15 Jul What you can do if your expected retirement income is inadequateRead Time: 5 minutes
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The adequacy or otherwise of any future income stream depends on the expenditure which it is intended to match. Before deciding that there is a need for more future income therefore, it is worthwhile to spend some time looking at what your post-work expenditure is likely to be. Your current lifestyle costs are a good starting point (most people’s lifestyle doesn’t change substantially after they stop paid work) but some costs may fall (travel to work, work clothes, lunches), while others increase (travel, heating, eating out). Other expenditures such as mortgage servicing and children’s education costs may also be coming to an end.
If you have been smart, you will have avoided the temptation to increase your expenditure to keep up with your earnings when you received promotions. This affords you the freedom to divert the extra cash towards helping to achieve your own goals rather than keeping you tied to your employer (so helping them to achieve theirs!) to meet your increased mortgage costs from moving to a larger house.
Obtain a state pension forecast
The foundation for anyone’s retirement income in the UK is the basic state pension which, after various changes over the years, now gives a full rate after 35 years’ national insurance contributions or credits. Inevitably there are complications and variations so if you don’t know how much to expect, you can request a forecast either online or by completing a BR19 form. The latter only takes around three weeks currently but the online route is quicker. The forecast will indicate to how much (in today’s terms) your current record entitles you. If you look like falling short of the maximum, it will also show how much additional benefit you can secure by purchasing added years through voluntary national insurance contributions. We generally find that the purchase of such added years represents a good deal for anyone in reasonable health based on the time taken to recover the value of the additional contributions paid.
Make use of employer-sponsored pension arrangements
If you are fortunate enough to be a member of an active defined benefit (final salary) pension scheme, consider purchasing added years from the scheme to increase your final benefits. The attractiveness of this route compared to boosting your pension benefits by other means depends on your circumstances and the scheme structure.
If you do not have a protected lifetime allowance and have sufficient headroom before reaching the standard lifetime allowance (currently £1.073m), either join your employer’s scheme if you are not already a member or look to increase your contributions to it if you are. Some schemes offer a facility whereby the employer matches member contributions up to a specific level, which can double your contributions at no cost to you. Just be aware of the annual allowance (£40,000pa) which limits the extent of tax relief on contributions to defined contribution schemes and on benefit increases for defined benefit schemes.
Repay debt while interest rates are low
While savers bemoan low interest rates, if you have debts the current environment represents a fantastic opportunity to accelerate repaying them as far less of each payment is going to meet interest costs. Even though base rates are at historically minimal levels, there are sources of borrowing which remain high cost so those should be the first to go. Once interest-free periods have expired, credit card rates in excess of 20% are not uncommon and there are no investments that will reliably give you that sort of return.
Review existing defined contribution schemes
Everyone has a degree of risk with which they are emotionally able to cope (as well as a degree of loss which they can afford to experience). However, our experience is that many new clients come to us with a ragbag of old arrangements that they have accumulated over years or decades. Although at the time, there may have been some rationale for the investments that they or their adviser selected, they are not necessarily still an appropriate solution. Changes in circumstances, investment conditions or objectives may all have impacted on their current suitability. A review can identify where improvements might be made to make better use of the assets.
While most schemes set up in the last 10 years have low cost charging structures, the same is not necessarily true of older schemes. The longer ago it was established, the more likely it is to have an expensive and complex set of costs, which can be hard to decipher. While costs are not the principal determinant of the ultimate return achieved, they are important because of the effect they have on the final benefits. If you can save 1%pa in costs, it is the equivalent of achieving an extra 1% of return every year, which is far more difficult. More importantly, achieving additional returns from investment generally entails taking more risk – doing so via reduced costs does not.
Redundancy has become a more common experience for many during the pandemic but while it is never pleasant, some of those affected will be in receipt of substantial payments from their former employers. Although the first £30,000 of compensation for loss of office is free of tax, the balance is added to income in the tax year of receipt and taxed at the recipient’s highest marginal rate. This could be as high as an effective 60% (if it entails the loss of the personal allowance by taking income above £100,000).
For those affected, it can be worthwhile to divert at least some of the excess above the tax-free limit by asking the employer to make the payment to a pension scheme. This requires careful analysis to make the most of it, as there is an element of juggling not only income tax allowances and bands but also the pension annual allowance rules. Remember that you can carry forward unused allowances from the previous three tax years though, which can help. Have an eye also on the lifetime allowance, as if you have a protected one then the protection may be lost and even if you don’t, making a substantial contribution can increase the risk of breaching the standard allowance.
Consider non-pension routes
I recall one of our clients at a previous firm where I worked having pretty well no pension income beyond the state pension. However, she lived pretty well off her portfolio. It’s very easy to associate ‘retirement’ and ‘pensions’ as though the first is not possible without the second and the pension industry, unsurprisingly, is keen for us to do so. While pensions have their attractions, they are basically just savings with tax benefits and rules and in some cases, the rules can get in the way of us achieving our individual goals.
In recent years, since pensions ‘simplification’, those rules have become even more Byzantine and confusing for non-specialists. As a result, an increasing number is being forced to consider alternatives. These might commonly be individual savings accounts, taxable investment accounts and investment bonds or, less frequently, enterprise investment schemes and venture capital trusts. The relative attractions of each vary and for many, a mixture will be appropriate but what that mixture should be is always dependent on the circumstances of each individual.
If you are confident navigating the minefield of information and potential traps, doing so will allow you to approach financial independence with a clearer idea of how you can meet the future. If not, you might find it worthwhile to consult a financial planner for some guidance.