The government has introduced a state pension top-up designed to allow pensioners and those close to retirement age to boost their pension incomes. A new class of voluntary national insurance contribution called Class 3A, was announced in the 2013 autumn statement. Only now are details emerging as to what the extra pension would cost. The good news is, it looks good value, offering a better deal than ordinary inflation-linked annuities.
What does it do?
This new, Class 3A scheme, adds to the existing ‘top up’ scheme called Class 3 national insurance contributions. Buying it will give you rights to additional state pension. Your benefits will be increased by the consumer prices index (CPI) measure of inflation each year.
Is it costly?
It depends on your age. For a 65 year old, each extra £1 per week paid out at age 65 will cost £890 and the maximum extra pension you can buy is £25 per week, which will cost you £22,250.
This is equivalent to an annuity rate of 5.8 per cent, when the actual market rate is around 2.9 per cent. So paying just £22,250 in this scheme would normally cost you approximately £45,000 in the open annuity market. For a 70 year old the rate reduces to £779 and for a 75 year old the rate is £674. You can check the Government website to see the different rates you pay depending on your age.
Who is eligible for the top-up?
Men aged 63 and over in April 2014 and women aged 61 and over in April 2014 qualify, because this top up is only available to anyone entitled to a UK state pension who reaches state pension age before April 6, 2016.
When will the top up start?
The new top up scheme will only be available between October 2015 and April 2017.
Who will benefit?
The scheme offers pensioners the chance to secure an inflation-linked income for life. It is designed for people in good health who have a partner, because half the pension can pass to a partner on death. It will be especially beneficial for those who do not qualify for the full state pension and who have not previously been able to top up their entitlement. This includes the self-employed and women who lost NI contributions while bringing up their children.
Who should sit tight?
The scheme is not so good for people in poor health. Someone with a short life-expectancy, who might already be ill, would not benefit because they will not receive the additional income long term.
A point to remember
Many will find the secure inflation-linked income attractive. However the income is taxable, which means some savers should pause to consider whether an ISA may be a better, more flexible option for their money, if they are willing to take more risk.
Investors can currently fund a tax-free 3.5 per cent yield from an equity income fund within an ISA. With the new £15,000 ISA allowance available from July, between them couples could invest up to £30,000 tax free.
What’s in it for the Government?
It is difficult to know what impact this will have on Government spending, because we do not know how many pensioners will take up the offer, how much extra state pension they will buy and how long they will live and how much inflation will be. What is clear is that this will have a positive cash flow impact, as the new money from pensioners will come into the DWP immediately, whilst any obligations to pay out more state pension will spread over many years to come.
The new top-up scheme is a very good deal for many people. If you’re 65 now and in good health, you will probably benefit, especially if inflation is high. The other option if you’re willing to take on a bit of risk, consider investing in the markets instead; the risks are higher but so are the potential returns.
So how long will your pension pot last?
Or, to put the same question another way, when do you expect to die?
Individual life expectancy is one of the pieces of information which, according to Steve Webb, the pension’s minister, all savers should be given at the point of retirement as part of the new “guidance” planned by the Government.
The guidance is promised alongside radical pension changes announced in last month’s budget, which will enable savers to access their pension fund whenever they want, once they’ve reached 55.
Mortality statistics are crunched more than ever before, giving increasingly detailed data of peoples likely lifespans.
How much will you need?
The most important step of any financial plan is figuring out how much income you will need.
The starting point should be to identify your fixed costs, which will reveal how much money there is to maintain your lifestyle above and beyond the essentials.
Have a margin of error
Once you have worked out your income requirement, think about how to spread your savings in order to manage.
Retirees have to test out such plans against their health position. You might receive a number from the government saying you are likely to live to 86 on average, but what happens if you live to 100, you have to consider this.
Do not forget to factor in the rising cost of living. For instance, if you spend £10,000 a year today, you might need £15,200 a year to make the same purchases by the time you die.
Plot the years
Once you retire your expenditure typically starts off high, possibly more than in working life, as you do all the things you wanted, but lacked the time or money.
Then your needs start to fall as you get slightly older. Then they increase again often due to deteriorating health. Just as people are poor at predicting life expectancy, they are also poor at predicting health. The cost of care is the sting in the tail, the great unknown and could be as high as £85,000 a year.
