How to make the most of your pension pot
Retirement is not what it used to be - the days of a comfortable old age cushioned by a clear-cut pension income are now the stuff of dreams for many of us.
Factors such as increasing life expectancy, the end of generous 'defined benefit' pensions based on a percentage of your final salary, poor performance from investment-based 'money purchase' pension funds, and low rates for the annuities (lifetime incomes) bought with those funds are all working against financial security in old age.
At the same time, changes in the law have made it difficult to know how to make the most of the pension opportunities we have.
For example, the European Commission's recent ruling that from December 2012 there should no longer be different annuity rates for men and women (although, statistically, women live longer) means that men's annuities are expected to shrink by around 5%, while women's may rise by around 8%.
Meanwhile, a tranche of pension rule changes came into force on 6 April - including an end to the obligation to buy an annuity by the age of 75, and major reductions to the amount we can save into our pensions each year.
So, if you're confused by all the changes and concerned that your pension pot won't deliver the retirement income you hoped for, what can you do?
MAXIMISE YOUR CONTRIBUTIONS
From 6 April this year, you can only pay in £50,000 per tax year (down from £255,000) to your pension fund, with a lifetime limit of £1.5 million (down from £1.8 million).
Such contributions are well beyond the reach of most of us, but in the run-up to retirement it's worth putting as much as you can into your pension, because you'll receive full tax relief on all your contributions.
If you're a 40% taxpayer, for example, and you pay in an extra £60 a month, the taxman will add a further £40, increasing your pension pot by £100.
There are different ways you can do this. If you're a member of a final salary scheme, you may still be able to make additional voluntary contributions (AVCs). Basically, you pay in extra each month in order to boost the number of years of service covered by your pension, though most schemes won't pay out more than two-thirds of your final salary.
"These AVCs may look expensive, but they provide what could be 25 or 30 years of extra retirement income," says Tom McPhail, head of pensions research at broker Hargreaves Lansdown.
"If your employer offers AVCs in a money purchase scheme, this could also be worth considering because such schemes can have very low management charges. However, they tend to offer only a limited investment choice."
But many employers no longer offer AVCs as an option. Instead, if you want to boost your retirement provision, you must set up your own stakeholder, personal pension or self-invested personal pension. You can then make up to the annual limit (£50,000 from April) in total pension contributions.
Use tax loopholes
Look at any other funds or investments you may have outside your pension. ISAs work well alongside pensions when you're saving, because although you can't save as much each year (£10,680 this tax year), they're much easier to access if you need the money before retirement.
If you have other non-ISA investments, it's worth moving them into an ISA wrapper. Remember, income from your ISA is tax-free, which may be valuable if you want to boost your cash flow without moving into a higher tax band.
MAKE YOU HOME PAY
If you have a spare room, why not rent it out under the government's Rent A Room scheme? Anna Sofat, managing director of wealth management specialist Addidi, explains: "This under-used scheme allows you to earn £4,275 of tax-free rental income each year."
Even a spare driveway or garage can earn you extra income. Website parkatmyhouse.com says it's worth doing if you live in "any location where there is likely to be a high demand for parking on both a short-term and long-term basis".
Most parking space owners can expect to earn around £30 a week, but some can earn as much as £3,000 a year.
Read: Five ways to cash in on your home
ACCESS YOUR PROPERTY VALUE
Another alternative is to tap into the value of your home. Many older people are happy to downsize from the family home to somewhere more manageable. This can bring a double advantage: it will release a capital lump sum to boost your savings or pay for a holiday, and could mean lower fuel bills and maintenance costs.
If you don't want to leave your home, an equity release scheme will allow you to borrow up to 25% or so of the property's value (as a lump sum or in tranches). But instead of the interest being paid monthly, it's rolled up with the capital released and the whole lot is paid off when the property is sold.
"Interest is fixed for the loan's life at around 6.5%, which means the total size of the loan doubles every 11 years or so," says Dean Mirfin, group director of specialist adviser Key Retirement Solutions.
