks are on the scent… be it “pension liberation” or rubbishy investments that aren’t regulated and promise more than they could ever deliver. An independent financial adviser can sort the wheat from the chaff, but a financial planner, will do that and also help you plan your income requirements to suit your unique requirements.

Was that really so hard?

Dominic Thomas

Dispatches: How to Blow Your PensionDominic2023-12-01T12:39:51+00:00

Annuities

An annuity is an income paid for life. Simple. Generally people buy an annuity with a pension fund, which for the vast majority of people is when they retire. The rules changed recently with George Osbourne’s Budget in the Spring, this meant that from 6th April 2015 nobody has to buy an annuity if they dont want to.

Why?

This is an acutaries field day, but let’s keep things simple. Annuity rates are closely linked to interest rates, investment returns and life expectantcy. Over the last 20 years interest rates have fallen considerably (as anyone can observe) so too has inflation and with that investment returns, though “real” (after inflation) returns have been fairly constant over the long term. People are also living longer (on average) – meaning that any income needs to be paid for longer. So actuaries do their sums and review their sums based on these factors.

As a result annuities have fallen from double-digit rates in the 1980’s and early 1990’s to very low and comparativley measly figures today. As a result people understandably look at the size of their pension pot and the projected annuity income and don’t like what they see. Hence pressure over the years to abolish the requirement to have an annuity, which is essentially a decision made once at 65 that cannot be altered and one you have to live with for life.

Regulatory Review

The current regulator (my fifth!) has recently published its findings about annuities and how they have been sold. Most of the report is nothing new, myself and other advisers have been calling for change for years. The main problem being that the vast majority of people do not think to consider the options at retirement properly. Far fewer still do any proper planning (working out how much income is needed, when and for how long etc). Most assume, rather strangley, that their existing pension company is simply offering them the “best deal” which is rarely the case… I’m reluctant to say “never the case” but I am tempted to do so. This is why people need to “shop around” but more sensible still – engage a financial planner to properly assess and explain your options. There can be enormous differences from simply getting a better deal, let alone the most suitable, which takes account of your needs, tax and so on.

Whilst the press have been covering Mr Osbourne’s pension freedoms, annuities certainly still have a place and are one of a number of “tools” to consider. For starters, of all the options, they are the only ones to provide guarantees. So if you know anyone that is in the process of retiring don’t let them get confused by the media noise, but encourage them to seek advice from a financial planner – like me.

Dominic Thomas

AnnuitiesDominic2023-12-01T12:39:43+00:00

Pension, annuities, the Budget and life’s big gamble

I’m well aware that we in financial services often seem to live and breathe pensions, savings, investments and tax… and for most people this is a necessity not an interest. This week my peers and I have been quite taken aback by the changes to pensions, annuities and ISAs. Assuming the proposals are approved, this means significant improvements for clients, but not without risks.

So What?… meet Mr & Mrs Cash from Wimbledon

Let’s suppose a healthy, non-smoking married couple Mr & Mrs Cash are both 65 years old, and live in the leafy suburbs of south west London in Wimbledon (SW19). They want an income of £30,000 a year and would like this to rise by 3% a year to keep pace with inflation. They want this income, even if one of them dies, continuing at the same rate until finally both have left this mortal realm.

Annuities are so poor at present that £100,000 buys only £3,359.04 a year, so as the Cash’s need £30,000 a year initially, they would need a pension pot of £892,857 to provide this, excluding any requirement for tax free cash. Now that you have picked yourself up off of the floor…a joint life 100% spouse’s annuity with a rising income today has a best annuity rate of 3.36% (and by today, I mean I got this quote online today).

Life’s Gamble…

So now the “interesting” part, which is where the educated guesswork begins and the gamble with life really gets exposed. Remember that the annuity I have shown will last for the lifetime of the couple, income will be £30,000 a year and keep pace with inflation (provided inflation is 3% or less). Once the couple die the annuity stops, there is nothing left.

The alternative for this couple, with a fund of £892,857 wanting £30,000 a year increasing by 3% a year is to convert their pension into a flexible Drawdown pension, keeping the money invested. Let’s suppose the investment grows at 6% a year on average (3% above inflation). It NEVER runs out. In fact by the time they are 100 the fund is worth £1.9m having had a total income of £1.8m out over 35 years (by the way their income in that year… 35 years from now is £81,957… which in real terms is £30,000 today. Yes the investment will fluctuate in value, but we are, in this instance only wanting a modest income from it each year.