Using life expectancy to plan retirement isn’t a new idea. Many professional financial planners have been giving clients this information for several years now, taking into account their entire wealth and needs including care or nursing fees. This helps them determine whether they have enough money to last.
Growth, losses and returns
If you keep your money invested and make steady withdrawals in retirement, you should factor in the effect of growth and losses, on the amount of money that will be at your disposal at different stages of retirement. You can reduce risk by spreading your investments, but you will need to rely on estimates of expected growth rates for different asset classes such as cash, bonds and shares.
You could keep all the money in cash, where returns are clearer but low. This is likely to mean dipping into capital on a regular basis, depleting your funds.
Other assets will provide greater scope for potential. For instance, corporate bonds might pay a yield of 5 or 6 per cent. A fund that invests in dividend-paying shares might yield 4 per cent. You could take this money as income without touching the capital.
Remember, the underlying value of these assets could rise and fall. If you need more than the “natural” income from bonds and shares, you could be forced to withdraw when stock markets are down.
Buying an annuity, an insurance product that converts a pension fund into a lifetime income, will provide a fixed payout at around 6 per cent a year, but you lose control of the money. This means that if you die before your projected life expectancy your estate may lose out. If you live longer, you will begin to profit.
The advisers believe a combination of different products and investments, with each used to meet different income needs and desires, is likely to make the best saving options.
The value of your investment and the income from it can go down as well as up and you may not get back the original amount invested. Past performance is not a reliable indicator for future results. Please contact us for further information or if you are in any doubt as to the suitability of an investment.
The Government is going to include your life expectancy in pensions ‘guidance’. We pre-empt that and explain how to make your money ‘see you through’
Fraser Brydon - Money Matters
HMRC’s determination is to get its pound of flesh from the middle class. How can you stay on the right side of the law but still keep your tax bills to a minimum?
The taxman is now going after the middle classes, no longer targeting just the super-rich, but everyday professionals are now feeling the pressure of this greater scrutiny with an increased likelihood that their tax returns will be challenged. HM Revenue & Customs (HMRC) has doubled the number of inquiries into taxpayers it feels are not paying enough tax over the past two years. When such inquiries become in depth investigations they can take years to conclude.
New powers have been proposed to allow HMRC to take money directly from taxpayers’ bank accounts, including joint accounts, without first obtaining a court order. If the proposals, which are subject to a consultation, are approved, there are concerns that HMRC will withdraw incorrect sums from accounts before giving taxpayers a chance to argue their case.
HMRC says that they do not plan to empty bank accounts completely as rules are in place to ensure that, after the tax owed is taken, a sum of £5,000 must remain in the individual’s bank accounts. The money can only be taken after four requests for the tax owed have been ignored.
Other existing measures, such as the creation of special “task forces” to target certain job sectors such as freelancers and buy-to-let landlords, have also helped boost the Revenue’s total tax take.
HMRC has beefed itself up by doubling its use of bailiffs and debt collection agencies over the last two years. Its focus on evasion and non-payment looks set to gather force.
One of the most controversial snooping powers the taxman uses to spy on individuals is obtaining information from third parties, including banks, credit card providers, employers and other government agencies such as the Land Registry.
The Revenue will also snoop on the websites that taxpayers use and check up on an individual’s mobile phone usage. They can use bugging or telephone tapping, but in practice they are rarely used.
This policy is seen as hitting the ‘easy’ target, using all its powers to crack down on individuals, rather than companies or other better resourced institutions. The sums involved may not be huge when compared to going after a major corporate, but individuals are a much easier target to squeeze and collectively they are now paying out a huge amount of extra tax. They are more likely to have made tax return mistakes but they are also more likely to capitulate without arguing, making HMRC confident of success.
Another aggressive tool used by HMRC is by threatening taxpayers with higher penalties as part of its tougher stance, which has helped increase tax returns for the Revenue because individuals are paying automatically to avoid receiving higher fines rather than looking at the amount owed and challenging the taxman if they think it is incorrect.