In theory, it's possible for the loan to be equal to the value of the property after about 22 years, but that would assume no growth in the property market over that time. "Even if prices rise by just 3% a year, that increase alone would cover both capital and interest," says Mirfin.
These schemes come with a 'no negative equity' guarantee, which means you can never owe more than the value of your property. It's worth taking specialist advice to get the best deal for your circumstances.
WORK FOR LONGER
New rules to stamp out age discrimination mean that from October 2011, no one will be forced to retire at 65. So, in theory, you'll be able to work beyond the age of 65 if you need or want to. You'll also be able to stay in your current job rather than having to find new (often more menial) work.
However, you may wish to look elsewhere for something part-time, or a job that's more flexible - setting up a new business, for example, or working from home.
Websites such as vivastreet.co.uk have job sections that include home-based jobs such as data entry clerks, remote typists, online sales consultants and PAs. You can also advertise your skills, for example, as a music teacher, tutor or translator.
Continuing to earn an income will bring additional financial benefits. First, you can defer your state pension. Either your eventual pension payments will increase by 10.4% for every year of deferment, or after a year's deferment, you can choose to take your deferred pension plus interest (2% over base rate) as a lump sum instead.
Secondly, if you're earning, you may be able to carry on paying into your own pension.
If you're working part-time, it's possible to supplement your earnings with pension income in a much more flexible way than in the old days. Fixed-term annuities, for example, run for a certain number of years rather than the rest of your life, and allow you to decide how much income you want to receive during that time.
Alternatively, you could buy a lifetime annuity with part of your pension pot, but still carry on paying into the remaining fund. Investors with larger pensions could simply draw down a supplementary income from their fund, while continuing to contribute to it.
REVIEW YOUR PENSION POT REGULARLY
Finally, if you want to make the most of your pension funds, it's important to review your investments regularly, to ensure your funds are performing as they should.
"The closer you get to retirement, the more tuned in you need to be as to how much you've got in your pension fund - and how much of an income it will buy you," warns McPhail.
Get the most from your pension pot
• Don't take the annuity income offered by your pension fund manager before you've compared it with those of other annuity providers.
• Check whether you are eligible for an enhanced annuity. You could get a better rate if you smoke, live in an inner-city postcode, or have a medical condition that may affect your life expectancy. Enhanced rates can be up to 30% better than conventional rates.
• If your spouse depends on your retirement income, you should consider a joint annuity that will continue to pay out after your death.
• If you want the flexibility to adjust your income in years to come, look at alternative products such as fixed-term and variable or 'third-way' annuities.
• Websites such as annuity-bureau.co.uk or an annuity broker will help you find the best deal.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
The circumstances in which a property is worth less than the outstanding mortgage debt secured on it. Although it traps householders in their properties, the Council of Mortgage Lenders (CML) says there is no causal link between negative equity and mortgage repayment problems. At the depth of the last housing market recession in 1993, the CML estimated 1.5 million UK households had negative equity but most homeowners sat tight, continued to pay their mortgages and eventually recovered their equity position.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Additional voluntary contributions
If you’re a member of an occupational pension scheme but want to increase your contributions to help boost your income in retirement, this is where AVCs come in. An AVC is a top-up pension that sits alongside your company pension and is administered by your employer. You get tax relief on your contributions and, if you move jobs, you can apply to transfer your AVC plan to your new employer or your AVC your contributions have to stop with your old employer and you will need to start a new AVC plan with your new employer. An AVC linked to a company scheme is subject to the rules of the main pension. (See Free-standing additional voluntary contribution).
A term to describe financial products or ‘plans’ that help older homeowners turn some of the value (equity) of their homes into cash – a lump sum, regular extra income, or sometimes both – and still live in the home. There are two main types of equity release: lifetime mortgages and home reversion plans (see separate entries for both). Whichever type you choose, you borrow money against the value of your property, on which interest is charged, and the loan is repaid when the house is sold after your death.