Pensions in goal-based wealth management
In a goal-based approach, funding retirement spending has to be planned holistically. Spending in retirement can be met from a variety of different sources including directly-held investment portfolios, ISAs and property holdings. For the majority, a registered pension scheme is likely to form the mainstay of their retirement funding.
Unless funded by inheritance, the sale of a business or property (‘my business is my pension’ or ‘our home is our pension’), retirement spending is a long process of ‘accumulation’ of capital through savings from earned income, followed, conventionally at the start of retirement, by some means of turning the resulting capital sum into an income stream. This second, ‘decumulation’, phase historically was much shorter than the accumulation phase but with increased longevity both stages could now be as long as 30-40 years.
At Fowler Drew we provide advice on the full range of pension and retirement planning issues at both the accumulation and decumulation phases. Our pension analysis and optimal decision making is an integral part of an Initial Review and a continuous source of added value in a discretionary management relationship.
A retirement plan is more than a pension
When we talk about a ‘holistic’ approach to retirement funding, we mean that the goal should be planned in terms of total spending from all sources. After taking into account any contribution to spending made by the state or defined benefit employer pension schemes,the balance of the required expenditure will need to be derivedfrom capital which may or may not be in a pension plan.
The key quantitative determinants of a spending plan are time (both in accumulation and decumulation), resources (the changing market value of the capital saved) and risk. A robust, realistic or workable plan is one in which there is internal consistency between each of these determinants. There is nothing wrong with an inconsistency as long as it is recognised and the implications for outcomes are quantified. Ideally, there will be an action plan, or a contingency plan, to deal with the inconsistency.
Risk in a spending plan is equivalent to the range of probable outcomes, expressed as real spending, either including or excluding uncertainty about future tax rates. For gross outcomes, it is possible to express risk differences as different outcome ranges, higher but wider with more risk and narrower but lower with less risk. As long as probable outcomes can be projected, risk can then be a decision informed by planning rather than as an input to the plan.
The role of pensions in a retirement plan
A pension is not an investment in itself. A pension account is simply a “wrapper” that dictates a particular tax treatment.
It is what the wrapper holds as investments that determine the gross investment return whilst the wrapper determines the after-tax return.
The tax incentives come at the expense of accessibility since the public-policy intention was to use tax incentives to encourage long-term savings and enforce the long-term nature with rules preventing access.
It follows that the role of pension accounts in the spending plan needs to be driven by tax but taking into account the inflexibility that the tax incentive comes with. This is not straightforward since not only do you need to consider the rate of relief that will be given on the contribution but also the likely rate of tax that will be paid when money is eventually withdrawn from the pension fund. With pension legislation in an almost constant state of flux these decisions can be challenging.
Pension freedoms and optimal choices about decumulation
With the introduction of the new ‘pension freedoms’ legislation, all previous restrictions on the amount that can be withdrawn from a pension have been lifted, except that access is still prevented until age 55. This is good news since it allows people to better tailor their pension withdrawals to suit their personal circumstances and tax situation and prevents people from sleepwalking into the purchase of a poor-value annuity product.
However, the wider range of pension withdrawal options (Flexi Access Drawdown, Uncrystallised Funds Pension Lump Sum, Flexible Annuity), and the associated tax consequences of each, make the retirement landscape far more demanding. Furthermore, the fundamental retirement challenge remains: how to maximise expenditure without running out of money before death.
Transferring a Defined Benefit pension
To access Pensions Freedoms when you have a Defined Benefit (DB) or final-salary pension, you first need to exercise your right to transfer a capital sum, equivalent to your employer’s cost of providing the benefits, into a personal pension plan. This right can be exercised any time in respect of deferred (or current) pensions up to a year from retirement (or at the employer’s discretion within a year). As long as the capital sum, known as the Cash Equivalent Transfer Value or CETV, for any one scheme is in excess of £30,000 you will need to have taken advice from a qualified adviser, known as a Pension Transfer Specialist, in a firm authorised by the Financial Conduct Authority to advise on transfers. Fowler Drew has these permissions.
Most individuals with deferred final-salary benefits from past employers are likely to have accumulated other savings, in or out of pension accounts, that can contribute to their retirement spending. With many DB schemes closed to new accrual of pension rights, individuals are increasingly building up personal or workplace Defined Contribution pensions. Proper planning of a retirement spending goal should already be holistic, encompassing all current and planned resources available to meet all spending.
Where the intention is to draw down from capital to meet spending, rather than buy an annuity with the capital, it is vital to consider whether the overall plan could be improved by transferring DB benefits. Without an intention to draw down, a transfer is usually pointless unless you are very young. Even if the DB pension is retained, it is important the overall approach to managing retirement risks takes proper account of the risk free underpinning to total spending provided by the DB pension.
Whether or not a transfer is in your best interests is partly a function of the way the scheme offering a CETV has calculated its cost, which in turn reflects how it is investing to meet its liabilities. If it has ‘derisked’ the scheme and now holds largely risk free assets, the discount (interest) rates it has to use to calculate the CETV could provide a very high value that makes a transfer better than retaining it as underpinning for a combined plan. We explained how this opportunity came about in a post in September 2016: What QE means for transferring your pension.
These, then, are the questions you should be asking Fowler Drew to help you answer:
How much is my CETV and is it unusually high?
Is my existing investment strategy making best use of my DB income underpinning?
Can better outcomes be achieved by transferring than by altering the existing strategy?
Can any of the non-investment features of the Pension Freedoms be achieved by life insurance instead of transferring?
What do these comparisons look like after lifetime taxes and IHT?
If I transfer how should I manage the combined capital to deliver sustainable real cash flows when I need them and within the tolerances I set?
What is the cost-effectiveness of replacing a cost-free DB income with paid-for advice and management?
Having transferred, could I manage the strategy myself?
Stuart Fowler explains what the new ‘Pension Freedoms’ mean for retirees
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