What to do if HMRC challenges your tax return
If you disagree with the amount of tax the Revenue says is owed, write to HMRC immediately. If you disagree with the amount of tax the Revenue says is owed, write to HMRC immediately. The taxman will ask to see certain documents. Don’t pass over everything, only supply them with the information they request. HMRC will write back to you and if it still believes its tax position is correct the next step is to make a tribunal date. Independently appointed tax judges will hear your case and come to an informed decision. But those taking their disputes to a tribunal face a long wait. Another option is the independent Adjudicator’s Office,which arbitrates complaints about HMRC. Telephone 0300 057 1111.
What action will HMRC follow to collect unpaid tax?
If the Revenue is confident that tax is owed it will demand the sum in writing. A time limit for a response will be set and if this is not met then the taxman will issue a fine and also charge additional interest. If this is still ignored the debt will be referred to a private debt collection agency.
What can I do to protect my money?
The best advice is to maximise the use of mainstream, clear-cut tax-efficient investments such as pensions, a maximum of £40,000 of your income can go into a pension each year and your full ISA allowance of £15,000. Avoid complex schemes such as film investment vehicles, which the Revenue has successfully challenged. Individuals can also set themselves up as a company if they have multiple sources of income on a contract basis. They create a “personal services company” or PSC. Clients pay the PSC instead of the individual and the individual pays only corporation tax at 20 per cent under £300,000 and 21 per cent above. The individual then takes dividends as income or winds the company up after a few years to access the money. This approach can help individuals avoid the highest rates of income tax.
Pensions were high on the agenda in the Queen’s Speech, which outlined the legislation Parliament will focus on for the next year. Two pension items were included in the parliamentary agenda.
There will be legislation to make way for the pension freedom announced in this year’s Budget, whereby savers will be able to access their pension pot as and when they want from age 55.
There will also be legislation to introduce ‘Collective Defined Contribution’schemes, which are established in the Netherlands.
Collective Defined Contribution schemes
The introduction of Collective Defined Contribution schemes is a controversial step, because Parliament will need to pass laws to allow pension schemes to cut people’s income in retirement, if the scheme doesn’t have enough money to keep payments up. The idea of these schemes is to pool people’s money together in one big fund and make payments out of this fund when they retire, thus applying an element of leveling to the ups and downs of the stock market. Unfortunately this means that if the fund’s returns aren’t as high as expected,pensions may need to be cut.
Is a 30% increase in pensions attainable?
There have been some claims in the press that Collective Defined Contribution schemes will provide 30 per cent higher pensions for savers, though there has been little evidence to support this notion. Even Steve Webb, the Pensions Minister who is proposing these changes, has been careful not to say these collective schemes will result in higher pensions for savers. Ultimately these schemes would be invested in the stockmarket, much like other pension schemes..
In addition, pension savers will not be in control of where their pension is invested,a notion that may not be appealing to many. Indeed, the growth in popularity of SIPPs (Self Invested Personal Pensions)would suggest people want to have control over their pension savings and choose their own investments.
Will they be lower cost than existing pensions?
There are some suggestions these collective schemes could have lower charges than existing pensions. Certainly where there are economies of scale, this can mean lower charges for investors.However existing pension providers already enjoy these economies of scale as they currently manage pensions for hundreds of thousands of people. Any new schemes may eventually get to this scale,but would have to start from scratch.
Collective Defined Contribution schemes
Collective Defined Contribution schemes might in theory suit savers who don’t want control of their pension and who don’t want to choose where to invest. Savers in such schemes would also have to be willing to accept that their pension income may fall once they are in retirement. It is worthy of note that these collective pensions may not allow savers to enjoy the pension freedom announced in the Budget,or if they do, may impose penalties for those who wish to use this flexibility.If these Collective Defined Contribution schemes are ever introduced, they would be made available through employers. However, there are still many hurdles they have to overcome first. Parliament will need to debate and pass laws, then pension providers will need to develop the framework for these schemes and finally employers will have to adopt them. It is therefore likely to be many years before these schemes see the light of day, assuming they make it through Parliament. In the meantime savers can obviously continue to save for retirement, either through their company pension, or through an individual pension like a SIPP.
