Plan and protect

A lot is happening currently in the world of pensions. In particular, at one end of the spectrum, a significant curtailment for many higher rate tax-paying solicitors of higher rate tax relief on pension contributions effected by the Finance Act 2009, and, at the other end of the spectrum, the introduction of personal accounts in 2012.

Changes to state pension benefits are both in the pipeline and being considered, as is the effect of the implementation of the retail distribution review and whether the availability of advice and the cost of investing will be reduced.

There are also concerns over increased longevity, and whether the push to compulsory annuitisation at the age of 75 is the right course for those who wish to stay in unsecured income (previously called drawdown).

The FT's intermediary forum

The Financial Times organised an intermediary forum in London on 10 November with a focus on pensions. Keynote addresses were given by Theresa May MP, shadow secretary of state for work and pensions and shadow minister for women, and Dr Ros Altmann. In the programme's introduction, Emma Hughes, the editor of FT Adviser, set the scene referring to a more complicated pension industry than existed three and a half years ago. She wrote:

'Final salary pension schemes have proven to be too costly for employers outside of the Civil Service to continue to offer.

'Baby boomers have been therefore engaged in a gamble that shares would produce enough money to keep them in the lifestyle they had become accustomed to once they retired. Confidence in this gamble has been shaken in the last 18 months.

'Despite government talk of deflation in 2009, we have a state pension that hardly covers the cost of escalating fuel and food bills plus stock markets that have gone on a rollercoaster ride.'

Ms May read a prepared speech which contained a lot of interesting detail. There were two fundamental themes. The first was the link between the pension system and the culture of savings with the view that debt was at the centre of the current economic downturn. It was 'too easy to fall into debt and debt was a key driver of poverty'.

She said the Conservative party had an ambition to create a 'saver society': to have more people saving in better schemes. The second major theme not stated explicitly was that dramatic government improvement could not happen because of the current government debt. Her main proposals are set out in box 1.

Dr Altmann is the well known independent pensions policy adviser and showed an impressive grasp of the strategic position. Initially, she focused on the current difficulties, indicating that half of pensioners were subject to means testing so pension credit undermined private pension provision. She then went on to spell out the 'huge threats' posed by personal accounts which she felt would level down and make pension provision worse, not better.

As to pension provision itself, Dr Altmann highlighted the concern of politicians with getting more money into a pension when what mattered was getting good pension provision out of the saving scheme. In this regard, she said she felt the concept of investment risk had been misunderstood and misrepresented to the public. She finished with five key proposals which are set out in the second box.

What should HNW clients be doing?

Unfortunately, there are no silver bullet solutions for HNW tax payers, i.e. those caught by the reduction in higher rate tax relief on pension contributions. The relief is very generous and effectively at 50 per cent (see box 3).

The key decision is whether basic rate tax relief is worthwhile for a pension contribution by a higher rate tax payer. At a general level, some advisers advocate that contributions should still be made even when tax relief is only at the basic rate. Smith & Williamson, in its booklet on the Finance Act 2009, assuming the private pension will be the main source of income in retirement and an annuity rate of six per cent, says you will need a pension fund of £975,000 before taking tax free cash to generate income that hits the 40 per cent tax rate. Smith & Williamson indicates that the benefits of the existing gross roll up 'can be quite substantial over the years when compared with funds that do not benefit from upfront tax relief or gross roll up'.

On the other hand, for many, the emotional argument will prevail. Particularly important is the lack of easy access to capital (beyond the 25 per cent tax free lump sum) within a pension fund. Indeed, there is a fear that the government may tax the tax free lump sum '“ a point I put to Theresa May who said that worry would be considered. The real damage caused by the surprise withdrawal of higher rate tax relief on some pension contributions '“ despite the cap on overall fund values '“ is the uncertainty created. What will happen next?

As the FT indicated in its programme:

'The Treasury has undermined the A day agreement which was designed to promote long-term pension saving. How can advisers encourage their clients to continue to save for retirement? Have the budget changes set an uncomfortable precedent, creating the assumption that tax relief can be altered at whim?'

HNW clients some way from retirement

Basic considerations for such clients should include:

• Where higher rate income tax relief can be secured, make the pension contribution.
• Remember a pension is no more than a tax umbrella. Ask your adviser: what are the underlying investments in the pension fund? Do any funds have a guaranteed annuity rate? What is the death benefit and where does that benefit go if you die before taking pension benefit? What are all the costs the fund is paying? Can these costs be reduced?
• Assess whether basic rate income tax relief will be beneficial for you.
• Consider payments within an ISA umbrella.
• Check the state pension provision due to you and any partner/spouse. It can be very beneficial to make voluntary NI contributions for non-working partners/spouses (google 'state pension forecast').
• EISs and VCTs will have more focus. Do not let the tax relief tail wag the investment dog: two IFAs told me at the conference that they did not want to pay the increased PI insurance premiums for advising on VCTs.
• Could you develop other interests, e.g. farming?

HNW clients approaching retirement

Clients in this position should consider all options, including:

• Do not dismiss an annuity out of hand (see health below). There are both permanent and temporary annuities.
• Staggered vesting means taking your pension in tranches. The tax free lump sum is spent as (tax free) income. Tranches can be in any size. Leaving some pension funds invested does have attractions not least the gross roll up.
• Taking unsecured income has attractions but also risks. A strategy that is dependent on capital growth to produce income has risk. That risk can be reduced '“ but not eliminated '“ with some focus on collectives producing a good spread of dividend return.
• Plan your use of your pension fund well before taking retirement benefits: if you want or need cash (for the TFLS or an annuity) start setting that aside gradually within the pension fund before you take benefits.
• Keep in mind the 35 per cent income tax hit if your spouse/partner wants to take your unsecured income fund as cash after your death.
• If your pension fund death benefit does not go to an exempt beneficiary, clearly document the financial planning reasons for your strategy '“ to help rebut an accusation that section 3 IHTA 1984 applies (omission to exercise a right).

Health

All financial advisers will or should ask about health, but some probes in this area are perfunctory. Many clients just do not appreciate the significance of health difficulties. I was talking to a lady in her early eighties last month and asked her if she had health difficulties. The reply was 'no': a few minutes later I was told of the irritant of suffering TIAs (transitory ischemic attacks).

The annuity market is segmenting between the healthy and the unhealthy. It must be worthwhile for all clients considering taking retirement provision to have a detailed health check before making any final decision.

The future

The future is grey and challenging: whichever political party is in power will need extra revenue. For many, their death will bring a payment of inheritance tax '“ and, unlike the recent suggestion made by the PM in Parliament, you will not all be personal friends of David Cameron living in Kensington and Chelsea. Good planning and good advice has never been so important.