Monthly Archives

November 2021

Mature woman at laptop calculating retirement income needs

Planning for income in retirement

By | Financial Planning

Transition from work

Money concerns are never welcome when entering retirement, particularly if the opportunity to earn your way out of them is no longer open to you. For many, the transition from work to retirement is often a gradual process. We frequently speak to clients who do not want the instant change from full time employment to retirement, and indeed, it is now quite common to see employees reduce the number of days they work prior to retirement.

The latest data from the Office for National Statistics shows that 14.0% of men and 8.0% of women still work beyond age 65. With the State pension age increasing this is perhaps not a surprise. However, it is unwise to assume that you can rely on continued earnings for a long period of time. Factors such as your health, your partner’s health, your enthusiasm and the type of work you’re engaged in, could mean you have to stop work at some point. If you think you will have to continue working indefinitely, then your (non-) retirement plans almost certainly need a serious review.

 

The role of pensions

Pensions, both state and private, are usually the main source of income in later life. For growing numbers of people,  private pension income will be via income drawdown, rather than the traditional pension annuity. The drawdown approach offers flexibility suited to gradual retirement, when individuals reduce the number of days they work and replace employment income with pension income, so that standards of living can be maintained. This flexible approach can also assist in wider planning, such as considering when to take tax free cash from personal and workplace pensions, and how best to use these funds to supplement the reducing income from employment.

It goes without saying that ongoing management of pension funds in drawdown is vital. The level of withdrawals needs regular review to ensure that the correct amount is being drawn. Taking too much from a fund can mean you outlive your pension, potentially forcing you to reduce the withdrawals in much later life, or even worse exhausting the fund. In addition, taking excessive income withdrawals could also lead to unnecessary income tax charges on pension income.

To help analyse the correct rate of withdrawal, it is important to consider life expectancy, which has continued to improve over time. Since 1981, life expectancy at age 65 has increased by six years for men (to age 85) and four years for women (to age 87). Drawing too much from the plan in the early days of retirement could seriously reduce the chances of the fund sustaining the level of income throughout your life.

Inflation is also an important consideration, and one that is very topical at present due to the elevated levels we are seeing around the world. For example, the buying power of the pound has dropped by about one third since the start of 2000, and static levels of income over time are likely to lead to a significant drop in standards of living as the years progress.

For some, pensions can be a powerful tool to pass wealth between generations, if retirement income can be obtained from other sources, such as investments. Taking lower withdrawals from a pension – or indeed no withdrawals at all – can allow pension funds to build up over time, which could then be passed on your children, grandchildren, or chosen benefactors who will ultimately benefit. This can be a particularly tax efficient way of passing assets between generations for those with substantial estates, as pension assets do not normally aggregate with the remainder of the estate when inheritance tax is calculated, thus potentially saving an inheritance tax charge of 40%.

 

Investment management

If you hold investments – including those underlying your pension arrangements – they need to be managed. What you require from your investments could alter over time and investment horizons naturally tend to shorten as you get older. For example, you may wish to increase the emphasis on security of income rather than income growth. Regular reviews of asset allocations can be very helpful in identifying areas of risk and ensuring that the portfolio continues to meet your needs and objectives.

Investments can also be a useful source of retirement income, which can be used as part of an overall strategy when combined with pension income to generate a tax efficient income stream. Collective investments and direct investments can generate attractive levels of natural interest and dividends, which are tax exempt if held in an ISA wrapper.

 

Pulling it all together

To maintain a coherent approach to planning, it is important to engage with advisers who take a holistic approach to planning. Considering each aspect as part of the whole, rather than individual components, can often lead to better outcomes. A global strategy can ensure that investment risk is monitored across all aspects and income levels can be altered from flexible sources to hit precise income targets in a tax efficient manner. At FAS, holistic financial planning is at the heart of our process.

 

If you are interested in discussing your retirement income strategy with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice. 

