The majority of people in the UK are now accumulating benefits under what is known technically as a Defined Contribution Scheme or commonly known as a Personal Pension Plan. These schemes have had several names including Stakeholder Pensions or even SIPPS (Self Invested Personal Pension Schemes) over the years there have been many rule changes to both contributions and the size of the fund that you are allowed to accumulate but in essence they all work under the same concept and that is Money Purchase.

So, what is a Money Purchase Pension (MPP)?

MPP schemes work on the principle of a piggy bank meaning that the idea is to accumulate as much money as possible over your lifetime to purchase an income for life. This income is purchased from an insurance company in the form of an annuity and is guaranteed for the lifetime of the person purchasing the annuity, this person is known as the annuitee.

Tax Free Cash Option

When you convert your pension to income, you are crystallizing the benefits and the Inland Revenue will want to check to see whether your pension fund exceeds what is known as the Lifetime Allowance which is the amount that you are allowed to save in pensions before a tax charge is levied. This allowance is presently 1.5 million pounds and should be sufficient for the majority of individuals.

If your pension funds are below this level then you are able to take 25% of your pension fund as tax free cash e.g. pension fund £500,000 x 25% = £125,000 tax free cash.

In our opinion in the majority of cases people should always take the maximum tax free cash even if they wish to invest the money into income as the tax free cash can be invested in a more tax efficient annuity than a normal compulsory annuity. The reasons for this are too complicated to explain in this article and if you want further details we highly suggest that you seek independent financial advice.

Annuities

The remaining 75% of your fund value can be invested in what is called a Lifetime Annuity which used to be called a Compulsory Annuity. These annuities come with several different options which include:

Spouses Pension – which means that on the death of the main annuitee a percentage of the pension, will be paid to a surviving spouse traditionally 50%

Escalating Pensions – means that pension will increase by a set percentage or by a chosen index like RPI. It is worth noting that if this option is selected, the initial income would be less than say a Level Annuity.

Level Pensions – meaning that the pension will not increase with a set percentage, these pensions are normally much higher than escalating pensions although over time an escalating pension will eventually over take a Level Pension, this can take up to 14 years but with an increasing life span this could be an important factor.

Guaranteed Period – meaning that the pension will have a period of time where the full annuity is guaranteed to be paid even if the annuitee dies. This income is either paid to the estate as a lump sum or to the surviving spouse as income.

Alternatives to Annuities.

There are several alternatives to annuities for people who have larger fund values, and these include Drawdown which allows people to draw their income directly from the fund instead of investing in an annuity. This is a complicated area of financial advice which has many rules and indeed investment decisions for people to make and therefore we would recommend that people seek independent financial advice if they are considering this option.

For those that may have accumulated a very large fund or even have a personal pension and a final salary pension in payment they may consider an option called Flexible Drawdown. This option is only available to those with a guaranteed income source of £20,000 or more, again we would recommend that people seek independent financial advice if considering this option.

Open Market Option

As you can see this is a complicated area of financial planning and people should always seek independent financial advice when looking at retirement options, as just taking your pension directly from the insurance company that you have saved with can cost you many hundreds or if not many thousands of pounds in lost income over your retirement.

People have an option to use what is known as an OPEN MARKET OPTION which enables people to transfer their pension to another provider who may provide you with a significantly better income for your pension pot.

Ill Health or Enhanced Annuities

If you suffer from high blood pressure, diabetes or are significantly over weight you could qualify for an enhanced annuity which could provide you with significantly higher levels of income than offered by your own pension company. Your financial adviser will be able to access this type of product through the Open Market Option mentioned above.

Quotation Service

Essential IFA is based in Ipswich and services the surrounding area of Colchester, Bury St Edmunds, Woodbridge, Aldeburgh and Hadleigh. I offer new customers a free initial appointment to discuss how we may be able to help in the area of converting your pension to income. We can provide quotations from the whole of the market as I am a licensed Independent Financial Adviser.

