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Pension Death Benefit Changes – April 2011

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.

Planning ahead

Throughout every stage of your life, finding the right balance of investments can be a challenge. When stock markets are volatile, investor sentiment is fragile and economic growth is weak, it can seem even more of a conundrum, particularly if you are near retirement. Achieving the right balance of investments is crucial if you want to enjoy a comfortable old age.

Britons are living longer, and it is now not unreasonable to expect 30 – or even 40 – years of retirement. State pensionable age is likely to continue its rise, forced higher by the massive budget deficit and increased lifespans in the UK. It is wise to start planning early – you shouldn’t wait until you are near retirement before considering your circumstances, so take stock of your situation well in advance.

In order to do this you need ask yourself some questions; When do you want to retire? How much do you need to ensure a comfortable lifestyle? What are your liabilities?  What have you saved so far? Consider all your assets that might be able to generate future income for you, in order to determine the maximum income you might be able to achieve.

As you approach retirement, your attitude to risk is likely to change, and effective asset allocation becomes even more important. Higher-risk asset classes, such as equities, tend to perform well over the long term; however, as you near retirement, your portfolio will have less scope to recover from a stock-market decline. Therefore, as you grow older, it makes sense for your portfolio’s asset allocation to evolve with you and you might want to consolidate your gains and shift into assets with a lower risk profile.

A reduced risk profile is likely to lead to a portfolio that focuses less on volatile assets, such as equities, and more on lower-risk asset classes such as bonds and cash. One simple rule of thumb relates to an investor’s age: if you are 25, 25% of your portfolio should be in bonds and cash; if you are 40, 40% of your portfolio should be in bonds and cash. On this basis, by the time you reach the age of 65, your portfolio should have a maximum of 35% invested in higher-risk investments such as equities.  At Concept Financial Planning we use risk and time adjusted portfolios which balance the risk reward trade off.

Of course, everyone’s circumstances are different, but proper planning will help you towards the retirement you want.  Nevertheless, this is a complex area; expert advice is essential.

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What’s so wrong with an Annuity?

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.

Case Study

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.

A Lump Sum Cash Injection – Buy Now While Stocks Last?

The minimum age at which you can take benefits from an authorised pension scheme is currently 50 but from 6 April this year the minimum retirement age increases to 55. Research published in June 2009 suggested that as many as 80% of 50 year-olds who planned to draw on their pension before age 55 were unaware of the change.

Anyone who is currently aged between 50 and 54 should now be considering whether it is appropriate to take benefits from their pension scheme before the opportunity is lost.

Benefits can be taken in the form of a tax free lump sum (usually capped at a maximum of 25% of the pension fund value) and a taxable income. It is possible to access a tax free lump sum and defer taking a taxable income and for many this could be attractive.

Consider the example of 52 year Michael who is a cautious investor with a pension fund of £80,000. In recent years Michael has had to meet some large expenses and as a result is now paying interest on an unsecured loan of £20,000 at a rate of 9% per annum. In line with his preference for a cautious investment strategy, Michael’s pension fund is invested in deposit fund and as such is currently offering a minimal return. Unless Michael’s pension fund offers the realistic prospect of an annual return in excess of 9% per annum Michael would be better served taking a £20,000 tax free lump sum from his pension fund and clearing his debt. The repayments he was making could then be used to replenish his pension fund.
Taking pension benefits prior to age 55 will not be appropriate for everyone but could be beneficial in certain circumstances. For example:

• If you are paying a high rate of interest on loans
• If you wish to help children onto the property ladder
• If are struggling to secure bank funding for your business
• If you wish to stop work before age 55

The above list is not exhaustive and anyone considering take benefits from their pension scheme should seek professional advice.

By David Anderson – Chartered Financial Planner

Concept Financial Planning

Rule Change !

From 6th April 2010, you will have to be 55, rather than 50, to access any money from a personal pension scheme. So if you are likely to want to take any benefits and you are over 50 but not 55 by April you do not have long to make a decision.

What is to decide?

Making this decision is not as straight forward as you might think, there are many things to consider. I have highlighted the 3 areas to think about.

Firstly, how does this fit into my financial plan and what I mean by that is – was this one of your objectives to ‘retire’ or ‘take benefits’ before 55?
Just because legislation changes you don’t have to take the opportunity if it is not in your plan.

Seondly, what are he cost implications for doing this?
Things to consider here…..
* Cost of the product not only now but ongoing
* Tax cost – if income is delivered how much tax will you pay on this?
* Investment – if you take the money-  what do you do with it? – the investment risk and tax status are both   considerations
* Death – once a pension is ‘opened’ you can attract a death tax by the government at a rate of 35%, whereas no tax is payable if your pension has not been opened.

Thirdly – the retirement options market has dramatically changed over the past years with lots more options and choices to make – so think carefully and make the right choice for you and your financial plan – this decision will be with you for the rest of your life, you can not reverse the decision once you have taken action.

These are not the only options you have, the decision that you make for your retirement are important and as such that the advice of a professionally qualified experienced planner to guide you through this complex topic.

Concept Financial Planning – Retirement