Running your own business can give you the opportunity to follow your passion and enjoy the ultimate flexible lifestyle. However, it does also mean taking on additional responsibilities. One of these is your pension.
This is the first of two articles where we look at ‘financial planning through the decades:’ how your financial planning needs change through the various stages of your life.
Clearly the average client’s planning needs are completely different in their twenties to their fifties and, while it’s true to say there’s no such thing as an ‘average’ client, this short guide will hopefully help to set most people on the right path to a well-planned and prosperous financial future.
In this article we look at financial planning in your twenties, thirties and forties – next month we’ll look at how your financial planning needs change as you move into your fifties and beyond.
In your twenties
For many people their twenties come with one huge financial planning plus – no children. If you’re what used to be known as a DINKY (dual income, no kids) then it makes sense to take advantage of it.
It may not sound much fun to think about a pension as you contemplate nights out and holidays in Ibiza, but making a start on saving for your retirement – even if the contributions are relatively low – will pay huge dividends later on in life. With the vast majority of people now set to retire at 65 or later, money invested in your twenties will have the best part of 40 years to grow and benefit from the tax advantages that pensions enjoy.
It’s also important to start saving for the deposit on your first home. Mortgage lenders have toughened up their lending criteria considerably over the past few years and the more deposit you can put down on your first home, the better mortgage rate you’ll be able to obtain.
If you are saving in your twenties, then make sure that you save tax efficiently by opening an Individual Savings Account (ISA). There’s no point paying tax on your savings when you don’t need to.
Finally, your twenties may be a good time to look to reduce debt. With university students now expecting to graduate with upwards of £30,000 of debt, the time before children and mortgages come along may be a sensible time to try and pay off some debt – and hence ease the burden of future interest charges.
In your thirties
Your thirties can be a tough time financially, especially if starting a family means that one partner isn’t working, or only working part-time. Perhaps the most sensible advice is to try and avoid debt building up in your thirties – but if it is unavoidable, keep an eye on the interest rate you’re paying and try and pay off ‘expensive’ debt (such as credit cards) first.
If you’re in a company pension then your contributions will automatically be deducted from your wages – however, if you’re not in a company scheme, or you’re self-employed, then it is vital that you start to make some pension contributions at this stage in your life.
It’s also a good idea to start working with an independent financial adviser to regularly review your finances – for example, to make sure you have the most competitive mortgage and that your pension is on track to give you the retirement you’ll ultimately want.
Even though your thirties may be difficult financially, it obviously makes sense to try and save a little. As in your twenties, remember to make sure that your savings are invested tax efficiently and don’t be afraid to take a long term view with them.
In your forties
The good news as you enter your forties is that you’ll now be approaching your peak earning years. The chances are that you’ll still have children at home and a mortgage to pay, but now is the time to be increasing your pension and savings contributions and cutting down on debt.
These are the years when good financial planning can make a tremendous difference to your long-term prosperity. It’s not that many years since you were in your twenties – and sadly, it won’t be that long until you’re retiring, so efficient and effective planning becomes ever more important.
Many people start to inherit money in their forties and it might also be the time to start thinking about the potential cost of further education for your children. A lot of clients we speak to simply don’t want their children to graduate with a huge burden of debt, and savings that are made now could help your children significantly.
As we said at the beginning of this article, there are as many ‘right’ answers to financial planning as there are clients, every client is different – but the guidelines above will hold good for most people.
If you’d like to talk to us at any time about your financial planning – irrespective of your age – then don’t hesitate to contact us. 01737 225665 or firstname.lastname@example.org
The nights are finally starting to get a little lighter – maybe we can start looking forward to Spring after all. In financial services, Spring means two things; the Budget (on March 20th this year) and the end of the tax year on Friday April 5th.
This article gives some suggestions on financial planning steps to take before the end of the tax year, so that you can make the most of your tax allowances and organise your affairs as tax efficiently as possible. However, the first point to make is a practical one.
Easter is early this year, with Good Friday on March 29th and Easter Monday on April 1st. With holidays bound to impact on administration at some financial institutions, our first suggestion is that if you’re going to act before the end of the financial year, don’t leave it until the last minute. If you want to make sure your transactions are processed in time, look on the week commencing March 25th as the last practical week.
