Pensions vs ISAs - how do you choose?

So George Osborne has once again targeted pensioners in his Autumn Statement: he’s already brought forward planned state-pension age increases and has now further amended contribution rules. Beginning in the 2014-15 tax year the maximum annual contribution (the amount you can get tax relief on) will be cut from £50,0000 to £40,000 and the annual lifetime allowance (the total amount you can have in your pot without suffering additional tax charges) will be cut from £1.5m to £1.25m.

You may be thinking “so what?” - £40k per annum is still a fair amount to be saving. What is worrying though is the trend amongst governments to tinker with pensions when they need to encourage people to save money. If we go back just a few years the lifetime allowance was £1.8m and you could contribute a whopping £255,000 per annum into your pension. Due to the complex nature of pensions and constant ‘adjustments’ by politicians,  not to mention the volatility and disillusionment brought on by the financial crisis of 2008, many savers are starting to ask themselves why bother? Some are considering ISAs as a simple alternative with the added benefit of instant-access.

On the surface it seems that ISAs may win out in some respects: you can currently save up to £11,280 a year in a stocks & shares ISA and you’ll pay no income tax when you withdraw it (unlike pensions). Best of all you can access the money whenever you want whereas with pensions you are at the mercy of the government’s rules on when you should be able to access it. Furthermore, due to their simplicity and popularity they tend to be relatively immune to government fiddling – after all, removing an ISA’s principal benefit of tax-free growth and withdrawals would kill the product completely.

But we’re forgetting two important things: tax-relief on pension contributions and what Einstein allegedly called the eighth wonder of the world – compound interest. If you put £10,000 into an ISA today it could grow to be worth nearly £34,000 in 25 years time¹ – a long time, I know, but even for a 40 year old today this still wouldn’t take them to the state pension age! Had they invested this in a pension instead they could have over £56,000 in their pot had they been a higher rate tax payer at the time of contributing. That’s a massive 66% more money in their pot than had they saved into an ISA!

So it’s a no-brainer then, pensions are actually better? Not exactly; you need to consider what the tax implications will be when you come to retire. Obviously no-one can predict this and ISAs may get tinkered with as well, but we can consider how things would be today: you could withdraw your £34k ISA money as and when you pleased with no tax to pay. However, the £56k in a pension would benefit from a tax-free lump sum of 25% but income tax would have to be paid on the rest which could erode much of the benefits gained whilst saving depending on your own tax situation before and after retirement.

This is why good financial planning is vital – your own individual and unique circumstances will determine how you should be saving for your retirement. You might be a higher or additional rate tax payer just now but plan to be a basic tax payer upon retirement. You may have other sources of income that will affect your tax situation in retirement and may change the best way to save for you retirement.

Osborne left the 40% and 50% tax-relief untouched this time round which makes pensions a very sensible option for these tax payers – but how long will this last? Perhaps a balance of ISA and pension investments is the best solution. If you’re concerned that you may not be sufficiently prepared for your retirement contact us for a discussion about your financial needs. It’s never too early (or too late) to start.

1 Assumes 5% growth – you can decide whether or not you feel this is too optimistic!

Enhance your retirement income - with honesty

“Annuity rates are at their lowest levels ever”, “the annuity trap”, “pension income on track for biggest fall in a decade”. The news doesn’t make for happy reading for those who are approaching retirement. After you’ve navigated the myriad of complex options and features on an annuity (which I’ve talked about previously) it seems that you’ll end up with a paltry income after all. That’s if you believe the headlines.

However, there is a way to boost your income, in some cases, by up to 50% if you’re aware of it and you qualify. Insurers refer to them as Enhanced or Impaired Life Annuities. Insurers try to judge the life expectancy of every customer so as to give the best rates and ensure that they don’t end up paying out more than they take in.

It sounds rather morbid, but any illnesses or health conditions that you suffer from could boost the income an insurer is willing to offer you as they perceive you as a lower risk to their profit margins (in other words they don’t expect you to live as long!) Some measures indicate that there are more than 1,500 medical conditions¹ that could boost your income: from high cholesterol and blood pressure through to strokes and heart attacks that you may have suffered.

An odd state of affairs with human psychology sees us being very honest about our health when purchasing insurance products - you don’t want to give them a reason not to pay out. However, when buying an annuity people tend to downplay their health issues. Yet this is exactly what you should not be doing.