The Queen’s Speech also confirmed we will be seeing legislation introducing the pension freedom announced in the Budget. This will allow savers over the age of 55 to take their pension as and when they want, rather than locking into an annuity assuming it makes its way onto the statute book.This measure has a great deal of popular support, because it gives people much greater control over their pension savings. As a result, savers are now likely to put more aside for their retirement, because once they hit 55 they will have total flexibility over how to draw it, rather than handing their money over to an insurance company.
If you’re looking for a savings account to squirrel away your hard-earned cash, then a good place to start is with an ISA. These tax-efficient accounts let you rack up interest without giving the taxman a share. With the tax-free allowance set at £15,000 from July 2014 they’ll be even more popular.
It is believed that many people don’t actually know the difference between a cash and investment ISA, despite the fact that many people view saving into an ISA a necessity and save on average over £100 per month.
This lack of ISA knowledge could potentially cost savers hundreds of pounds and there are concerns that when the new rules come into force the majority of savers will put their allowance into lower rate cash ISAs rather than exploring investment ISAs for the potential of better returns.
Cash ISAs are accounts that let you save in cash, keeping things simple and giving you a great home for your money.
There are various versions you can choose from depending on your circumstances. Instant access accounts, where you can put money in and take it out as often as you like and fixed rate versions, where you’ll deposit a lump sum and keep it in for a fixed length of time, with the trade-off usually being a better rate than with instant access accounts and all interest will be free from tax.
Cash saving means there’s no risk whatsoever; as long as you don’t deposit more than 85,000 with any one institution you’ll be covered by the Financial Services Compensation Scheme (FSCS).
An investment ISA, otherwise known as a stocks and shares ISA, is different, you’re not saving in cash but are instead actively investing your money in the stock market, but you still retain the tax-efficient element of a traditional ISA.
Again there are different types you can choose, depending on whether you want to invest in individual shares yourself or leave it to the hands of a fund manager, but the majority of these accounts will use collective investment funds to spread risk and allow you to invest across a range of different areas.
The most important thing to bear in mind is that your money isn’t necessarily safe. There’s a greater amount of risk quite simply because you’re actively investing in the stock market, you’re not getting a set interest rate, so your returns will depend entirely on the performance of the funds and there’s a chance you’ll be left with less than you put in.
Investment ISAs are more suited for those with a longer-term view, as although you’ll usually be able to access your money should you need to, it’s not as easy as with a cash ISA. Another key point to remember is that although the FSCS still applies, the rules for investors are slightly different and you’ll only be covered for up to £50,000.
Generally the potential for better returnswhen compared to traditional cash ISAs is higher.
Whichever ISA you choose from July 2014 you’ll be able to save up to £15,000 however you please, so it could pay to consider both options carefully.The value of your investment and the income from it can go down as well as up and you may not get back the original amount invested. Past performance is not a reliable indicator for future results. lease contact us for further information or if you are in any doubt as to the suitability of an investment.
Fraser Brydon - Money Matters
What is happening and why?
Before 1977, married women and in some cases men, were able to elect to pay reduced national insurance contributions. In doing so they gave up their right to build up a State Pension in their own right, instead relying on their husband’s contributions for a pension payday.
Although the married woman’s stamp was removed for marriages on or after April 6 1977 women who were already married were able to carry on paying at a reduced rate. Women who decided to do this are, under the current system, able to claim a State Pension worth 60 per cent of the basic rate which is £66 a week. If their spouse dies they receive a widow’s pension of up to £110.15 a week.
Divorced couples are also entitled to a pension based on their former spouse’s NI record for the period of the marriage, if it is better than their own.
So what’s changing?
From April 2016, pensioners who have worked for a minimum of 35 years will get a flat-rate State Pension of approximately £144 a week. The current basic State Pension and means-tested add-ons is £110.15 a week.
People with fewer than the minimum number of qualifying years, expected to be around ten years, will not receive any State Pension.
Why is this a problem for women?
Central to the plan is the requirement people should qualify for the single-tier pension on the basis of their own contributions and not on that of their spouse. By 2020, the Pensions Minister expects around 30,000 female pensioners to be worse off as a result.
Who is most at risk?
