Retirement Planning
In our opinion planning for retirement is probably one of the most important things that we do, because the standard of living enjoyed (or not) later in life may depend on decisions made while working.
The government recognises that it simply cannot provide a sufficient state pension and despite it having announced that the link between average earnings and pensions will be restored in 2012 (with additional protection based on inflation and a minimum 2.5% increase), this will be starting from a base that has eroded for almost 20 years, through being linked to inflation during that time.
In general terms, pensioners have been getting progressively worse-off, compared with those in work, for more than a decade because wages usually rise faster than inflation.
Because of this, personal provision is important and the government wishes to encourage more of us to save for our own retirement and changed the rules in April 2006 so that UK residents could potentially invest a substantial amount of money towards their retirement.
Anyone (together with their employer, if they have one) can invest as much as they wish into any number of pension schemes. However there is a limit beyond which no tax relief is available, set at £255,000 for 2010/11. From April 2011, the maximum contribution will be reduced to £50,000, although it will be possible to bring forward unused allowances from up to the three previous years.
- For personal contributions tax relief is limited to earnings from trade profession or employment, where this is less than the annual allowance.
- If employer contributions are made in excess of the annual allowance a substantial tax penalty applies.
Tax relief is allowable for UK residents up to £3,600 (Gross) and then up to 100% of their relevant UK earnings (within the annual allowance) at the highest marginal rate they pay. Personal contributions above this level do not attract tax relief and employer contributions above the annual allowance involve a hefty tax penalty.
The total fund must not rise above a “lifetime allowance” set at £1.8 million for 2010/12, although form April 2012 this will be reduced to £1.5 million. If the fund does rise above the lifetime allowance, a substantial tax charge will apply. (It will be possible to retain the £1.8 million limit beyond 5th April 2012, provided that no further pension benefits are accrued after that date.)
At retirement
For most people at retirement, an annuity will be the most obvious choice since this provides a guaranteed income for the rest of your life. However, advice is required to ensure that the most appropriate form of annuity is chosen, because various types offer different levels of benefits for a widow or widower (from nil to 100%) while others offer indexation at an agreed rate, or in line with inflation. It is important to be aware that seeking either a widow’s benefit or indexation can significantly reduce the initial level of income provided. Any tax free cash that is required must be taken at the outset of an annuity; once in place it cannot normally be altered, although some larger retirement funds can opt for more modern version that are more flexible, including with profit and so called “third way” annuities.
When you come to retirement, you do not have to take your annuity from the company which built up your retirement fund for you. In fact it is often not the best option, because the companies offering the best annuity rates are seldom those providing the best investment growth. Fortunately, you usually have the right to take your pension fund and use it to purchase an annuity from any insurance company authorised in the UK.
If you are in poor health at the time you retire an wish to take pension benefits, exercising your right to buy an annuity from another company could significantly increase your retirement income.
Under the new rules everyone is entitled to a pension commencement lump sum (currently free of income tax) of up to 25% of their pension fund (subject to a maximum of 25% of the lifetime allowance). This can be taken at any time from age 55, even if they continue working and do not draw an income from their pension.
It is not necessary to purchase an annuity, but an income can instead be drawn from the fund from zero up to 120% of the amount you would get from a level single-life lifetime annuity that could be purchased by a person of the same sex and age. This option extends beyond age 75, subject to different limits, but new rules make this less attractive, so that annuity purchase by age 75 may be more practical. Any “tax free” cash lump sum required must be taken by age 75.
Plans are in hand to alter the basis on which retirement income can be taken without the need for an annuity to be purchased. Broadly, under basic drawdown, the maximum that can be drawn will be reduced to 100% of the annuity for a person of the same age and gender, but the rules will carry on beyond age 75 and it will be possible to take the pension commencement lump sum after age 75, as well. A new flexible drawdown option will be available to anyone who has a guaranteed lifetime income of at least £20,000 a year (including state benefits) and there will be no maximum level of withdrawal.
There are other proposed changes, particularly relating to death benefits, and you should ask us for details.
We believe it is vitally important to seek personal, independent advice before making any decision about your retirement options.
THE VALUE OF YOUR INVESTMENT CAN GO DOWN AS WELL AS UP AND YOU MAY NOT GET BACK THE FULL AMOUNT INVESTED. LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE AND THEIR VALUE DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF THE INVESTOR. THE FINANCIAL SERVICES AUTHORITY DOES NOT REGULATE TAXATION ADVICE.