Its all in the gene’s..

Ok, so back to life’s big gamble…. How long will Mr & Mrs Cash live? The average UK female aged 65 will live another 20.62 years which is longer than the average male who has 18 more years according to the ONS figures. Let’s assume this is a couple that due to diet, lifestyle and good genetics live longer – to 90 (that’s 25 years). To do this they would need £512,153 in a portfolio, which grows at 6% a year. This would then run out at 90. Nothing left, nada, gone, zilch.

My point being that a much smaller pension pot is required (with these assumptions) its about 58% of the fund you would need to do the “same thing” when buying an annuity. I say “same thing” as of course if the couple live beyond 90 the annuity continues to pay out, the pension has all gone.

Not living long enough

Equally if both of them die “prematurely” at say 78, then the annuity finishes, there is nothing left. If the money is in the pension, there is a balance which can be passed to beneficiaries. Today this would suffer a 55% tax charge, but if I’ve understood the proposals, this will reduce to income tax rate levels. This is still to be clarified, but either way there would be money left in the pension (£1.2m by my maths). Let me say that again… there is £1.2m (one point two million) left rather than nothing.

The advantage an annuity provides is that it is guaranteed for life, so you know what you are getting. This can be a very good thing in the right circumstances. But it’s a one time decision and if you don’t live long, one might suggest that it was terrible value for money, it is only in year 22 that the total income that you would have had over 21 and a bit years would surpass your original capital investment… making one or both of you 87 essentially before you’ve “had your money back”. This is all down to low annuity rates, which are due to interest rates, inflation, economics and life expectancy… things that you and I can influence very little.

Should we trust people with their own money?

Of course the danger of access to a pension is now being discussed in the media, there is justifiable concern that people may simply take their fund and blow it all at once…. on a nice car? Remember that this is taxable income, so any amount over £150,000 would be taxed at 45% and once its gone its definitely gone with no further help from the Government. There are concerns, and yes some people will blow it. However, from next Thursday, this feature is only available if you have £12,000 a year in guaranteed income (in your own name) currently you need £20,000. This amount does include your State pension and any other employers pension. So a lot of people will qualify, but of course not all by any means. Those with small pensions will not be able to use this feature, but they can use “capped drawdown” instead, which has also been improved, but clearly those with smaller pensions probably need more certainty for their own budgeting.

So where is the catch? well, between you and me….. I imagine that the cost of residential care will now be raiding many people’s pension pot in a rather more aggressive fashion, so spouse’s be warned… have your own pension pot.

Of course there are many more options and you could always decide to use the fund to buy an annuity at a later date (annuity rates tend to improve with age) and careful maths needs to be done and dreaded terms like “critical yield” may become a familiar term to many pensioners in the future. This is why reviewing your financial planning regularly (annually) with a us is really important and of course we can demonstrate the options and their consequences. So get in touch.

Dominic Thomas: Solomons IFA

Pension, annuities, the Budget and life’s big gambleDominic2023-12-01T12:39:03+00:00

What is the best way to save for retirement? Part 3

This is the third post in the series “what is the best way to save for retirement?”

So what are the alternatives to a pension?

As we have discovered, a pension, at least in the way the financial services industry use the term is a savings plan. Its has two main advantaged over other forms of savings plans. The first is that an employer or business can pay into the savings plan for you. The other a more obvious is that contributions attract tax relief. These are both massive advantages and could be described as “money for nothing”. Under the new auto enrolment rules your 4% payment to a pension is essentially doubled, with 3% from your employer an 1% from HMRC. However be aware that as with all things, today’s rules are no predictors of the future, one that I may remind you is shaped by economic realities and the politicians that attempt to pretend otherwise.

So what are the alternatives? Well they are almost infinite, but lets narrow this down to three simple ideas.

Investments
Property
A Business

As a pension is simply a pot of money to take income from for the rest of your life (with the option of buying an annuity if you want to). Then any form of investment can do this job, including a bank account (if indeed we can call holding a cash deposit account an “investment”). Today I will only focus on the investment option.

An Investment Portfolio

Investing is fraught with possible mistakes, almost every investment promises “out-performance”. This is largely hot air. Apart from selecting suitable investments and constructing a portfolio, investing has costs and any income from an investment, for example a dividend payment is liable to tax. Gains are also subject to capital gains tax. There are “tax free” investment products such as ISAs, but for many people the amount that can be put each year into an ISA is unlikely to be enough for your retirement (though many will find it more than they can actually save).