Such things as whether your partner smokes, you take regular medication or even if you snore too loudly can result in an increase in your income. The Telegraph reported earlier this year that sleep apnoea (which results in loud snoring) can add up to £800 a year on to your retirement income!

So the most important thing to remember when purchasing an annuity it to be honest about your health – it could add thousands of pounds to your annual income in retirement.

There is a wealth of information about pensions and investments; speak to an independent fincancial adviser who can help you navigate the options and make the best choices for you.

 

1 Medical conditions covered by Just Retirement as at October 2012.

 

Inflation - a real blow to pension income. What to do?

When selecting a pension income there are numerous possibilities: full/phased capped/flexible income drawdown; level/rising guaranteed (or not) annuities and many options in between, all of which are offered by dozens of different providers. To say it’s potentially confusing could be an understatement. Sound, independent financial advice can help ensure that you get the most appropriate retirement income for your needs with the least amount of stress. For example, did you know that shopping around for your annuity could add 20% to your income compared to accepting your existing provider’s annuity¹?

But shopping around isn’t the only important consideration; you also need to consider your current and potential circumstances - and what is important to you. In this respect the effect of inflation is an important concept which can often be hard to fully grasp. For example, during the 1970s inflation averaged 13% p/a which would reduce an annual pension of £10,000 to the equivalent of just £2,500 after ten years!
Obviously, by today’s standards we’d consider this to be ‘high’ inflation (the Bank of England’s target is 2%) but recent figures showed a shock rise, the biggest for over a year, to 2.7%. Inflation of just 4% per annum would reduce the purchasing power of a 65 year old’s pension by nearly a half by the time they reached 75.

What’s more, the government’s measures of inflation are of little relevance to pensioners who tend to experience a considerably higher level due to proportionally higher spending on commodities such as food and fuel. Last year Saga calculated that real inflation for 55-64 year olds and the way they live was in fact 6.6%.

The good news is that you can buy an annuity that grows in value in line with inflation so as to maintain your purchasing power. However, these policies typically mean that you need to accept a lower initial income – often more than a third less² and it can take many years to recoup the difference. You need to consider what factors you deem to be the most important in relation to your future retirement. Choosing your retirement income is a completely personal and individual choice and it can be challenging to know where to start . Speak to a financial adviser if you feel you need guidance to make sure you ask yourself the right questions and, ultimately, make the right choice.

1 According to Money Advice Service (government advice service)

2 Based on Hargreaves Lansdown’s “best buy” rates for 65 y/o male (checked 13/11/2012)

 

Gender Equality – is anyone a winner?

Currently UK insurers have an ‘opt-out’ on the EU’s ‘Directive on Equal Treatment’ meaning that they can use gender as a determining factor when assessing and pricing insurance products. However, from the 21^st December 2012 this will be revoked – meaning that your gender won’t change the price or benefits of an insurance product. This move has been welcomed by many in Europe as a step towards complete gender equality but reactions in the UK have been mixed – here we have a look at why.

What happens at the moment?

The effects are going to touch nearly every insurance product: from car and life insurance to critical illness cover and annuities. For example, in the UK a 65 year old woman is expected to live, on average, 2½ years longer than her male counterpart. As a result, insurance companies offer women a slightly lower annual payment than men for equal pension pots – as the company expects to have to pay it out for longer.

Similarly, it’s a well-known (though highly-disputed!) fact that women are safer drivers – at the very least, women are involved in fewer fatal accidents than men. As such, women cost insurance companies less in pay-outs and are rewarded with lower premiums. Companies such as Sheila’s Wheels have built their whole business based on this premise alone.

But all this will stop! From the 21^st December onwards gender cannot be used as a determining factor in pricing.

How will this affect me?

Obviously the answer to this question depends on whether you’re a man or a woman and what you want to purchase! Nobody knows what prices the insurance firms will use post G-Day as it has come to be known but the new prices will likely lie between current male and female rates but erring towards caution from the insurer’s perspective. In other words, where one gender pays more than the other we expect the new price to sit closer to the higher price than the lower. Insurance companies will still need to ensure they make profits within their risk appetite and pricing at the more expensive end is the easiest way to achieve this. Some predicted shifts are as follows:

Car Insurance:                      Good news for men – Bad news for women (particularly young women)

Research by MoneySupermarket suggests that men aged 17-19 pay a massive 69% more than women for their car insurance. This disparity reduces with age but with prices set to be the same women can expect a substantial increase in the price of their car insurance.