Individual Savings Accounts
The overall personal limit for an Individual Savings Account (ISA) for the current tax year is £11,280 and this will increase to £11,520 for the new tax year commencing on April 6th. It’s important to note that if you are only contributing to a cash ISA then the maximum is exactly half the overall allowance – so £5,640 and £5,760 respectively. The other key point is that if you don’t use your ISA allowances for this tax year then they are lost – they can’t be ‘carried forward’ to the next tax year.
We’d always recommend making use of your ISA allowances if you can – you pay no tax on capital gains which you make within an ISA or income you take from it. For long term investment there is a huge range of funds available within an ISA ‘wrapper’ from the very cautious to the very adventurous: as always, we’d be happy to discuss all the options with you if you’d like some advice.
Capital Gains Tax
Accountants will tell you that CGT is the ‘forgotten’ tax relief – people who religiously use their full ISA allowance completely fail to utilise their CGT allowance. For the current tax year everyone has a CGT allowance of £10,600 – meaning that capital gains made on investments such as shares are free of tax if they are within this limit. Husbands and wives can gift assets to each other without incurring a CGT charge, effectively giving a married couple a limit of £21,200. Like the ISA allowance though, the CGT allowance is an annual one, and cannot be carried forward to a subsequent tax year.
The current individual limit for Inheritance Tax is £325,000 and this will remain the same for the tax year 2013/2014. Remember though, that you can make gifts during a tax year and these will be exempt from IHT if they fall within the Revenue limits: the limit is £3,000 per person, so £6,000 for a married couple. Although these amounts are small they can still help to reduce the value of an estate.
There are, of course, far more complex and sophisticated Inheritance Tax planning measures such as the use of trusts; if you feel that you would like specialist advice in this area then we will be happy to help.
Why have we left pensions to (almost) the end? For a simple reason – because whilst there is enormous scope to make tax efficient investments through your pension (especially for higher-rate taxpayers) the legislation and rules are complex and it is an area where specialist financial planning advice is almost always required.
The top rate of tax is shortly being reduced from 50% to 45%, so many very high earners will be motivated to make pension contributions now, and as usual there is the chance to make use of reliefs and allowances which haven’t been used from previous tax years.
Equally, those people who are self-employed or directors of companies may need to think about making sure their pensions are as tax efficient as possible, and set up to ensure that they receive the maximum benefits from the business they are running. It all adds up to an area where specialist advice is essential and we are always ready to sit down with clients and use our expertise and experience to make sure they have exactly the right pension planning.
Hopefully that’s a useful overview of the planning steps you should take before the year end. There are also other possibilities such as the Enterprise Investment Scheme and Venture Capital Trusts which we haven’t touched on due to their complexity. The key message is simple: “talk to us.” We’re never more than a phone call or an e-mail away and we’re happy to explain any of the subjects above in much greater detail. 01737 225665 or email@example.com
*The Financial Services Authority does not regulate taxation advice or trusts.
Information from Her Majesty’s Revenue and Customs (HMRC) signals that there will be a number of significant changes in the pension death benefit rules from April 2011.
The main changes after April 2011, concern three aspects:
1) what pension benefits can be passed on at death
2) what the tax charges may be
3) what the implications are for Inheritance Tax liability
The last major revisions to the HMRC Pension Death Benefit rules were made in April 2006.
For deaths after 5th April 2011, pension lump sum benefits will be allowed at any age. If these benefits are paid to dependants from ‘crystallised rights’ (relevant existing pensions being paid to the individual, which can be an aggregate of several pensions) a tax charge of 55% will be made – an increase from the present 35%. A tax exemption may be allowed if this lump sum death benefit is made to a charity.
From 6th April 2011, the risk of Inheritance Tax charges on pension rights is lessened. Previously any changes to pension rights by an individual, prior to death, such as deferring taking retirement benefits (depriving an estate by an ’omission to act’) or reducing pension income, could be perceived by HMRC as an attempt to benefit others after their death.
Where HMRC perceives that an individual had deferred taking their retirement benefits or had reduced their pension income for retirement planning reasons, HMRC will not pursue a claim, particularly if the benefit is paid to a widow(er), civil partner or financial dependant.
On death, if before age 75, after 5th April 2011, any lump sum benefit will still be tax free if paid from ‘uncrystallised rights’ – funds held in respect of the member under a money purchase arrangement that have not as yet been used to provide that member with a benefit under the scheme and so have not crystallised.