These new rules apply to people who reach the State Pension age on or after April 6 2016. Those that reach State Pension age before this date are subject to the current rules.
It could become very complicated if the dates you and your spouse reach the State Pension age are each side of the April 2016 transition to the single-tier pension. For example: You have claimed the married woman’s stamp and reach the State Pension age before April 6 2016 but your spouse reaches the State Pension age after this date. You will qualify for a payment based on your spouse’s contribution up to April 5, 2016.
You have claimed the married woman’s stamp and reach the State Pension age on or after April 6 2016 but your spouse reaches that milestone under the current system. You are not entitled to State Pension based on your spouse’s contributions unless covered by special transitional rules.
Transitional rules apply if at any time in the 35 years leading up to State Pension age you decided to pay reduced-rate NI contributions. You will be able to claim any entitlement built up under the current system to 2016 or a single-tier pension based on your own contributions, including any qualifying years after 2016, if higher.
Fraser Brydon - Money Matters
Solar farms, wind and tidal power are the renewable energies which are moving into the investment mainstream. The launch of specialist funds and the crowd funding plans mean private investors can invest in renewable for a minimum outlay.
During 2013, developers raised funds directly from investors, this has caused a wave of activity from private investors moving into the renewable energy sector.
In the past, investors could only access renewable energy by investing in complex Enterprise Investment Schemes with high minimum investment. This has now changed with dedicated investment trusts, which are all listed on the stock exchange.
Private investors also have the option to invest through two retail bonds as well as funds issued this year, Good Energy and Energy Bonds.
Each type of investment offers different advantages. Single company bonds are good for investors seeking short term returns and to diversify away from building society type bonds.
Returns are generated from the sale of electricity to the grid and also from Government subsidies or ‘feed-in tariffs’(FITs) for smaller scale projects and Renewable Obligation Certificates for larger scale projects. So the advantage of including renewable energy in a portfolio is the returns are linked to energy prices, meaning as prices rise, returns follow suit.
The main concern for investors has been the reliance of renewable energy on subsidies and because of a wind-down in these subsidies developers are looking to raise capital from private investors.
Renewables are still greatly impacted by Government policy decisions and so they should only be considered by those who already have a significant and diversified investment portfolio in place and are prepared to accept the risks.
For those thinking about including renewables in their portfolio they need to be aware they are not savings accounts, even if returns are steady, your capital is at risk.
Fraser Brydon - Money Matters
The retirement decisions we make today will determine the standard of living we will enjoy in the future. When you approach your retirement there are some very important choices you need to make that will determine how much income you live on once retired.
So what are the first steps?
Check your personal, company and State Pensions. You must make sure you have enough income to provide for your needs in the future. If you are thinking of using your pension to buy an annuity, it is essential that you shop around and don’t accept the first deal offered by your pension provider, because in doing so you could potentially lose out on a significant amount of money over the lifetime of the annuity.
Investigate your ‘Open Market Option’
You should always investigate your ‘Open Market Option’. This will enable you to get the best possible deal for your pension fund. Comparing all the different rates available,instead of simply buying the annuity offered from the pension company with whom you have built up your pension savings, could result in an increase to your retirement income of up to 40 per cent depending on your circumstances. Other factors such as health and lifestyle can also produce an increase in the amount of pension you receive. Remember you can buy your annuity from any provider. The amount of pension income you receive from your annuity will vary between different insurance companies, so it’s vital you seek and receive professional financial advice before making your decision.
Consider the effects of inflation
With people living longer, you are likely to spend around 20 or even 30 years in retirement so future inflation could have a major impact on the purchasing power of your savings. You may want to opt for an inflation-linked annuity rather than a level annuity; this will offer protection against rising costs of living.
You don’t have to purchase an annuity, an alternative is to leave your pension invested and take a portion of the pension pot each year as an income, this is called ‘income drawdown’. This option could mean that you could possibly leave your family some legacy when you die, as your pension pot, after tax of 55 per cent, passes on to your family according to your wishes. The downside is that, if you take out too much, your capital will or could be eroded to very little. However, the upside of not buying an annuity is your funds remain invested with the potential for future growth.
