Boost your retirement income
Will you have enough to live on comfortably in retirement? If you intend to rely on the state pension to provide the bulk of your pension income, the answer is almost certainly no.
Anyone reaching state pension age from april 2016 onwards will receive the single-tier state pension, which replaces the current system of basic state pension, State Second Pension (previously SeRPS) and pension credit. The government says the new scheme will make it clearer to people what state pension to expect when they retire, reduce means testing and provide a firmer foundation for saving.
The one thing it will not do, though, is provide sufficient income for most people to maintain the standard of living they have enjoyed during their working lives. The new scheme will pay up to £144 a week or £7,488 a year in today's money when it is introduced, and millions will be worse off than under the current system – having to contribute more money for longer in return for a state pension that will, for many, be smaller.
Sadly, even if you have been contributing to a private pension scheme, you may still not have enough set aside to live a comfortable retirement. government data published in May 2013 revealed that the median private pension savings for households where the head is aged 50 to 64 is £135,200. That might sound a lot, but at today's rates this would convert into an annual income of £4,421.
If you plan to work for another few years, there is still time to resurrect the situation. even if you are at the point of retiring, by making the right choices you can boost the income you receive for the rest of your life.
Nigel Green, founder and chief executive of independent financial adviser Chase de vere, says: "it is very important to stress that whatever age you are, the time to start saving is now. it is never too late, as there's always something that can be done to help you secure financial freedom in retirement."
His colleague Mitch Hopkinson, uK managing partner of the firm, says you need to think about when you want to retire, what retirement income you would like, and where that income will come from.
And be realistic. "is retiring at age 60 or earlier something that is actually going to be possible?" he asks. "you might need to push your retirement back."
You can find out how much pension you are likely to get, and what difference investing more can make, by putting your details into the government's Money advice Service pension calculator (moneyadviceservice.org.uk/ en/tools/pension-calculator).
If you are 10 or even five years from retirement, it is still worth putting money into your pension plan. you may feel it's too risky to go for stockmarket investments at this stage, but you can opt for lower-risk pension investments, such as bond and cash funds, and benefit almost immediately from tax relief – 20%, 40% or 45% depending on your tax bracket.
This means that £100 will go into your pension scheme for every £80 that you contribute. if you are a higher or additional-rate taxpayer, you can claim the difference through your tax return. you can contribute up to 100% of your earnings, subject to the annual allowance cap of £50,000 for the 2013-14 tax year.
Even if you don't pay tax, you can still pay into a personal pension scheme and benefit from 20% basic-rate tax relief on the first £2,880 a year you put in. So if you contribute £2,880, the government will top this up to £3,600.
Annuities versus pension drawdown – or both?
You need to start thinking about how you want to generate your pension income a good 10 years before retiring. Tom McPhail, pensions expert with independent financial adviser Hargreaves Lansdown, says: "You need to make the most of your investment returns and in order to do this you need to plan in advance how and when you might want to draw your retirement income."
Most people who have saved through a defined contribution pension scheme use their fund to buy an insurance contract called an annuity. This is popular because the income is guaranteed until death of the policyholder. There are several variations, allowing you to adjust the contract to the needs of you and your dependants.
Alternatively, with pension – or income – drawdown, you leave the money invested and take out an income up to a limit prescribed by the government (unless you have a secure income of £20,000 from another source). The limit means you can draw up to 120% of the amount you would get from an annuity, but because your money is still invested, there is always the danger that the fund can fall in value.
The income you can withdraw is reviewed every three years. For this reason, pension drawdown is generally only considered suitable for those with pension funds of at least £100,000.
But there are advantages too: the fund could grow if the stockmarket goes up, and when you die, any remaining fund will be passed on to your beneficiaries, once a 55% tax has been deducted.
Alternatively, you might decide to opt for a combination of both annuities and drawdown, providing the dual benefits of a guaranteed income and the ability to pass on some of your pension savings to your family. Either way, it is vital to take independent financial advice.
Prepare for retirement
Deciding early on how you intend to generate a retirement income is important because you need to prepare your pension fund for the transition.
If you are planning to convert your entire pension fund into an annuity on day one of your retirement, then you need to gradually switch your money into bonds and gilts at a rate of about 10% a year. This will prevent your fund being decimated by a stockmarket crash in the last few months or weeks before you quit work, but still enable your fund to benefit from any stockmarket growth.
Some schemes will do this automatically for you, based on the retirement age you or your employer have selected – a process called ‘lifestyling'. But if you intend to take retirement earlier or later than this date, you will need to adjust the rate of switching into less volatile investments.
Those who intend to use drawdown should keep the bulk of their pension fund invested in equities in the run- up to, and beyond, retirement, says McPhail, "perhaps even keeping a portion invested in overseas equities".
Shop around for annuities
Increased longevity and economic factors have combined to make buying an annuity much more expensive now: the cost has leapt by 29% between December 2009 and March 2013, according to data published by Pension Trends, a division of the Office for National Statistics.
While it would have cost a man £118,000 and a woman £133,500 to buy an annual income of £5,000 in 2009, based on unisex annuity rates, the cost now is £152,800. This makes it vital to shop around for the best deal.
If you suffer any medical condition that might shorten your lifespan, this could entitle you to an ‘enhanced' or ‘impaired life' annuity. Bob Bullivant of retirement specialist Annuity Direct says some people have benefited from a 20% boost to their retirement income after discovering they qualified for an enhanced annuity.
Although lifetime annuities are a once and for all purchase, taking retirement does not have to be, according to deVere's Hopkinson. He points out that most people end up with several pension funds by the time they reach their sixties, enabling greater flexibility in how and when they take their retirement income.
"Make a decision each year or so about what you want to do with part of your pension, rather than making a one-off decision," he says. That way, you can make sure the outcome fits your circumstances as they change.
A feature of defined contribution pension funds. As people move closer to retirement, their tolerance to risk reduces. “Lifestyling” recognises this and provides an automatic switching facility from funds with higher volatility to ones with less volatility as retirement approaches. Generally this means the pension fund manager gradually moving a client from riskier assets such as shares into corporate bonds, gilts and cash as they near retirement.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
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.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).