Lump sum death benefits paid to charities from ‘crystallised rights’ will not be subject to the 55% tax charge. After 5th April 2011 the option to pay non-annuitised pension benefits tax free to charities, has been extended to include deaths before age 75, subject to a number of criteria, including that the deceased member or dependant has nominated a recipient charity. It will be no longer possible for a scheme administrator to nominate a recipient charity.
One of the most enduring debates in the world of investment management is that between active and passive management. Which one provides clients with the best outcomes?
Active managers build portfolios by choosing to invest only in companies that they believe will outperform their peers, also known as ‘stockpicking’. Active managers use a variety of techniques to decide which companies to invest in. In some years active managers will outperform and in others they will fail to achieve their benchmark.
Passive managers take a more systematic approach. They try and replicate a market or index by buying each stock in proportion to its market representation. There are different approaches to passive management along the theme of market replication. Supporters of passive management believe that markets are efficient and in general terms a Company’s share price reflects its true value, so there is little to gain from active stock picking. Let’s look at the key areas in more detail.
Costs are almost always higher with active managed funds as there are additional costs associated with research and analysis. Conversely passive funds have lower costs due to the fact that the investment process is ‘systemised’. Cost is a key factor as an expense ratio of 2-3% on an active fund will have greater impact on the overall return than a passive fund with a lesser charge.
Here’s the big question, which one produces better return for investors? Unfortunately there is no clear answer to this, otherwise we wouldn’t be having the debate! The benefit of passive management is that the performance risks are more manageable as they will be closely aligned to the sector in which they invest, therefore eliminating a nasty surprise if the investment manager gets it completely wrong.
By its nature it’s true to say that with passive management you will never significantly outperform your market benchmark. However, it could be argued that you are more likely to achieve your long term objectives with a passive approach as the degree of uncertainty is lessened.
There is increased risk with active management as not only is there market or sector risk, but also the risk of the manager under-performing. Passive funds are not without risk. In addition to the inherent market risk there is also an element of manager risk as not all tracking methods are the same. Some will replicate the whole market, others will sample only a proportion of the index. As with active funds, the timing of buying and selling can also affect performance.
What do the academics think?
There have been numerous studies comparing the two approaches. Academics tend to sit on the side of passive management, often quoting the ‘efficient-market hypothesis’; the basis of which is that generally market prices reflect all market information, therefore it’s impossible to systematically ‘beat the market’.
The key advantage of active management, the potential to beat the market, is only useful if you can consistently select the winning managers. There is no systematic way of ensuring this is the case as future manager performance cannot be predicted. However, some investors want to take additional risk in exchange for the chance of achieving a higher return.
When a passive fund is used you know in advance that you will be achieving a return that is approximately in line with the sector or market it’s tracking. This approach is one that is favoured by many advisers who are focused on helping clients achieve their investment goals with the minimum amount of risk.
The debate will continue amongst advisers who often have a preference for one or other methodology. At Concept Financial Planning we do not have a preference for one over the other, what is important is the asset allocation decision, which we believe returns the majority of investment performance in a portfolio. We use both methodology when selecting how to invest in the asset classes, as we believe a blend can give you the best of both worlds. If you are looking to invest in UK equities and looking for dividend income can a index tracker fund provide you with this? Similiarly, why pay for active management on a gilt fund, when the cost can normally outweigh the addition return needed.
What is important however, and is crucially more the case with regards to active management on your portfolio, is that your investments are reviewed on a regular basis, this should include your risk profile and time scale for the investment to ensure that the asset allocation remains suitable and aligned to your financial goals.
The above headline could have easily read “Tough Times Ahead for Everyone” but it is likely that the effects of the austerity budget, and the financial deficit it aims to redress, will be felt more acutely by the younger generations and these effects are likely to last for many years.
With inflation out pacing wage growth, tax credits being withdrawn, child benefit frozen and the Child Trust Fund abolished, families are becoming progressively worse off. Undoubtedly the elderly on low incomes will also be hit by higher inflation but it is worth noting that winter fuel payments, free bus passes and free TV licenses have all been retained and that the basic state pension was the only benefit to be increased.
If this was a case of short term pain for long term gain things wouldn’t be so bad but unfortunately the longer term picture looks even less rosy.
The NHS is the only major department whose Budget has been increased and it is reckoned that around 45% of total spending goes to the 16% of the population who are over 65. This is perhaps not surprising, after all, it is inevitable that people will require more medical care towards the end of their lives but this generation are taking out more than they have put in.
