When should I retire?
Stuart Chapman, 64, lives with his wife Elizabeth, 63, in Chepstow, Monmouthshire. Since June 2006 he has been a self-employed management and accounting consultant, and earns between £30,000 and £40,000 a year after tax.
Elizabeth works part-time, taking home £330 a month. She also receives a state pension of £95 a week. Stuart holds directorships with a housing association and a charity; for these positions he receives £5,000 and £12,000 a year respectively.
The Chapmans' home is worth approximately £450,000; they have an outstanding mortgage of £85,000, which is interest-only.
Stuart has a self-invested personal pension with Standard Life worth £140,000 and a Transact personal pension plan worth £248,000.
Stuart's main aim is to achieve a pension income of £25,000 a year. "I plan to continue working until at least August 2011, at which point I will review my financial position," he says.
Plan of action
Marlene Shalton is a chartered financial planner with Bluefin Wealth Management in Cardiff. During her meeting with the Chapmans, Shalton focused on the couple's pension arrangements.
Stuart's main objective is to maintain the same standard of living for himself and Elizabeth into retirement, with both of them covered financially in the event of the other dying.
In terms of pension planning, Shalton says Stuart has a number of options. "If he were to take benefits now from the Transact pension fund, based on the current value he could take a tax-free lump sum of £62,000 [25% of the fund's value]," she says.
With the remaining £186,000 Stuart could either proceed with income drawdown (which is a way of taking an income from his pension while leaving the remainder invested) or he could purchase an annuity.
Shalton says: "Stuart is not currently taking income from the Standard Life plan either. If he opted for income drawdown on both plans, then he could expect to take an income of up to a maximum of £28,948.80 gross a year.
"This income would be taxable and would be reviewed every five years by the Government Actuary's Department."
Under current legislation, Stuart will have to purchase an annuity by the time he is 75. Prior to this, should he die, Elizabeth would have a number of options regarding his pensions.
She could continue to draw down the income up to the maximum allowable until she reached 75, when she could either purchase an annuity in her name or withdraw the entire fund minus a 35% tax charge.
Based on current annuity rates, if Stuart decided to purchase now he could expect a rate of £19,332 gross a year (non-smoker rate) – if he bought a level annuity with no future increases.
If he bought an increasing annuity, which would grow along with inflation, he could expect £11,376 gross a year. Both of these options assume Stuart opts for a 50% spouse's income with a 10-year guarantee.
"This would mean that if he died within this timeframe the full income would be paid to his wife," says Shalton.
"Thereafter, Elizabeth would be paid half of the pension." If Stuart opts for a spouse's pension of more than 50% it would reduce the amount of the starting annuity.
Safeguarding the future
Stuart would also like to repay his mortgage and achieve financial independence by the time he retires. Shalton notes that he can do this using the £62,000 lump sum from his Transact pension in combination with £24,000 from his stocks and shares ISA.
However, if he does this, he will only just have a sufficient emergency fund for the future. So Shalton thinks it's essential for Stuart to carry out a cashflow exercise with a financial planner.
"Stuart has a feeling that his income will cover his expenditure, based on their current lifestyle. He believes if he's able to obtain an income from his pension plans of £25,000 gross, along with his additional income, then he could manage," she says.
The problem with this plan, according to Shalton, is it assumes his additional income will continue for the foreseeable future.
"It doesn't take into account the effects of inflation over time and how much growth Stuart needs on his pension plans to achieve his objectives."
She recommends that the couple completes a detailed expenditure questionnaire to determine the real cost of their standard of living.
An alternative to purchasing an annuity at 75 would be an alternatively secured pension (ASP). This is similar to income drawdown but the level of income is lower, which may not seem as attractive.
Also, if Stuart died while using this option and there were funds left in his pension pot, there could be tax to pay of up to 85% on it. This is a choice Shalton thinks he can leave until later.
"The choice of income drawdown, ASP or annuity will be very much linked to Stuart's attitude to risk and health," she says. "He says he's in good health, with no medical conditions, as is Elizabeth – and neither of them smoke.
On that basis, there would be no reason to opt for maximum income unless his tolerance to risk is low." This is because taking the maximum income would mean his pension fund is depleted quicker and this would lead to a lower income in the future.
Shalton says: "If Stuart chooses the option of income drawdown, then he'll need a coherent investment strategy to ensure income payments can be made from cash in the early years, with a portfolio that has the correct asset allocation to meet his objectives and risk profile."
Finally, Shalton notes the couple have made wills, and carried out nil-rate band planning with an adviser, prior to the changes in inheritance tax rules, to mitigate any potential IHT on death.
However, she recommends they review their wills and consider putting in place lasting powers of attorney as well.
Stuart found the makeover experience a useful one: "Having a discussion with a new face and getting some new ideas were the real benefits. It was a worthwhile exercise and I'm sure if I do a cashflow exercise it will also help to plan my future."
Marlene Shalton is a chartered financial planner with Bluefin Wealth Management in Cardiff.
Personal pension plan
A money purchase (defined contribution) pension that the holder can make contributions to if the company they work for does not provide an occupational or final salary scheme they can join or they are self-employed. PPP contributions qualify for tax relief.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
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.