Another option to consider is flexible drawdown
There are qualifying rules for flexible drawdown which state you must have a guaranteed pension income of £20,000,known as the ‘Minimum Income Requirement’. If you are eligible, then you can withdraw the rest of your pension fund in a manner that best suits your circumstances, whether that’s in its entirety or in part withdrawals. It is often sensible to spread withdrawals over future years, because you still pay income tax on any withdrawals and the larger the withdrawal the more tax you’ll pay.
Do you have forgotten pensions?
It can be easy to lose track of pensions over time, especially if you moved jobs in the early years. You can locate a lost pension by contacting the Pension Tracing Service online at www.gov.uk/find-lost-pension. This is a free service, and if they locate your pension they’ll give you the address of your scheme provider.
Fraser Brydon - Money Matters
Many believe that the annuity market which millions of Britons rely on for income in old age isn’t working. Returns are falling and many of us simply can’t find the best options and are potentially missing out on tens of thousands of pounds.
Steve Webb, the pensions minister, says "switchable annuities” are the answer, so that pensioners will be able to shop around and change annuities in the same way that homeowners can switch their mortgage every few years.
It seems a great idea but commentators have been quick to point out that when you look into switching annuities there are many other problems that could arise.
Getting people engaged with shopping around once for their initial annuity is one thing, let alone repeatedly if they are going to switch every few years. An even bigger issue is whether insurance companies will be prepared to offer annuities that will last for a lifetime if there is a caveat enabling people to switch at any time. The natural outcome is that insurers would be more likely to reduce rates to reflect the added risk, should they lose the money at any point if their customers switched away.
Steve Webb may argue that you should be able to swap to a better rate should rates improve in the future, but this could amount to short term gain yet long term loss. For example, when is it best to swap, and what will the cost be? How long will it take to recover the costs? Will insurance companies impose exit penalties? With people living longer, the most proficient arrangement would be a cost effective lifetime investment solution with an insurance element against short-term fluctuations. The combination of annuities with investment backed by insurance, allows the customer to benefit from stock market returns safe in the knowledge that there is a level of downside protection should something go wrong, this being the general policy in the USA.
People here currently buy fixed-term annuities that enable them to benefit from improving annuity rates further down the line and they can also use a combination of fixed-term annuities, income drawdown and phased retirement plans to run “mixed” pension arrangements with some annual income through their annuity and the rest of their savings invested, another suggestion from Mr Webb.
So, whilst we wait on Mr Webb, what can we do?
One of the easiest ways people can immediately boost their retirement income is to shop around.
The overwhelming majority still fail to take the Open Market Option (OMO) and potentially lose thousands by automatically choosing the annuity rate offered by their pension provider. So, better guidance on the products available is essential. This includes deeper understanding of investment-linked annuities, index-linked annuities, spousal benefit and enhanced annuities for people with health conditions.
Pensioners should also consider alternatives to annuities, like deferring buying an annuity and going into drawdown which is becoming increasingly popular. The Association for British Insurers recently revealed that more than half of people who bought an annuity in 2013 had not taken advice.
Many buy annuities online because they believe fee-based advice is too expensive, but using your professional financial adviser will be cheaper because typically the advice should ensure greater personal yields.
Fraser Brydon - Money Matters
If you have savings or investments in any UK institution you may be aware of the Financial Services Compensation Scheme (FSCS). This is the Government-backed safety net for UK banks and financial institutions.
What is the FSCS?
The FSCS is a Government-backed safety net which exists to protect individuals and small businesses if something serious happens to a financial institution like a bank or investment firm. Depending on the amount of deposited savings, and where they are placed, up to £85,000 per person, per institution is safe, but investments might only be £50,000.
How do you know your savings are protected by the FSCS?
The simplest way is to check out their online tool. This will quickly tell you whether your savings are protected by the FSCS. Just enter the amount of your savings and the institutions, and the tool will instantly tell you if your funds are protected. If your savings are not protected by the FSCS, or you have too much money placed with one institution, this tool will tell you what you should do.
Are your investments protected by the FSCS?
Most regulated investments are protected by the FSCS, but how they are protected depends on the type of investment. If your investment provider becomes insolvent you are protected up to £50,000 per person, per institution.
Fraser Brydon - Money Matters.