Breaking down the barriers to early retirement
Michael Titley, 56, is a PC technician living in Sprotbrough, Doncaster, with his wife Alison, 42. He earns £16,681 a year, while Alison earns £16,000 as a technical support officer for Rotherham Council. Michael owns his house, which is worth approximately £180,000. The Titleys have no credit card debt or outstanding loans, and have a significant amount of savings and investments.
In total, Michael has £249,000 across a combination of individual savings accounts, investment plans and managed funds. He is also a member of his company’s final salary pension scheme, paying £100 a month into it, and he has a personal pension with Standard Life worth £26,248, which he’s currently not paying into. He doesn’t have any life insurance or critical illness cover but, through work, he has death-in-service cover to the value of £67,000, and has a will that reflects his current wishes.
Michael is looking to recover from what he deems to be bad investment advice from the banks. He would also like advice on his retirement and wants to know whether he’s in a position to retire early.
Will Palmer is an independent financial adviser for Atkinson Smith financial planners in Doncaster. He understands that Michael is frustrated with the performance of his investments, which have not made many gains during the stockmarket rally, but believes his expectations were too high when taking into account the type of products he invested in.
Michael has £27,000 invested in two Halifax products (the collective investment plan and personal investment plan), both of which are fully invested in the Halifax cautious managed fund.
“Michael’s attitude to risk scored four [on the risk spectrum], with one being low and 10 high,” says Palmer. “So his investments in the Halifax cautious managed fund are probably still within his tolerance limit, since the fund currently has 52% equity exposure.”
Palmer points out the fund’s recent performance in its sector has been good due to its relatively high exposure to equities (the highest equity exposure in the cautious managed sector is 60%), which means it has done well in the recent stockmarket recovery. Over one year it has risen by 23.33% compared with an average of 15.46%, and is ranked in the first quartile.
But Palmer also notes its performance over three years has not been so good (it has ranked in the third quartile over this period of time).
“Michael feels disappointed with the fund’s performance when he compares it with other funds in the sector,” Palmer explains. “However, he should realise the makeup of funds in the sector is significantly different and so they perform differently in varying market conditions.”
Michael’s other investments have also left him frustrated. He invested £50,000 in Halifax Guaranteed Investment Plans in 2004, and a further £70,000 in 2007. These plans guarantee his capital from the fifth anniversary onwards or 80% of the highest value achieved.
“On the face of it, these offer the perfect solution for the cautious investor,” comments Palmer, “as they potentially can generate better returns than a savings account and provide security for the original capital. However, the underlying fund has been managed with security in mind, and so when the stockmarket recovered, the fund didn’t, as it was – and still is – invested in cash.”
Palmer believes it’s unlikely the fund will move back to an element of equity exposure in the future due to the guarantees it has in place, and considers it an expensive way of holding cash.
Since the management fee of the fund is 1.75% a year, he suggests Michael cashes in both plans and puts his money in a combination of cash funds and an absolute growth fund. But he should keep in mind that savings over £50,000 will not be covered by the Financial Services Compensation Scheme, and spread the money accordingly.
As far as retirement is concerned, Michael has a number of options. At the moment, his outgoings are approximately £800 a month. Palmer has calculated that from his investments alone, Michael could expect to generate £1,041 a month.
This means, if he really wants to retire now, he can maintain his current standard of living without any real struggle and without having to draw on his pension early. However, the terms of his final salary pension scheme mean for each year Michael works for his current employer, he will receive 1/60 of his final salary as a pension.
So far, he has been with his employer for 12 years, and Palmer recommends he stays there until he is at least 60. “If he does this, he’ll build up an additional pension of £1,133 a year,” he says.
He also suggests Michael uses some of the money he has in assets to top up the personal pension he has with Standard Life – currently, the fund is worth £26,248. While he’s working, Michael can contribute up to 100% of his salary to his pension each year.
His employer’s contribution into the final salary scheme can be estimated at £2,833 a year, which leaves Michael with a maximum contribution of £13,848 a year.
“The benefit of making this contribution is that he’ll get 20% tax relief at source and can draw 25% of the fund back as a tax-free lump sum,” adds Palmer.
In four years’ time, for example, if he continued to make maximum contributions and took 25% as a tax-free lump sum, Michael’s pension would be worth £41,544. For a pot of that size, using the open market option and taking into account his age and the fact he’s a smoker, Michael could expect to get an annuity valued at around £2,866.53 a year. He is also in line to receive the full state pension, which he can draw at 65.
“I think Michael is in a better position than he imagines,” says Palmer. “He has to understand that investments can go up as well as down. Generally, investing for the medium term will give better results than cash, but of course the road can be rocky.”
|Michael’s To–Do List:|
|Keep investments in Halifax cautious managed fund to maintain current level of risk|
|Cash in guaranteed investment plans|
|Top up pension with money from assets|
|Decide what age he wants to retire and plan pension funding accordingly|
Will Palmer is an independent financial adviser for Atkinson Smith in Doncaster. Visit atkinsonsmith.co.uk or call 01302 341 282.
Open market option
People who have a money purchase or defined contribution pension, at retirement must use their fund (minus an optional 25% as tax-free cash) to purchase an annuity. As the annuity market is very competitive and rates differ vastly between annuity providers on a daily basis, the open market option is your right to shop around and buy the annuity from the company offering the highest rates at that time.
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.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
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).
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
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.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.