Graphic of a business woman dodging pitfalls

The pitfalls of default funds

By | Pensions

Pensions remain one of the best ways to accumulate long-term wealth into retirement, but if you have accumulated pensions with several different employers down the years, it might be worth checking whether they are invested in default funds.

As the world of work has evolved, it’s become extremely rare for people to go through their career with the same employer. For most people, working for different companies down the years means they have accumulated several different pensions, arranged by their employers. If this sounds like you, then you might also have chosen the default pension fund suggested by the pension scheme or pension provider. If so, you’re not alone – according to research published by the Pensions Regulator, 95% of people who have defined contribution (DC) pensions arranged through their employer are invested in the scheme’s default fund.

 

What is a default fund, and why do they exist?

Whenever you start a job, you are now opted into your employer’s pension scheme unless you explicitly tell your employer you don’t want to be. If you do participate, your future pension contributions will be placed in the standard ‘default’ investment fund, and will stay there unless you decide otherwise. Employers and pension scheme trustees have a regulatory duty to ensure their default fund remains appropriate for their scheme, which means pension schemes generally take a very similar “average” approach with their employees’ money. But that doesn’t mean default funds will be the best pension option, or offer the best value, for each contributor.

It is sensible for employers and pension fund providers to encourage most people to invest in a default fund as it is designed to suit the average employee. It keeps employees invested in a pension fund which is not too aggressive, and not too conservative, but somewhere in the middle in terms of the risk profile it adopts. Furthermore, it’s low maintenance – for the employer and the employee. A default fund takes the simplest and often the cheapest route to investing a person’s pension contributions, without asking anything of the employee apart from opting in, rather than opting out. A default fund ensures the employee’s contributions are invested from day one, without them having to do anything. The fund will carry on until the employee leaves the company, or until their retirement date. Without a default fund in place, the money would be held in cash, earning a rate of growth similar to a bank account (so close to 0%).

 

What are the disadvantages of a default pension fund?

The biggest disadvantage with staying in a default fund is that the investments within it have not been tailored to suit your individual needs. Instead, they have been chosen to meet the needs of the average scheme member. The result is that their performance tends to be disappointing for too many people. At FAS, we firmly believe investments should be built around a person’s specific needs, as well as their personal attitude towards risk and preferences, such as adopting a socially responsible investment policy.

 

Are some default funds better than others?

In our experience, most older default funds suffer from a lack of diversification and perhaps questionable asset allocation (the mix of assets the fund invests in). Often, the older-style default funds have an overreliance on UK asset classes, ignoring the growth potential available across other regions and global investment markets. They could also be a bit behind in terms of investing in alternative asset classes that can be valuable for diversification purposes. Default funds also traditionally don’t react to market events, and they have a fairly rigid asset allocation, which is intended to smooth returns, but can just as easily flatten them.

Additionally, if the pension scheme was set up before pension freedoms were introduced in 2015, the default fund may still be designed for purchasing an annuity that offers a guaranteed income at retirement, whereas you may be more interested in taking advantage of the freedoms to stay invested for longer.

 

Failing to take into account your time horizon

The other big drawback with default funds is that they don’t take into account the age of the employees joining the pension scheme. This means that an 18-year-old gets placed into the same default fund as someone with just a few years to retirement. Clearly this may not be ideal for either of these employees – the 18-year-old would be well advised to take on more risk with their pension investments as they build up their retirement savings over several decades, whereas the employee approaching retirement may be better off with a lower volatility pension fund that takes fewer risks with their capital in the final few years before taking their pension.

 

Talk to us if you have older pensions invested in default funds

We know from experience that people often build up a handful of pensions managed by former employers down the years, and there’s a strong likelihood that some of these pensions may be held in more traditional default funds. So, if you think this might apply to you, let us know.

We can review your current pension arrangements – especially those older pensions with past employers that you haven’t considered for a while – and work out whether you would be better off transferring those older pensions into a new pension vehicle designed specifically for you, and has been constructed based on when you plan to access your pension savings.

 

If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice. 