Are investments more risky than a pension?

No, you could have identical holdings in a pension and a “regular” portfolio. The issue is understanding how the portfolio is constructed, why and what returns over the long-term are likely to be achieved. Anyone that promises guaranteed results is being less than honest with you. Everyone has a different idea about which assets or markets will perform best – that’s kind of the point of a market – where people agree a price on something when they disagree what direction that price is heading. Its true that there are other tax efficient ways to invest, using EIS, VCTs and such like, but be warned, the term venture or enterprise is used sensibly and most people are neither.

So let’s take an example and agree lots of assumptions

Suppose you need an income of £20,000 a year and inflation-linked at 3% a year (yes we are guessing). If you only expect to live 10 years from retirement at 65 and are happy with this assumption (that the money runs out, all gone, nothing left!) then the income (actual cash) you take will be nearly £230,000 over 10 years to age 75. If we assume that the portfolio grows at 5% a year during this time (which may be ambitious as you are probably keen to have certainty that the money will pay out for 10 years) then you need a fund of about £175,000 at 65. If you expect to live for 20 years and then the fund runs dry… well you would take out total income of nearly £540,000 and need a pot of £320,000 at 65 to provide this.

What would an annuity give me?

If you were to buy an inflation linked annuity at 3%pa as a 65 year old, you would probably need about £500,000 at 65. This is based on a 4% annuity rate (4% of £500,000 being £20,000pa) The advantage of the pension route is that if you live longer than 20 years (85) it continues to pay a rising income until you die. The investment pot has run out. Both have the same assumptions about inflation (which will be wrong in practice, unless you are going to credit me with mystic powers).

Pension or ISA?

So here’s the hard numbers. The pension pot needs to reach £500,000 and the ISA investment portfolio, well let’s go for £320,000 and assume we can predict death at 85. Lets suppose we start saving at 35, giving us 30 years to grow the money by the time we are 65. Let’s also assume the pension and investment portfolio hold the same stuff and perform identically, with the same charges, let’s assume that over 30 years the funds grow at 7% for the sake of simplicity. We will also assume that you increase what you save by inflation (3%) each year so that the amount you pay is proportionally the same each month. This is now virtually a GCSE maths question (if only they’d taught us the maths that was important in life right!).

So to build £320,000 in the ISA investment portfolio, you need to invest £195.64 a month rising by 3% a year, a total outlay of £113,220 over 30 years. As you may imagine to achieve £500,000 in the pension over the same time with the same returns, you need to invest £305.69 a month initially, increasing by 3% a year. A total outlay of £176,906 over 30 years. So the pension costs you £63,686 more (about 36% more). However, with the pension you had 20% tax relief, so you really paid 80% of £176,906 or £141,524, still more than the ISA, but not that much more.

£500,000 Pension pot actual cost for basic rate taxpayer £141,524
£320,000 ISA pot actual cost for basic or higher rate taxpayer £113,220

Your employer can make payments too

Now imagine that your employer was also paying into your pension pot (which they cannot do with an ISA). Suppose that they are paying 3% of your salary – as they will be under auto enrolment, let’s assume you want £20,000 a year because you reckon that’s what you need to support your equivalent lifestyle today, so let’s just assume you earn £30,000 at the moment, so 3% is £75 a month. So if your salary rises at 3% a year in the same way, over 30 years, that’s £43,404 of employer payments in total. You can therefore reduce your own payments from £305.69 a month by £75 to £230.69 a month, which in practice is £184.55 a month net of basic rate tax relief…. Which is marginally less than the £195.64 you need to save into an ISA.

£500,000 Pension pot with 3% employer contribution £106,804 net of 20% tax relief
£320,000 ISA pot £113,220

Of course the more your employer pays the better, but I hope that I have demonstrated that tax relief and employer contributions make a big difference. Don’t forget that the annuity dies with you (unless you build in benefits for your spouse) but anything left in the ISA portfolio is merely added to your estate and subject to inheritance tax. The big gamble is predicting your life expectancy.

Tomorrow I turn to property as an investment. I hope that it evident that this is not advice, I am merely outlining an example and doing the sums. You should get specific advice to suit your circumstances.

Dominic Thomas: Solomons IFA

What is the best way to save for retirement? Part 3Dominic2023-12-01T12:38:52+00:00

Money Box asks has your pension been burgled?