Price: The Association of British Insurers expects female prices for under 25s to increase by up to 25% whilst the Treasury expects male rates to drop by about 9%.

Annuities:                             Bad news for men – Good news for women (but not by much)

As mentioned previously, men’s shorter life expectancy has usually resulted in a higher retirement income than for women.

Price: Male annuity rates could drop by up to 13% according to Treasury forecasts. Female rates, on the other hand, are unlikely to rise much, if at all, and Canada Life has recommended that women shouldn’t count on their potential incomes increasing!

Other insurance:                 A mixed bag

Women could end up paying more for life insurance; less for income  protection and probably the same for medical cover as much of it is already on a gender-neutral basis.

So who is the winner? Insurance companies?

In the short-term the answer is most likely no; insurance providers are spending large sums of money to ensure that their systems can quote correctly and that their processes are fully compliant. That said, many providers are also quick to point out that their pricing systems take into account many factors besides gender and that the directive’s ruling won’t have a huge effect.

A step towards gender equality or actuarial madness?

The gender directive certainly isn’t going to make any insurance products cheaper and some critics say that if gender can’t be a discriminator when actuaries calculate risk then nor should age. One dreads to imagine what the insurance world would look like in such a scenario where annuities are not priced on age and a 20 year old pays the same rate as a 70 year old…

So what should I do?

Unsurprisingly insurers are telling customers not to panic and to wait until they next receive a renewal quote – but for many this will be too late. Certainly women under the age of 40 should ask their current car insurer about its plans and be prepared to look around for better deals. At the same time men should consider the potential effects to their income of delaying retirement until after the change.

For protection and life insurance both men and women need to consider their options. It’s possible that income protection and life cover will become more expensive for everybody as insurers may look to add margin to their books through raised premiums.

If you’re concerned that you might lose out because of the gender directive you should speak to a qualified financial adviser who can help you make the right decision. Depending on the cover you need and lifestyle you have, thousands of pounds could be at stake!

Women and pensions in 2012 - the key facts

It's not top of everyone's list of "things I enjoy thinking about" but it is becoming increasingly critical. Planning for your retirement and what you are going to need financially in order to figure out at what age you'll be able to retire, how much income you will need to live a comfoftable life, what pension or other fund value you need to produce that income and hwther what you have will last a full retirement is just plain essential.

A report out this week from Scottish Widows shows that 42% of women are saving adequately for their retirement. Current economic pressures mean that women have been neglecting their long-term savings, with 19% saving less than the year before and 28% still not saving at all. Just 16% of women have made the effort to save more over the past year.

Women who are already saving into pensions are reluctant to cut their contributions and are well aware of the need to save for old age; 28% of those surveyed who plan to save more over the next 12 months are doing so for their retirement. Whilst 72% of women agree with the statement that people will have to take more responsibility for their own retirement, actions are not following words, with other savings being prioritised over pensions. The problem here is that women can be missing out on the significant tax benefits of saving into a pension and also they are at risk of plundering the savings accounts when a rainy day threatens - or a luxury starts looking like a necessity. On average where women are saving for retirement outside of a pension wrapper they contribute around £200 a month - and they are missing out on the benefits of pension tax relief in the process.

40% of women said they saved mainly for the short term and 28% mainly for the long term. Whilst there is very little difference between the sexes in levels of participation in employer-sponsored pesnions, men are TWICE as likely to be paying into an individual pension. When prioritising for their fanilies' finanical needs, women are putting mortgages and debt repayments at the top of the list  - completely understandably. 25% of women said they have prioritised mortgage payments over the last 5 years and 31% have paid off debt. 42% have hd to prioritise living expenses over pension saving.

Divorce has a huge impact on both parties' finance but only 15% of women said pensions were discussed as part of their divorce settlement, even though t is a legal requirement that they should be. Women should ensure that this is part of any discussion, in order that they don't lose out. We can help advise on this tricky situation and help you navigate through the options.

As the report states, "Knowledge is power" - the underuse of pensions could be due to a lack of understanding about the benefits, or a knowledge gap around pension benefits or funding levels.

"Pensions are a hot bed of jargon and confusion, making them unattractive to the uninitaited, whereas ISAs are a starightforward and popular savings vehicle" the reports goes on. This is a fact - and many people have neither time nor inclination to trawl through complex and often impenetrable data to try to figure out what they should be doing. This is where a financial adviser is worth their salt - they can save you money in tax, increase your savings through sound investment and help flex programmes to suit your changing life. The question increasingly becomes not whether you can afford to take advice, but whether you can afford NOT to take it.