Mature man reviewing investment performance at home on laptop

Ensuring trust investments remain appropriate

By | Investments

The use of trusts to protect the wealth of a person (or a family), and to pass it down to their beneficiaries has been commonplace in Britain since the Middle Ages. In olden times, before knights set off to battle in The Crusades, they would create a trust to protect their financial interests and ensure their wives and children would be looked after.

While the use of trusts has long been associated with only the very wealthy, trusts have a wide number of uses and are still used today to solve a variety of financial issues, such as mitigating inheritance tax, providing income or a home for a spouse, preserving family wealth, investing for children or grandchildren, or making care provisions for vulnerable relatives. As a result, thousands of people each year are appointed as ‘lay’ trustees, and there’s also a thriving industry of professionally appointed trustees.

 

What are the responsibilities of a trustee?

Whether a lay trustee or a professional, whoever is appointed as a trustee owes duties of honesty, integrity, loyalty, and good faith to the beneficiaries of the trust. They must act exclusively in the best interests of the trust and be actively involved in any decisions. The general duties of trustees include:

  • To observe the terms of the trust, and follow any duties and directions set out in the trust deed
  • To act impartially when dealing with one or more beneficiaries, and balance competing interests
  • To keep records and accounts for the trust and provide information when required
  • To act unanimously, carefully, and to distribute assets correctly

 

What duties do trustees have when investing trust funds?

Trustees also have clear and specific responsibilities when it comes to managing investments, which centre on following the duty of care towards beneficiaries and acting in their best interests. For example, while in most instances trustees are able to invest in any type of asset (unless the trust deed specifically restricts some investments), the trustees must consider the purpose of the trust, and – most importantly – the needs of the beneficiaries when establishing the investment policy.

 

Choosing the right investments

A trustee also must, from time to time, review the investments in the trust and make sure they are still appropriate. This is often the area of responsibility that lay trustees and indeed professional trustees overlook. In our experience, it’s all too common that after a trust is set up and investments are made, the continued monitoring and oversight of the investments is forgotten about. Not only is this ignoring the responsibilities of the trust, but if investments are left alone and underperform over several years, the loss of capital could have disastrous consequences for the beneficiaries.

 

What are the risks of not doing anything?

If you have been appointed as a trustee, you could be liable if beneficiaries feel that the trust has been mismanaged and this includes the investment decisions made. Ultimately, this could lead to a trustee being taken to court by the beneficiaries to recover any amount of money lost due to trustee negligence or mismanagement. It’s important to note that a lay trustee who is not acting in a professional capacity is just as liable as a professionally appointed trustee.

Therefore, anyone appointed as a trustee – professional or otherwise – has a personal responsibility to take advice that ensures funds placed in a trust have been appropriately invested, and that the funds are monitored and regularly reviewed.

 

Can people get help with their duties as a trustee?

Managing a trust can be complicated at the best of times. It’s important to keep up with the rules relating to trusts, as well as any new legislation that crops up. The good news is that trustees can get professional help from financial planners, accountants, and solicitors. When it comes to managing investments, we think it’s in the best interests of the beneficiaries and the trustees that advice is sought – and taken – from professional financial planners like us. We can help to make sure the investments held in the trust are on course to meet their objectives, and we can carry out other key tasks, such as ensuring the trust is properly structured, and that investments are tax-efficient and well diversified where necessary.

Acting as a trustee is a privilege, but it doesn’t also have to be a burden, provided trustee responsibilities are carried out as fully as possible. Where necessary, it’s a good idea to take professional financial advice before making decisions – particularly investment decisions – on the trust, and to ensure regular reviews are carried out.


If you are interested in discussing trust arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

Piggy bank in the middle of an animal trap

Don’t fall into the Money Purchase Annual Allowance tax trap

By | Pensions

When “pension freedoms” were introduced, many saw it as a great way to access their pension well before retirement age. But the tax incentives with pensions can often prove too valuable to give up, and hasty decisions risk leaving some people worse-off in the long run.  

 

What is the Money Purchase Annual Allowance?

