Pensions and retirement planning

To properly assess and quantify a client’s retirement aims and objectives and their ability to achieve them, it is important for an adviser to gain a full and specific understanding from a client about:

Their available assets and any liabilities that should be cleared

Their income and expenditure - identifying surplus income and any likely increase or decrease

Their provision in the event of serious ill health prior to retirement, which will impact on their ability to provide for their retirement (amongst other things)

The age they wish to retire - the shorter the period to retirement the more pressing the need to act; also, the longer the period to retirement the, less accurate the projections of their future income and expenditure are likely to be

Whether at retirement they intend to stop working altogether or gradually reduce their hours

Their income requirements at ret...

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... based on standardised growth rules set by the FCA. The adviser must ensure that the agreed contributions are - and will remain - affordable to the client. This must be kept under regular review, and if the client is agreeable, automatically increased in line with inflation/earnings.

The adviser must draw the client’s attention to the fact that these projected returns are for illustration purposes only and are not in any way guaranteed, and that the income in retirement will depend on the return on the underlying investments after deduction of any charges. The adviser will also point out to the client that what is of most importance over the term to retirement is the real rate of return, i.e. the difference between the rate of return on investments and the rate of inflation.

What is the key issue that will motivate the client into taking action?

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There are many different options available to meet a client’s retirement objectives. The most common ones are:

Basic State Pension/Additional State pension/new State Pension

Defined Benefit schemes

Defined Contribution schemes

Hybrid schemes

Additional Voluntary Contributions (AVCs)

Free Standing Addit...

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...cts (RACs)

National Employment Savings Trust (NEST)

The above are a combination of State provision, occupational schemes (both defined benefit and defined contribution) and private provision.

List two schemes from the above list that will be wholly or partially final salary schemes.

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Ultimately, a pension is merely a vehicle for long-term saving with the aim of providing an income in retirement to meet the client’s goals and aspirations, and as such the pension vehicles listed in the previous section are not the only investment vehicles that can be used to provide for retirement.

Pensions do, however, offer the following tax advantages:

In most instances, contributions will benefit from tax relief, though rules exist to restrict the availability of this tax relief especially for higher earners

Once invested, the monies within the pension grow free of any capital gains tax

Income received from investments within the pension wrapper will be free of any income tax liability

In most instances, a maximum of 25% of the fund value can be taken as a tax-free lump sum at retirement (pension commencement lump sum)

Death benefits can usually be received free of any Inheritance Tax liability

Pensions do also have a few disadvantages:

Except for specific professions such as sportspeople or those retiring early du...

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...hilst continuing to live in it. These products have appeal to those who have little in the way of other options but there are various considerations to take into account before using.

Your own business

Owners who choose to invest solely in their own business to provide for their retirement are generally taking a high-risk approach. Pensions and other investments are normally more diversified and more liquid than unquoted businesses. Furthermore, business owners often encounter difficulties finding suitable cash buyers, especially at a time to coincide with their planned retirement. However, IHT relief at 100% is usually available after 2 years of ownership and business asset disposal relief on disposal of the business (10% capital gains tax on the first £1 million of qualifying lifetime disposals and 10%/20% thereafter) does add to the appeal. (A higher lifetime limit may apply if assets were sold before 11 March 2020).

State the position of both pensions and ISAs with regards to taxation of withdrawals.

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Regular reviews are essential to establish whether the client is on target to achieve their retirement goal. During these reviews, it may well be established that the client is unlikely to attain their target income at the age they wish to retire, in which case, one of the following courses of action will need to be carried out:

Increase pension contributions

Defer the date of retirement

Accept a lower level of income in retirement

Adopt a higher risk investment strategy for the potential for greater gains

Allocate additional assets towards retirement planning

The investments held within the pension itself will also have to be reviewed regularly to ensure that they remain suitable:

As retirement draws nearer, it is generally appropriate to switch gradually out of equities and into fixed-interest securi...

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...lar structured reviews as well as ad hoc reviews is very clear, and at the very least an annual review is recommended for the following reasons:

Review of products previously taken out for their continuing suitability and whether performance is acceptable

Use or consideration of annual allowances for pension and ISA contributions, capital gains tax and giftings/inheritance tax transfers

Change in client circumstances, e.g. marriage, divorce

Change in client views, e.g. attitude to risk, preferences

Changes in legislation, e.g. tax rates and allowances

Changes in availability of products

List five potential actions that may need to be carried out if it is established that clients are unlikely to attain their target income at the age they wish to retire. 

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Cash flow modelling is an assessment of current and forecasted wealth, helping to create a picture of someone’s finances now and in the future allowing for investment performance and inflation.

Cash flow modelling is particularly important for someone ...

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...ssets eg stock market crash, business failure

The need to increase income taken from a portfolio

The need for a large ad hoc withdrawal

Future inflation is higher than expected

Living longer than expected

Future returns are lower than expected

It is generally accepted that the foundation of investment strategy is asset allocation. Research demonstrates that most of the difference in investment returns comes from asset allocation rather than fund or stock selection. The concept of asset allocation applies to investments across the board, with a pension vehicle merely being one form of ‘tax wrapper’ for receiving such investments.