So Call Today and Speak to Peter Herd your Local Independent Financial Adviser for Your Free Initial Appointment on 01473 276141

This three minute video shows the reasons why it is so important to plan for the future and gives an important insight to the areas that an independent financial adviser will cover in a consultation. Our busy lifestyles and need to enjoy life now, sometimes means that we do not look at the very real problems that we may be storing up in our future, so see what independent financial advice can do to help you address these problems and click on the above video

2.If you have utilised Cash Isa allowances in previous years then make sure you check the interest rate, as Banks and Building Societies are terrible at reducing the rate once the special offer is over. You are able to transfer an Isa to another organisation but please remember that you have to follow the transfer procedure of the new organisation. Do not simply withdraw your money from your Cash Isa and then place with the new organisation, as you will be invalidating your previous Isa allowances. If you find a good account then asked the new organisation for their transfer procedures first.

3.Check the interest rate on other deposit accounts that you may hold outside of your Isa’s as you might be surprised how low the interest is, as Banks and Building societies have no interest in upgrading your account automatically.

4.Take a look at National Savings products, particularly if there are any index linked bonds on offer, as these offer interest rates that are linked to inflation. These types of certificates are also tax-free. Unfortunately there are no issues on offer at present, but it is always worth registering your interest for future issues, as this type of account is particularly handy when inflation is high.

5.For those that are willing to speculate with the interest, there is also National Premium Bonds, which can give an average rate of return of approximately 1.5% tax-free if you have the full £30,000 invested. With this type of investment you also have the thrill of potentially winning one million. Please note that the 1.5% is not guaranteed as it is linked to the potential winnings from monthly draws and the maximum that can be won is one million. It’s like playing the National Lottery but never losing your original capital, as you can encash to Premium Bonds at any time and get all of your original capital back.

6.If you’re willing to speculate with the capital then the next type of investment you should invest in is equity linked Isa. The full allowance for 2011/2012 is £10,680, which can be invested in a range of equity linked funds. You can also use these types of accounts in connection with Cash Isa but it will then restrict the overall maximum in cash and equity to £5340 each. We offer advice on a number of solutions but it is important to make sure that any investment matches your attitude to risk. These types of investments are typically held for at least five years but remember that they have no maturity end date. You can also switch funds within the Isa, free of capital gains tax and these types of Isa can produce tax-free income particularly if they are invested in Corporate Bonds. The average rate of return from a Corporate Bond fund is 4.5% and it is important to remember that there may be potential for capital growth as well. Please note that yield rates from corporate bonds do change and the capital from these types of investments can go down as well as up.

7.If you have more than £10,680 to invest then you could utilise an Open Ended Investment Company commonly called an OEIC. These types of investments offer the same range of funds as an equity ISA but are not a tax free investment like an Isa, as there can be a liability to income tax and capital gains. It is important to remember that everybody has an annual capital gains tax allowance of £10,600 and therefore it is possible to manage these types of investments tax efficiently. Money from these types of accounts can also be transferred into an Isa once allowances become available.

8.For those people who are higher rate tax payers there is also a range of insurance bonds, which offer the chance of deferring tax liabilities for up to 20 years. An individual is also able to take 5% income from these types of investments without having a liability to a higher rate tax. These types of policies can also be written in trust for the benefit of children if individuals are looking to mitigate inheritance tax liabilities.

9.Almost every individual in the UK has a pension shortfall and it is a fact that most people in the UK do not understand how pensions work. The simple fact is that for every £10,000 you have saved in a personal pension it will generate roughly £500 of income in retirement. Therefore if you are looking to retire on £20,000 pa. excluding state pension you will need lifetime savings of approximately £400,000 in today’s terms. To help people save into pensions the government allows tax relief on personal contributions up to your highest marginal rate whether that is 20%, 40 or ever 50% tax relief. The contribution is limited to £50,000 gross but you are able to utilise up to the three previous years allowances. Pension planning has become even more attractive as you are now able to pass your pension over to your children after your death via flexible pension income, although tax will be charged on the remaining fund if death occurs after retirement.

10.The most important tip, I can give is to make sure that you seek independent financial advice, as you can see investing money is complicated and it takes time to research and know the best thing to do. An IFA will make sure that any recommendation is tailored to individual circumstances and will take into consideration your tax position, your attitude to risk and how long you’re willing to tie money up for. Getting independent financial advice is very important but also making sure that you review that advice at least once a year is even more important, as your circumstances will change and any investment will also change.

So if you want advice on savings and investment why not contact us on 01473 276141