There is good news and bad news on pensions.
Lets get the bad news out of the way first. The squeeze on incomes being faced by the majority of people in the UK is coming from all sides. Mervyn King is relaxed about his 2% inflation target and that is a signal that the Bank of England will continue to miss the target for the foreseeable future.
Real incomes are now back to 2003 levels and for the majority, income increases are below the rate of inflation. Add in the hike in VAT and that is another 2% out of your purse on Vatable items.
The value of the pound has been dropping over the last few weeks as the Dollar and the Euro strengthen against a weaker pound. Yes you heard right! The Pound has been flapping like a dead parrot against the Euro.
When I bought Euros last autumn I was getting close to €1.30 to the £1.00. At present it is below €1.16. Good for our exporters but not so good for holidays in Euroland or buying those imported goods we are addicted to.
For those close to retirement age or now retired there is obvious concern about how the value of pensions today will provide in the years ahead. If you have various pensions accrued over the years you have choices as to how you deal with them.
The usual route is to buy an annuity after taking the 25% tax-free allowance. It is important to shop around and not take the deal your provider offers as income returns may be better from another provider. Buying an inflation rate increase over the years can substantially reduce your immediate income and needs to be carefully considered.
The advice on pension planning is to think about it early so your pot will grow over the years, but it is still possible to add to future pension provision even if retirement is upon you or you are already retired and that is where there is a bit of good news.
The amount you can put into a pension is capped at 100% of annual earned income if you are still working, subject to a lifetime allowance, but that is not what I want to talk about here.
A rapidly expanding area of the market is SIPP’s, standing for Self Invested Personal Pensions. If you are retired and drawing a state pension and perhaps annuities, that income does not count, but anybody without qualifying income can still put £3,600 a year into a pension.
Now here is the good bit. You put £2,880 into your SIPP and the Treasury, with billions to spend on this, adds £720 making the total up to £3,600.
It is a really good time to think seriously about this as the end of the tax year is only weeks away and after 5th April you will lose this allowance for the current tax year. Gone forever. But the good news is the new tax year brings a further £3600 allowance and you do not have to be a taxpayer to get your £720 from the Treasury.
So if you have been following this, you will have worked out that by acting now and putting another £2880 in again after 5th April this year you can extract £1440 from the Treasury and it is automatic.
Once you have opened your SIPP this is paid direct into your SIPP account. Your SIPP provider does all the paperwork.
Every individual has this allowance so couples can double up on this and could together get up to £2880 from the taxman if they each open a SIPP before 5th April and add to it after 5th April 2013.
This does mean you have to find £2880 for each personal contribution to obtain the taxman’s £720 input. If you have money sitting earning nothing or getting silly bank and building society rates you should at least think about transferring it into a SIPP. The standard tax rate is 20%. 20% of £3600 is £720, but you only have to find £2880 and £720 is 25% of £2880.
It is a no brainer and the payment comes through to your SIPP account in around 8 to 10 weeks. Even if you cannot find £2880 you can still open a SIPP. Most SIPP providers have minimum investment levels, either a lump sum or a minimum monthly investment.
It is possible to find providers that have a minimum lump sum injection of £1000, which means you find £800 and those nice people at the Treasury pay in the required £200 difference.
There is one important caveat. You cannot contribute into a pension once you become 75. You can still contribute in the tax-year in which you become 75, but not on or after the date of your 75th birthday. Hard luck if your birthday falls on 6th April.
The big thing about a SIPP is you are in control. You make the decisions. You are not paying out for someone else to manage your pension and taking an annual 1.5% or more of the total value of your pension pot – year after year.
If you have an existing pension pot of £20,000 with a private pension provider, and that is a relatively small sum, they will slice out around £300 or more. If the next year the value rises to £21,000 they will take out around £315 or more. So if you have any pensions you have not yet taken it is really important to look at the annual statements.
You can make lump sum, regular or irregular payments into a SIPP as it suits you but you do need to consider the number of years left to take advantage before your 75th birthday cut-off. Any windfall: an inheritance, life insurance payout, cashing in a poorly performing investment, or just regular drip-feeding what you can spare after your minimum opening investment.
It is important to stress you are tying this money up for a future provision. If you are already retired the objective is to make some additional provision for later life and although you cannot put more money in after age 75 you are no longer forced to buy an annuity at 75.
Interest, dividends and capital growth roll up and you can continue to manage your investments until you are ready to either buy an annuity or start drawing down the income your investments are generating. Once in drawdown you can no longer continue to pay money in.
If you have a small underperforming private or work pension you can transfer this into a SIPP and manage it yourself. This has already benefitted from tax allowances, so does not qualify for the tax benefit mentioned here. Before transferring an existing pension policy to a SIPP it is vital you check the transfer value against previous valuations. Older pension policies may have a valuable guarantee so check that out also before you switch as these are not transferable.
Investment returns are better some years than others depending on market performance. In the later years, with a personal pension, your money will be increasingly moved into traditionally safer areas like UK gilts. Nobody in their right minds would put their money into UK gilts these days with negative returns after inflation, but pension companies are required to change the proportion of equities to government stock as your probable pension date looms.
There are dozens of SIPP providers to choose from. I use Hargreaves Lansdown, a FTSE 100 company, voted best SIPP provider for the last 6 years.
There may be charges depending on what investments you choose. If you buy shares, corporate bonds or those jaded gilts, Hargreaves charge 0.5%, or one third of what you may be paying on a personal pension policy at the moment. This is capped at £200 per annum.
I have not come across a personal pension provider that caps their charges. Many increase them as the years go by so check the original policy and the latest statement.
On our £20,000 example, Hargreaves annual charge amounts to just £100, saving you probably at least £200 a year. There is no set up charge. Hargreaves Lansdown offer about 2400 funds and there are no charges on filling your SIPP with these. Over 1000 come with a loyalty bonus of 0.5%.
It is important to stress that you are in charge. You make the decisions. Through your account you have access to a great deal of information and reports to help you choose your investments. If this is not for you, you can choose from several ready-made fund selections.
In a follow up article I will set out some options on what you might consider investing in. This will not be personal advice. I am not a financial advisor and never use one. I will set out the pitfalls, particularly at this time when the FTSE has finally broken through 6000 this year and at the time of writing also broken 6200 and now hovering at 6300.
Another advantage of a SIPP is that the fund is transferrable to your spouse. Your wife or husband, on your death, can take it over and add it to one they may have.
Unless an annuity includes provision for a spouse and/or a guaranteed period the annuity dies with the holder. On the death of one, household income levels will be reduced in most cases. This also is where even late contributions to tax efficient SIPPs could mitigate these consequences at a difficult time.
There is though a very important caveat. If the SIPP holder dies after age 75 or the pension is already in drawdown there is a tax take of 55%. This tax is separate from Inheritance Tax.
Given concern for people living longer and having to retire later this tax rule needs to be changed in the case of a spouse and be subject to exemption.
Getting money out of a cash-strapped treasury sounds too good to be true but true it is. This article focuses on the opportunities for non-taxpayers and those on the 20% rate.
Higher rate taxpayers do even better. Our tax system may on the face of it be progressive, but the allowances that high-income earners are able to take advantage of means that they can shelter large amounts of their disposable income from tax.
28th February 2013
This article is intended as general information and is based on present tax rules that may change in future. It does not constitute personal financial advice. Anyone who is over the age of 55 can access the 25% tax free payment from a SIPP and draw down income from the balance of the fund should they need to.