It is interesting the way that the meaning of certain words change with time, and ‘retirement’ is certainly a word that evokes a very different meaning nowadays to what it did 40 years ago. David Gibson, consultant, Mattioli Woods plc.
Retirement in 1970 was likely a company pension, state benefits, and five to ten years to put your feet up, before age 70 meant you statistically ‘retired’. By comparison, 40 years later and ‘retirement’ is now seen in a totally different light, as a time of freedom and enjoyment.
Pension provision and flexibility has certainly also adapted to cope with the change in the concept of retirement, and we have never had it so good. Over the last decade, we have thrown off the shackles imposed through annuity purchase, and as such embraced the flexibility offered by income drawdown and now flexi-access. For pension provision, retirement from employment is also no longer directly linked to enjoyment of pension benefits and, as such, people are enjoying reduced working hours and, through the 25% tax-free cash entitlement, enjoying a similar level of income, but having more time to follow social pursuits.
The flexibility offered by income drawdown over the last decade has allowed individuals to tailor retirement income to their lifestyle (to a degree), such as drawing a higher income in early and active years, balanced out by a lower income in later years, but at the same time with certainty that any residual balance on death can be passed on to beneficiaries. Flexi-access has now taken this one stage further, allowing the individual to select their income level to meet their retirement needs, and even pass on any balance to beneficiaries tax-free prior to age 75. By contrast, annuity providers have never had it so bad, with falling sales seeing further falls in annuity rates, with a £50,000 pot for a 65-year-old male paying out an annual income of £3,250.
However, all of this positive news and flexibility comes with its own dangers. The government’s stance over allowing us control over our pension funds is to be commended, but thoughtful management is key. Firstly, in careful management and investment of the money, with cash rates being non-existent, returns have to be generated from other asset classes, such as fixed interest, property and equities. These assets can be volatile, as is evidenced in the decline of the FTSE 100 of around 10% over the last year; so understanding your attitude to risk, the effect this will have on return, and the likely longevity of your fund as a result are vital. After all, you can’t draw 7% of your fund and expect it to last long if you remain in cash at 0.5%. Sound professional advice is essential in helping this aspect of retirement.
Equally important is the concept of cash management. The stability of annuity income was always good for budgeting, but for the majority of retired individuals, enjoyment of the money is more appropriate in your 60s than 80s. Flexi-access will now allow individuals to manage their income needs, so they can draw higher sums in the early and active years of retirement, albeit with the knowledge and understanding that this might mean a lower income in later life. Common sense is required, but often not considered, or is sadly abused. Indeed the number of individuals cashing in their entire pensions since flexi-access came into force has taken the government by surprise (and pleased the Chancellor), but it suggests a potential ticking time bomb for an element of the population who are not considering the longer-term consequences of ‘spend, spend, spend’.
It is also clear to see that those who have given an equal importance in their retirement planning to include tax wrappers such as New Individual Savings Accounts (NISAs), venture capital trusts (VCTs) and enterprise investment schemes (EIS) have boosted their retirement income by saving early. These have tax incentives to either increase the initial investment amount, defer a capital gains tax liability (CGT), or exclusion from your estate for inheritance tax (IHT) relief, coupled with tax free income and capital gains payments at maturity.
1. A NISA provides tax-free income and capital gains, with an investment allowance of £15,240 p.a.
2. A VCT provides tax-free dividends and capital gains with an upfront income tax relief of 30% (if held for five years), with a maximum investment amount of £200,000 p.a.
3. An EIS provides tax-free capital gains, can be used to defer a CGT liability, has an upfront tax relief of 30% (if held for three years), and is exempt from IHT if held for two years. The maximum investment amount is £1,000,000 p.a.
The selection of which investment you hold within each tax wrapper is critically important to make best use of the reliefs and to understand fully that with any appreciating asset, there is the risk of negative returns.
Building a portfolio using all of these reliefs, via regular investing, will build a diverse retirement pot, not reliant upon one tax relief system. Hence the risk of future rule changes is minimised, maximising the net income in retirement to the individual.