The allocation of the investment for a client’s retirement planning vehicle is an important part of the financial planning process with correct allocation of assets depending on several factors:

Attitude to investment risk

A client’s attitude to investment risk may differ between their pensions and their other investments. A person may be cautious with respect to their pension funds but prepared to take considerably more risk with med...

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...relatively small proportion of a client’s overall invested wealth the client may be prepared to take more risk. Someone who expects to have their pension as their only source of retirement income is, however, likely to be more cautious.

Studies associated with asset allocation theory suggest that more than 90% of the variability of returns within an investment portfolio is determined by strategic asset allocation. However, whilst strategic asset allocation is a major determinant of investment performance, at the same time the investment process should not be limited to strategic asset allocation alone. Investment managers can potentially add value through tactical asset allocation and stock selection.

State what determines more than 90% of the variability of returns within an investment portfolio.

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The main asset classes are:

Cash/Deposits

Cash deposits provide a high level of security for an investor. The amount of interest paid reflects the amount deposited and the terms and conditions that relate to the investment. Generally, the longer an investor is prepared to leave the funds deposited, the better the return they will achieve. In return for placing their cash on deposit investors receive a regular interest payment for their deposit at the prevailing interest rate. Their capital is not exposed to investment risk but it is unlikely that the real return after tax will keep up with inflation.

Fixed Interest Securities

A fixed rate of interest is secured with the potential of a full return of the initial amount invested if held for the whole term (they have a fixed redemption value known as the par value). If the investment is encashed during the term it should be sold on the bond market and the value received will be subject to supply and demand; it could be more or less than the initial purchase price.

Gilts and corporate bonds are the main types of fixed interest security available. Gilts are loans to the Government whereas corporate bonds are loans to companies seeking to raise c...

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...et-backed investments such as property and equity funds. As retirement approaches funds are gradually shifted towards fixed interest securities and cash (usually five to ten years before the individual’s selected retirement age).

The whole process happens automatically unless scheme members are able to intervene with their own personal decisions.

Lifestyling is not without its drawbacks as the automatic nature of the switching ignores investment timing considerations, e.g. equities may be sold when markets are depressed. Furthermore, the process works backward from a fixed retirement date and in practice few people can predict their retirement age with complete confidence, with the result that actual retirement may be earlier or later than anticipated or even possibly phased over several years.

Target date funds are used by NEST as default funds for members. If someone intends retiring in 2035 they will select the 2035 target date fund. The fund invests in growth assets initially and moves into less risky assets as the target retirement date gets closer. The fund is actively managed, unlike a lifestyle fund.

List three ways of investing in property.

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The changes in April 2015 to the rules for defined contribution  schemes as well as the changes to death benefits have brought an extra dimension to retirement planning, especially at the point of decumulation:

Income benefits: it is possible to have full access to monies held in a money purchase...

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... would have no wish to make further pension contributions once they have flexibly accessed their pension. However, those who have, for example, flexibly accessed their pension prior to their retirement to release a necessary capital lump sum, their ability to replenish their pension will be restricted

Tens of thousands of people go it alone every year with self-invested pensions. By self-investing, the client has access to a wide range of investments from shares, gilts, OEICs, investment trusts, insurance company funds and commercial property (but not residential property).

The client also has more choice if the investments perform badly, as they can simply move the money to another investment house rather than being tied when a fund performs badly. The client can make the decisions themselves or use a stockbroker or financial adviser to do it for them.

This is particularly useful for owners of small businesses who can buy premises through their pension funds. There are attractive tax advantages in using the fund to buy commercial property. The rental income is received tax-free by the fund and when the property is sold, which must be before the pension is drawn, there is no capital gains tax. In addition commercial property has the potential to produce a positive real return over the longer term.

Someone with their own business might decide to use the property assets - such as offices, factories, agricultural land and warehouses - as part of a retirement nest egg. In this case, they would pay rent directly into their own pension fund rather than to a third party (usually an insurance company).

The main drawbacks are that the client does not have the buffer of a prof...

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...vestment in the member’s employer should always be treated with caution - it is high risk as employees will be depending upon their employer for their retirement income as well as their current earnings. If the employer fails the employees could lose everything.

Furthermore, shareholdings in an employing company can create conflicts of interest, e.g. members may wish to sell their shares when the employer does not wish to see sales taking place. With unlisted companies, shareholdings will generally be highly illiquid and therefore difficult to sell.

Taxable property

The list of ‘taxable property’ covers residential property (with some minor exceptions, e.g. a caretaker’s flat) and most forms of tangible moveable property. Residential property is defined in detail, e.g. beach huts are residential property but student halls of accommodation and prisons are not. Tangible moveable property basically means personal chattels (e.g. antiques, art and cars) but excludes certain business assets valued at no more than £6,000.

Any investment in taxable property, whether directly or indirectly, will result in the scheme and/or member being subjected to one or more of the unauthorised payments tax charges.

State the restrictions that apply to a SSAS investing scheme assets in its sponsoring employer.

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Estimated st...

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...s learning outcome.