To redress this the state pension age has increased, and we are likely to see further increases over the coming years as the working population are forced to contribute to the welfare system for many more years.
The counter argument is that money is now passed down the generations, as increased home ownership provides the next generation with a level of inherited wealth not previously enjoyed. However, inherited wealth cannot be relied upon as increased longevity and rising long-term care costs force more people to sell or borrow against their homes.
So what can be done? The key issue to recognise is that while there may be less spare money available, saving for the longer term should not be the first victim of household budget cuts. Because of the effects of compound growth, a pound not saved now will be far more damaging to your longer-term wealth than a pound not saved in later years.
A recent report by Unbiased, the Independent Financial Adviser search website, has revealed that 36% of those seeking independent financial advice do so in relation to retirement planning.
The large number of people seeking advice in this area is perhaps not surprising. Despite “Pension Simplification” retirement planning remains complex. Increased job mobility means that by the time they retire many people hold a range of pension plans, some occupational, some personal and unsurprisingly these plans are often not fully understood by those that hold them.
There may be a strong temptation to consolidate pensions in order to cut down on paperwork and ease the administrative burden but before undertaking any consolidation exercise, the benefits offered by your existing schemes should be thoroughly explored. While older contracts may have higher charges they may also offer useful features such as guaranteed minimum growth rates or guaranteed annuity rates (the rate at which the capital will be turned into income once you retire). If you have final salary pensions then a thorough analysis should be carried out to determine the viability of a transfer.
When you come to take benefits from pension schemes the options are again many and varied but unfortunately most people end up buying an annuity from their existing pension provider. If annuity purchase is deemed to be the most suitable means of drawing income, it pays to shop around to get the best possible annuity rate.
Whilst it is crucial to take advice on making the most of your retirement funds it is equally important to ascertain the competence of your adviser. Unfortunately the Financial Services Authority continues to uncover examples of poor advice in relation to retirement planning. With increased longevity the effects of the decisions you make regarding your retirement could be long lasting and it is therefore vita that you take good advice and make the right choices.
As the new tax year is upon us, why not take time to re-appraise your financial position. By making some simple changes your financial position could be significantly enhanced. With the new higher rate of income tax and low interest rates, it is time to take action to make sure your financial planning meets your objectives.
Our top 10 tips are listed below;
1) Make use of your ISA allowances
If you are fortunate enough to have savings it is important to make sure that you do not pay unnecessary tax on the interest. The Cash ISA allowance has now been increased to £5,100.
2) Make full use of personal allowances
Your personal allowance will depend on your age and income but if you are not using all of your personal allowance consider whether income producing assets can be transferred from your spouse.
3) Consider ownership of income producing assets
If your spouse pays tax at lower rate than you it might be worth moving income producing assets into their name.
4) Protect your personal allowance
If you have taxable income over £100,000 your personal allowance will be reduced by £1 for every £2 in excess of £100,000 until it is completely eroded. The personal allowance could be reinstated by making pension contributions or by sacrificing salary in favour of other benefits.
5) Look at your protection arrangements
Life cover is one of the few things that have got cheaper over the years. If you have old life policies it may be worth seeing if these can be replaced with cheaper cover. This would not be advisable though if your health has deteriorated. It is also important to also make sure that your cover is sufficient and the term remains appropriate.
6) Put life cover in trust
If your life cover is not written under a trust it will form part of your estate and may therefore be taxable on death. Furthermore your beneficiaries will not get the proceeds until probate has been granted.
7) Claim gift aid
If you are a higher rate taxpayer and have made gifts to charities you can claim tax relief at the rate of 20%
8 ) Set mortgage interest against rental income
If you have a buy to let mortgage interest can be offset against your rental income for tax purposes. It is therefore best to secure debt against your rental property rather than your main residence although what matters is the purpose of the borrowing.
9) Consider repaying Mortgage Debt
With savings rates at all time lows it might make more sense to use savings to repay mortgage debt, particularly if you are on an uncompetitive fixed rate. Watch out for early repayment charges.
10) Make a Will
The laws of intestacy are complex and are unlikely to result in the best outcome for those you would want to benefit on your death. Having a valid and appropriate will in place is vital.