The Money Purchase Annual Allowance (MPAA) was introduced as part of a range of pension changes carried out by the government back in 2015. One of the changes that some have taken advantage of is the ability to take out up to 25% of your pension as a tax-free lump sum, with the remaining 75% still subject to tax. Back then, the rule changes were touted as being ‘pension freedoms’, although some of these freedoms do carry a bit of a sting in the tail.

 

Understanding pension allowances

Whenever you or your employer pays money into your pension, the government tops up your contribution with tax relief. For most people, the amount they can pay into their pension each tax year and get tax-relief on is limited to an annual contribution of £40,000. Also, when you make contributions to your pension, you benefit from being able to use the ‘carry forward’ rule, which means you can claim any tax relief you haven’t used for pension contributions made in the previous three tax years.

However, the government’s generosity when it comes to offering tax incentives while you accumulate your pension pot get swiftly taken away once you decide to access your pension. The MPAA is triggered once you’ve started to draw on the taxable part of your pension (this doesn’t include the tax-free lump sum you are entitled to) and from that point forward, the MPAA effectively limits the amount of tax relief you can receive on any future pension contributions.

Back in 2015, when the MPAA was first introduced, the annual contribution limit for those affected by the MPAA was set at £10,000, rather than the full £40,000 Annual Allowance. However, this limit has now shrunk significantly and, for the 2021/22 tax year, the MPAA is set at just £4,000. This means that if you’ve triggered the MPAA you can expect to pay tax on all future pension contributions above this amount, and the MPAA will be with you for life.

 

Who risks being caught in the MPAA trap?

The MPAA only affects those with defined contribution (DC) pensions, and who have chosen to access their pension flexibly, including self-invested personal pensions (SIPP). Money purchase restrictions do not affect defined benefit (DB) pensions.

Should you start to make use of pension freedoms to flexibly access your pension, you will trigger the MPAA, which means you will only then be able to contribute up to £4,000 to all your DC pensions each year. Also, you will not be able to make use of any unused pension contribution allowances (known as ‘carry forward’) from previous tax years.

We have heard examples of people who have taken out their tax-free lump sum, and then topped up this amount by drawing down a smaller amount from their taxable pension. Unfortunately, this is just the type of activity where the MPAA rules are catching people out.

 

What happens if you break the rules?

If you do happen to go over your annual contribution limits, then you should expect HMRC to catch up with you at some point. When they do, you will face a tax charge in line with the rate of tax you pay.

 

Example: Meet Victoria

Here’s a quick example of what can easily lead someone into falling foul of the rules. Victoria has £100,000 invested in her personal pension, and is also still a member of her employer’s pension scheme. Victoria would like to build a new conservatory, which costs £25,000, and would also like to draw down an extra £5,000 for a holiday. She instructs her pension provider to drawdown £30,000, knowing that she will pay tax on the £5,000 above the tax-free lump sum (25% of the pension) available.

Unfortunately, once Victoria takes out the £30,000, she has triggered the MPAA, because she has withdrawn more than the 25% tax-free element of her personal pension and is deemed by HMRC to have ‘flexibly accessed her pension’. Had Victoria chosen to get financial advice before contacting her SIPP provider, she would have been made aware of the dangers of triggering the MPAA and revised her plans accordingly. Instead, from now on, Victoria will only be able to contribute an annual maximum of £4,000 across all her pensions, which could well prove costly as any contributions above this level will attract a tax charge.

 

When does the MPAA not apply?

It’s definitely worth remembering that you won’t trigger the MPAA if you only withdraw from your pension an amount that doesn’t exceed your 25% tax-free lump entitlement. You also will not trigger the MPAA if you use your pension to purchase a lifetime annuity, or if the cash accumulated in your pension pot is valued at less than £10,000.

If anyone is considering accessing their pension, and taking advantage of ‘pension freedoms’, we suggest you talk to us first. We can help you to work out the most tax-efficient way of accessing your pension, without making any costly mistakes that could leave you worse off in the future.

 

If you are interested in discussing your current pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.