Money Box asks: has your pension been burgled?

Once again pensions were in the news, the Radio 4 show Money Box took on the rather complex issue of annuities. Charges, fees, value for money Financial Services Consumer Pension and even the very funny Jeremy Hardy’s comments on The News Quiz also received some mild stick, following his joke about not wanting to understand anything about annuities, or listen to Money Box and his intention to be a burden to the State..of course he was being ironic.

Yawn… annuities are just so dull

Anyhow, Jeremy is pretty much right, annuities are very boring and not something to spend too much time worrying about… until you actually need to. So what is an annuity? Ok simple stuff… an annuity is an income for life. You can have a rising income or a level income. Importantly an annuity dies with you.. eh? When you die your annuity stops… but if you want you can build in some guarantees… such as the income continues to pay a spouse or your estate, in full or part.. you can build this in at the design stage, not later on.

So why are Money Box and the FSCP talking about annuities?

Well, most people have no idea what to do and most is a lot – something like 400,000 people retire and buy a annuity each year. It’s a large market. Most people assume that there is not much between annuities (sadly and expensively wrong) there is an enormous difference and it costs you no more to get the most suitable one (on the whole). I’ve not met anyone that likes a pay cut, particularly one of 20% or even 40%… yet that is precisely what the wrong annuity is effectively like….for life!

So can I shop around for a better annuity?

Yes, you should (no you MUST). Start by checking out the MAS site, the site that supposedly advisers dislike, yet pay for via our fees… and plug in some details. If you like to be frightened, do this now. This is only part of the story and did you notice all the disclaimers? You could then approach the annuity providers yourself and set up your annuity. You won’t get any more money than if you did this via an adviser, but the provider makes a bit more money out of you, and you carry the risk for picking your own.

So should I use an annuity broker?

Well you could, but be warned that they may simply focus on getting you the biggest annuity (which seems ok doesn’t it?). If the company provide guidance rather than advice, they are not liable for any mistake, you are. They will charge a fee for their selection. However, this might be akin to going to a garage with a car that has a flat tyre and won’t move… demanding a tyre at a decent price… but failing to observe that the car has no engine (ok it’s a metaphor). My point being that there is no context for good planning, it’s just selling or arranging products, as Paul Lewis reminded the listeners.

So should I pay for financial advice about annuities or retiring?

Well, I would say this wouldn’t I, but of course! There are lots of issues and lots of solutions. My main gripe with annuities is simply that once you set one up, that’s it, decision made for life. A bit of a straight-jacket if you ask me. More importantly perhaps the adviser is qualified and responsible for the advice.

So what will a good financial planner do?

Start by forgetting about products. Discuss your plans for your retirement and determine what that really means for you. In short, what lifestyle are you aiming for? How much will it cost? So this is about income, not products. The sort of things that need thinking about and understanding are your requirement for income, your tax position, your other assets, your marital status, your expectations about inflation, your health and how long you will live. Advisers need to help work through the tricky discussion about the risks of not knowing. There are alternatives (lots) and of course there is the option of not even buying an annuity at all. Good financial planning is not about products it’s about figuring out what you really need and then building a plan to get you there.

Do financial planners have to arrange products?

No, but we often do. I really wish that Money Box would grasp this point. A good financial planner may not ever arrange products at all (I have a dream)…frankly because arranging products is a pain and very, very dull. Solving problems and helping people to get the life they want… well that’s an entirely different matter…however if you want a job done properly…

Anyway, keep up the good work Money Box… time often seems against any proper full discussion on the main media channels, so I am currently toying with my own show…well a podcast anyhow.

Dominic Thomas: Solomons IFA

Money Box asks has your pension been burgled?Dominic2023-12-01T12:38:45+00:00

12 Next

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This is the third post in the series “what is the best way to save for retirement?”

So what are the alternatives to a pension?

An Investment Portfolio

Are investments more risky than a pension?

So let’s take an example and agree lots of assumptions

What would an annuity give me?

Pension or ISA?

Your employer can make payments too

Money Box asks: has your pension been burgled?

Yawn… annuities are just so dull

So why are Money Box and the FSCP talking about annuities?

So can I shop around for a better annuity?

So should I use an annuity broker?

So should I pay for financial advice about annuities or retiring?

So what will a good financial planner do?

Do financial planners have to arrange products?