By David Anderson – Chartered Financial Planner @ Concept Financial Planning Ltd
The continued unwillingness of people to make provision for their retirement continues to be a source of concern to policy makers. Much of the debate as to how to encourage retirement saving has centred on tax breaks and product design and the obligation to purchase an annuity is frequently cited as one of the reasons people do not contribute to registered pension schemes. Indeed the Tories have now promised to end compulsory annuity purchase if they get into power and presumably, should this happen, pension providers will be flooded with new applications. But are annuities really that bad?
The main objections to annuities are that they are inflexible, poor value if you die prematurely, and rates are poor. True, they are inflexible in that once you select the features of your annuity you cannot change them. Yes they are poor value if you are short lived but conversely they are good value if you are long lived. But are rates really poor? And if so, what are they poor in comparison to?
Certainly annuity rates have fallen significantly since their peak in 1990 so are they poor value on a historic basis? No not really. In 1990 interest rates hit 14% and inflation was running at around 7% per annum. While this was very bad news for borrowers it was good news for savers. Today savers are lucky to get a 3% return on their cash. Furthermore, in the last 20 years we have seen life expectancy increase further.
A 60 year old man in good health can currently expect to receive an annuity rate of just over 6%. This is for a level annuity with a 10 year guarantee. When considering equity based investments an assumed rate of growth of 7% is generally used. This might lead one to conclude that annuities are poor value since the annuitant only receives what might reasonably be expected as an investment return, while the capital itself is sacrificed.
The key point though is that an annuity carries no investment risk. Buying a level annuity involves exposure to inflationary risk, life company solvency risk and mortality risk, but not investment risk.
To assess whether paying into a pension and then buying an annuity, is worthwhile we need to look at a similar risk alternative.
Let us consider the case of Owen Michaels who is nearing retirement. Owen is aged 50, earns a salary of £40,000 and is in good health.
Let us assume that rather than invest into a pension fund Owen chooses to use Cash ISAs as his retirement funding vehicle. This means he is free to draw money out without restriction and without tax liability.
ISA contributions of £400 per month are made from net salary for the next 10 years. After 10 years, the value of his ISA portfolio (assuming a 3% growth rate net of charges) stands at £55,896.
If contributions of £400 a month had been made to a personal pension fund, tax relief of 20% would have been received and at the end of 10 years (again assuming a 3% net growth rate) Owen’s pension fund would be worth £69,870. From this amount, he could take tax free cash of £17,467 and a net income of £2,527 would be generated via the annuity. From the tax free cash let us assume that £631 a year were withdrawn (25% of the net annuity rate) giving a total annual income of £3,158.
If Owen were to draw £3,158 each year from his ISA portfolio, and assuming a continued net growth rate of 3% per annum, the ISA portfolio would be exhausted after 23 years. Coincidentally, the average life expectancy for a 60 year old male is now just over 23 years.
Clearly if Owen does not survive the 23 years the decision to save via ISAs would have been vindicated but, if he had gone down the pension route and taken tax free cash his beneficiaries would still have access to the residual tax free cash and remember, the annuity rate used had a 10 year guarantee so the minimum return would be £25,270 (£2,527 for 10 years). After 10 years Owen’s ISA is worth £35,642 but the pension residual tax free cash would be worth £15,339, so the worst case scenario is a loss of £20,303 when compared to the ISA route.
So when viewed against a similar risk alternative, annuity purchase continues to stack up reasonably well. The real benefit it offers is as an insurance against longevity and if it were viewed as insurance rather than investment it might get a better press. Like any insurance it is good value if you claim (live beyond average life expectancy) and poor value if you don’t claim (die prematurely).
Pensions are intended as a vehicle to providing income in retirement. As a mechanism for turning capital into an income stream which is guaranteed for life, annuities are perfect. Certainly there are more flexible alternatives and it is possible that in future these alternatives will be available beyond age 75 but for those unwilling to accept investment risk annuity purchase continues to be the most appropriate option and still has much going for it.
State Pension Ages are changing for men and women.
Between 2010 and 2020, the SPA for women will increase to 65 to ensure equality. Women born between 6 April 1950 and 5 April 1955 are affected by this change.
Between 2024 and 2026, 2034 and 2036 and 2044 and 2046, the SPA for both men and women will rise to 66, 67 and 68, respectively. Those born after 6 April 1959 are affected by these changes.
Use the link to find out what age your state pension will be paid …
State Pension Age Calculator