Last week we were considering annuities, the need to shop around and consider the various options available, of course one needs to know how much income is going to be necessary to maintain the present standard of living. One can start by looking at your latest pay check and the final take home pay after deductions of tax, NI, pension contributions and any other amounts.
This is what you are living on at present, when you retire, you may pay tax at a lower level but nothing else, you should also be free of mortgage payments, travel and work costs and children’s expenses (hopefully). This results at around 40 to 50% of your gross wage and is the amount good pension provision aims for.
The aim should also be to clear all debt and mortgages before retirement, to give a clean position; one must also add on costs associated with the extra things promised for retirement; travel, short breaks, hobbies, sport and leisure activities, visits and meals out and other well deserved indulgences. These may be short lived as by age 80 you may be less able or want to indulge in these, so living costs would then reduce.
Another area is the 25% tax free lump sum that can be taken from Fund value; your provider may ignore this and quote the annuity on the full fund, but this may not be in your best interest as you could possibly put the money to better use. Take the money, even if you buy an annuity with it you will get a better rate; use it to clear outstanding debt in the first place as the interest due will cost you more than you can earn.
Otherwise invest it, someone who spent £13,000 on solar panels on his roof yielding some 2,200 Kwh of electricity and also FIT payments giving £900 to £1,000 per year (almost 8%), tax free, inflation linked and guaranteed for 25 years; the money goes into the electricity account to pay his dual fuel bills. It also adds to the house value.
If your pension falls short of your needs, you could be entitled to benefit, particularly Council Tax or Housing benefit, don’t be afraid to claim, you paid for it whilst at work and are entitled. If you own your house, then equity release is being pushed hard, recent interest rates charged have dropped to 5.5%, but this soon erodes the balance asset value and is not a good option.
A better option is to downsize, using the money released to drawdown from the invested fund, any savings could be used in a similar manner, just keep a minimum contingency amount in reserve; you can’t take it with you!
However the whole pension scenario leaves much to be desired and gives a poor return on contributions made, particularly from annuities, which are the main reason for the poor performance and high contributions of pension provision particularly in defined contribution schemes which are almost totally dependent on annuities, losing money in real terms. This is the major problem with the new contributory scheme just introduced.
Doubling the return on annuities or pension payments will halve the contributions needed for a given pension, if the fund grows at the modest rate of 4% then over 40 years it will be worth in real terms 60 times the annual contributions, if this only gives 3.5% then the overall yield is only 2.1 times contributions, losing money in real terms.
At this level to obtain a pension of £7,350 would need a Pension Fund of £210,000 requiring total contributions of £3,500 per year, a massive 14% of average wage, the new 8% contribution (£2080 pa) would only give £4,368 pa pension, a poor and inadequate return due entirely to annuity shortfalls.
It is not necessary for pension schemes to effectively finish at retirement and fund continuity through work and retirement has a lot of advantages, particularly if combined with more stable investment. One gets the best o f all worlds, the advantages of annuities, the smoothing out of the ups and downs, the strength of large investment funds and low costs and charges, with asset transfers across the age distribution.
Such Super Trusts would have large inherent strength and could afford to invest in a secure and social manner in UK infrastructure and business; some Councils run schemes for investment in sound local businesses, which give returns of 6.5% and with a good mix could go down to 4% giving worthwhile returns.
There is little doubt that pension funds and annuities could perform better and reduce contributions or increase returns, allowing greater security and confidence in the retirement future.
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