Annuities - dull? Desperately important. We keep it simple..

In the world of pension planning annuities are a hot topic. It’s not everyone’s burning desire to read about them, so we are going to give you a short series of bit-size blogs to help you understand what you might need to know about them. The next 4 weeks will focus on some of the important considerations that people face in the lead up to retirement and how good advice can help you make the right choices.

Despite what many people say, annuities are not necessarily a straight-forward automatic option. There are a few myths to debunk immediately:

·         Your pension automatically becomes an annuity

·         Annuities are restrictive

·         Annuities are a bad deal

Choice

When you come to retire you have a choice. In fact, you have a huge array of choices and the whole thing can become somewhat overwhelming: do you want an annuity or income drawdown?; a spouse’s allowance?; growth in line with inflation?; a guarantee period?; full tax-free cash? I could go on and on but the fact of the matter is that your retirement decision is not a simple one and it’s often one that you’ll be stuck with for a lifetime. Sound financial advice can ensure that you take the decisions that are best suited to you and are going to serve you and your family well in retirement.

Flexibility

Annuities might not be the most flexible retirement income model (we’ll come on to that in a future blog) but there is certainly a lot of variety to consider besides the traditional ‘bog-standard’ annuity. For an extra price you can ensure that your spouse receives an income after your death or that your income grows every year. If you suffer from poor health or are a smoker you can also qualify for an uplift in the income that you’ll receive – for example, high blood pressure could add up to 31% to your income^*!

A good deal better than you might think

Annuities are getting a lot of bad press at the moment, and rightly so: rates are at near record lows largely due to the current economic climate. Despite this, annuities are still the best option for a large number of people: it is the only way to ensure a secure income for life without any investment risk. In its simplest from, insurers consider the number and lifespan of those who live long lives and those who don’t so as to offer the best rate somewhere in between (minus a bit of profit of course!).

We all hope we’re going to live to 100 but few of us would have the means to finance this if we did!

So that was my whistle-stop introduction to annuities. In the coming weeks I intend to demonstrate a bit further some of the interesting aspects you may be unaware of and hopefully prove that there’s still value in a product that can trace its history back to Roman times! As ever, though, with such an important investment in your future, solid, independent financial advice is crucial to making the right choice for your own personal circumstances.

* Source: HL Annuity Supermarket and Just Retirement, 25 June 2012 compared to lowest healthy life annuity rate

RDR - the swings and roundabouts of change

There is much debate and mistrust about the upcoming RDR changes within the financial services industry. With clearer charging structures (from the client’s perspective), differentiation between types of advice (genuinely independent vs restricted) and higher standards of adviser qualification, the principles of RDR are positive and logical.

In practice it means, for some businesses, a change in structure, new client segmentation, hard work passing new examinations and maintaining professional standards and finding new ways of communicating with clients.

It would seem logical to say that those who come through the RDR process will excel. Surveys indicate that a fairly significant number of advisers will leave the business after 2012 and this market contraction can only positively serve those who remain. Change is afoot for us all, but some businesses are more prepared than others and the timeframes are clear for all to see, so we all need to be make the necessary changes gradually rather than waiting for the 11^th hour in December 2012.

Let’s face it - regulation changes are nothing new. The late 80s saw a complete change in regulation and the way retail financial services were to be provided to clients and in 1994, we saw the introduction of commission disclosure, which aimed to reduce contract charges by allowing investors to see transparent costs and enabling them to shop around. Whilst Armageddon had been predicted, the industry weathered that storm too.

Much of the debate about RDR rages around whether the consumer will in fact be better off as a result – and as with most things, it’s probably a set of swings and roundabouts. There will be clearer communication and clearer charging from higher qualified advisers – but there will be fewer advisers (at least initially) which could reduce choice. Over time, more and more qualified advisers will come into the market and issues of choice will be addressed, whilst everyone will soon become familiar with the new ways to charge. The soundest IFA businesses have always been those that put the client first – the ones who do not ‘product push’ but who know their clients over the long term and understand how to add genuine value – and who appreciate that some clients make you more money than others, but everyone must be treated fairly.

A commitment to solid business processes and efficient handling of compliance and competitive charging is now an even greater imperative. With a continued emphasis on putting the client first, on communicating the changes to them and always being there to explain any concerns and questions they might have, those same businesses have little to fear from RDR in 2013 - and plenty to gain.