- “The State Pension is not designed to live off”
Those people retiring now with full entitlement to the current Basic State Pension will receive £168.80 per week (£8,777.60 pa). It’s stating the obvious that this is not enough to live off with any decent standard of living. I am amazed by the number of people who have been relying on this as a significant portion of income in retirement. I know some Financial Advisers who refer to the State Pension as “the wine allowance”. If you can view the State Pension as the extra slug of income on top of your other pension income, you’ll be able to enjoy nearly £9,000 pa of discretionary spending – holidays, one off luxury purchases etc.
- Women’s State Pension Age is not 60 anymore
It is hopefully not necessary for me to tell you this, given the very high-profile plight of the “WASPI women” over the last few years. It was a particularly hotly debated topic in the run up to the last General Election. I list this fact here only as a general reminder, because I would really not wish for anyone to get caught out! You can visit the following website to find out your exact age for State Pension entitlement: www.gov.uk/state-pension-age.
- Property investment alone is not a great pension saving strategy
Currently, contributions into a pension scheme receive tax relief at your marginal rate, so that’s 20% if you are a basic rate taxpayer, 40% if you pay higher rate tax, and 45% for additional rate taxpayers. This can be considered free money, and it is not to be sneezed at. Most people have an annual allowance for pension contributions of £40,000 pa. There are some exceptions, in particular for higher earners (i.e. over £110k), but the rules are complex, so I am keeping this very “general”.
- If you purchase a property you receive no tax relief on the purchase price, in stark contrast you will be subject to additional stamp duty if the property purchase means you own more than one property after the purchase. For a £250k property, you’d be expected to pay £10k in stamp duty – a hefty barrier to entry for this kind of investment. You also get taxed on the income earned, again at your marginal rate, and beware that the expenses that can be claimed against your rental income for tax purposes, is now far less generous than it used to be. According to Property Investments UK, “a good rental yield for buy to let property is 7% or more”. Less than that would mean there might not be enough cash-flow in the property to cover running costs, mortgage payments and those unforeseen, expensive problems that often crop up when you invest in property.
- In comparison a balanced portfolio (with around 60-70% equity) invested in a multi asset pension portfolio could potentially return performance (growth and reinvested income) similar to the good rental yield mentioned above – bear in mind that costs will apply. If you sell your investment property you will also be subject to a large capital gains tax bill on any profit (18% for basic rate tax payers and 28% for higher and additional rate tax payers).
- The major differences between these two types of investments are, that the property will yield you a taxable income immediately, whereas the pension savings cannot be accessed until you are at least age 55. You can also sell your property at any time (as long as a buyer can be found), but once contributions have been made into a pension scheme the money has to stay there until you are at least 55. At this point you can, under current tax rules, withdraw up to 25% tax free, and access the remainder as taxable income. The pension is therefore the most tax efficient way to save for your retirement, albeit recognising that growth of the investments held within the pension portfolio can never be guaranteed – your capital is at risk. But then, it also at risk in the property market.
- One other advantage of pensions is that should there be anything left in the pot when you depart this world, your beneficiaries can inherit the pot tax-free if you die before 75, and will pay tax at their marginal rate if you are over 75. A property, unless in trust or being left to your spouse, will fall into your estate, and should your estate be over £475k (consisting of the Inheritance Nil Rate Band (£325k) and the Residence Nil Rate band (£150k in tax year 19/20)), any excess will be subject to 40% Inheritance Tax.
- My view is, if you want exposure to the property market, you can do so by including within your diversified risk-aligned pension portfolio, an element of property-based funds – talk to your Financial Adviser about such a strategy.
- Annuities are no longer the “norm”
Annuities (annual guaranteed income) used to be the “norm”, but in recent years due to the Pension Freedoms legislation, there are now other options and combinations of options. The trouble with annuities is that the value you are given is based on an actuary’s view of your longevity based on age, postcode and your state of health. Some people will be short changed. If you live to a grand old age you are a likely winner, but if you get hit by a bus the day after starting your annuity, the insurance company wins – big time! Another popular way to take a retirement income these days is by setting up a Drawdown pension. These are complex arrangements and should be managed by your Financial Adviser, but in short, the pension funds remain invested and therefore can benefit from ongoing gains made by the stock markets but are clearly still vulnerable to downward volatility as well as upward. You’ll need to be prepared to take a long term view and ride out the market movements, but if your fund is sufficient enough to provide adequate income for your retirement needs, you could still be left with the capital at the end of your life, which can be inherited as explained above. The flip side of this is that the capital can be depleted due to downward market movements, or due to withdrawals being made that are higher that the income earned by the portfolio – you do run the risk of running out of money, which is more likely if you experience long term bad market performance, withdraw too much and/or live to a grand old age.
- Note: The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
- Pension saving is not for the old
OK, so you probably get the message now. If you start pension saving young, you can benefit from something called “compounding”. This is an amazing phenomena. Compounding is every investor’s friend and every borrower’s nightmare. If you reinvest income earned, that in turn grows and earns income. So, the longer an investment is held, in theory, the bigger the pot will grow to – if a 20-year old starts contributing to a pension they will have benefitted from 45 years of compounding by age 65. Conversely, if a debt accrues interest which is not paid, interest is charged on that interest and the debt grows – fast! Always make sure that compounding is working for you and not against you.
- Pensions are a waste of time, or can’t be trusted
I recall a new customer saying this to me and I was flabbergasted. Having said that, this was a person who was developing a retirement strategy based entirely on investment property, so enough said. I truly believe that if this is your strongly held belief, it is very likely that you do not understand pensions, and in particular the tax relief and allowances available. I know many people find the subject a real turn off, but we are creatures of denial. We don’t like the idea of getting older, and often we favour immediate gratification over delayed gratification. If you can overcome these hurdles, you give yourself a good chance of achieving a stress-free and comfortable retirement, rather than making yourself a candidate for pension poverty.
The opinions expressed here are my own, and do not in anyway, constitute personal financial or investment advice. It is recommended that you discuss your financial planning needs with a trusted Independent Financial Planner or Adviser, who will seek to provide a bespoke financial plan suitable for your personal circumstances. The current tax year ends on 5th April for anyone wishing to make use of the current year’s pension contribution allowances.
Contact Emily Pool to discuss tax and other areas of financial planning.
Call: 07786 854048