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Valuing Your Future
Ian McKeever & Co Consulting Actuaries
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Issued by Ian McKeever & Co. Authorised and regulated by the Financial Services Authority in the conduct of investment business
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Retirement And Immediately Pre Retirement
At this stage in your life, your primary objective is to provide for yourself and your family in retirement. A secondary objective is to provide for future generation of your family after yourself and your spouse are dead. Hopefully you are healthy and this secondary objective is a more long term one.
These pages not only deal with retirement but also with the ten years up to retirement. However, the pages on the mature family are still relevant and should be read. Retirement is the next big event in your life. In order to plan for retirement you need to see the world from the perspective of someone at the point of retirement so that you can see what risks and opportunities you need to take account of in your planning. The following therefore looks at the options from the perspective of someone retiring now.
At the end of this section the implications for someone coming up to retirement are considered but to understand the why's and wherefores it is worth reading about the issues you will face when you do actually retire.
Before the more serious business of financial planning it is worth taking stock of your life when you do actually retire. Whatever your state of health and whatever the needs of your children, when you actually retire you should use some of your cash to invest in some memories. You are entering a whole new stage in your life and for what is probably the first time in a long time you can invest a significant amount of time and money in memories. Shakespeare coined the phrase a lease of life and that is all that we have, a lease on life. It is to be enjoyed. A trip round the world is an investment well worth considering.
Money is necessary but at the end of the day it is there to be spent. Many people have been careful with money all their lives but ultimately we make money to live. We do not live to make money. Travel may not be your dream but retirement is not only a problem it is also an opportunity to make at least some of your dreams come true, even if it does mean temporarily breaking the habits of a lifetime.
Do you have any old policies?
Many old pension policies contain guaranteed annuity rates. The terminology can be confusing as many annuities have a guarantee period. If an annuity has a five year guarantee, the first five years annuity/pension payments are made anyway even if you die in that period. However these are guaranteed annuity rates which are different. That is where the policy promises to convert the cash sum at retirement on guaranteed terms or at market rates if better. Many of these policies were written when interest rates were a lot higher than they are now and life expectancy was a lot lower. The guaranteed annuity rates are therefore likely to be better than any that are on offer today.
Many of these guaranteed rates only apply at specific ages and for specific types of annuity. Check if your policy has them and take advantage of them, even if it means taking the benefit earlier or later than you intended or the escalation rate you want is not available. Make adjustments to your other policies if necessary so that the overall effect on your pension arrangement is minimised. The financial benefit is generally worth it. See also the comments on tax-free cash below.
The disadvantage of these policies is that the death benefit before retirement can be very poor and may only be a return of premium. If you are retiring now the lack of death benefit is irrelevant but if retirement is some way off you may want to consider the options.
Tax-Free Cash When to take it and When not to take it!
For most pension policies you can take a quarter of your pension in the form of tax-free cash. Given the choice of whether it is better to take tax-free cash or a taxed pension the obvious answer is to take the tax-free cash. Certainly if you intend to travel the world you will need some money to pay for it.
Even if you have sufficient capital and wish to maximise your income, taking the cash is generally the best option. You can take the cash and use the money to buy what is called a purchased life annuity. These are taxed differently from a pension annuities, as part of the income is treated as a return of your capital and is tax-free. You will therefore increase your net income this way. However, it may have Inheritance Tax implications as, for tax purposes, you will in part be living off capital.
However it is worth being aware that sometimes it isn't beneficial to take the cash and you need to check that does not apply to any of your own pension entitlements.
One possible exception is if you are a member of a company final salary scheme. In this case your basic entitlement is a pension, which you can commute. Although in general commuting to the maximum extent is still the best option whether it is in fact the best option depends on the terms of the commutation. If commutation rates are laid down in the scheme rules, or they are not be on market terms for some other reason, you might be better off taking the pension.
The other situation is where you might be better off taking the pension is if you have an old policy with guaranteed annuity rates.
In either case it worth making a rough check
1) Look in the financial press for an annuity rate at roughly the right age and on roughly the same terms as you want.
2) Find the difference between the full pension with no cash sum and the reduced pension with the cash sum.
3) Multiply the reduction in your pension by the annuity rate and reduce the result by your tax rate (i.e. take 80% or 60% of it) and that is the rough value to you of the pension.
If the cash sum is not significantly greater than the calculated value of the pension reduction, get get advice on what you should do.
Inflation
Actuaries talk about inflation, so do insurance companies and financial advisers and even governments but generally in terms of a percentage rate of growth. In truth the future rate is uncertain. When you were a teenager, a boy could take a girl to town on the bus, take her to the cinema, pay for fish and chips or a drink afterwards and bring her home and get change from a ten bob note. Ten bob is now 50p and doing the same thing today would probably not leave much change out of £25.
That was forty or fifty years ago but assuming you are healthy you might expect to live for 25 or 30 years or half that period of time. Of course inflation has varied a great deal over the last 50 years. It has been as low as 2% a year and has gone over 20% a year. It was thought that inflation was almost dead but it seems that like Mark Twain "Reports of its death have been greatly exaggerated".
Inflation creates winners and losers. The winners are people who borrow. When I took out my first mortgage interest rates were almost 20%. It was a real struggle to save the money and then service the mortgage but pretty quickly my salary rose with inflation and the cost of servicing my mortgage fell rapidly. The really big winner is the Government. The real cost of servicing its huge debt falls, interest rates rise and the tax collected on the interest rises with it. Savers have to pay tax on their interest and so the real value of their savings falls and they lose out. The big losers though are pensioners whose fixed pension, which had provided them with a good standard of living, falls in value and life becomes a struggle.
These pages not only deal with retirement but also with the ten years up to retirement. However, the pages on the mature family are still relevant and should be read. Retirement is the next big event in your life. In order to plan for retirement you need to see the world from the perspective of someone at the point of retirement so that you can see what risks and opportunities you need to take account of in your planning. The following therefore looks at the options from the perspective of someone retiring now.
At the end of this section the implications for someone coming up to retirement are considered but to understand the why's and wherefores it is worth reading about the issues you will face when you do actually retire.
Before the more serious business of financial planning it is worth taking stock of your life when you do actually retire. Whatever your state of health and whatever the needs of your children, when you actually retire you should use some of your cash to invest in some memories. You are entering a whole new stage in your life and for what is probably the first time in a long time you can invest a significant amount of time and money in memories. Shakespeare coined the phrase a lease of life and that is all that we have, a lease on life. It is to be enjoyed. A trip round the world is an investment well worth considering.
Money is necessary but at the end of the day it is there to be spent. Many people have been careful with money all their lives but ultimately we make money to live. We do not live to make money. Travel may not be your dream but retirement is not only a problem it is also an opportunity to make at least some of your dreams come true, even if it does mean temporarily breaking the habits of a lifetime.
Do you have any old policies?
Many old pension policies contain guaranteed annuity rates. The terminology can be confusing as many annuities have a guarantee period. If an annuity has a five year guarantee, the first five years annuity/pension payments are made anyway even if you die in that period. However these are guaranteed annuity rates which are different. That is where the policy promises to convert the cash sum at retirement on guaranteed terms or at market rates if better. Many of these policies were written when interest rates were a lot higher than they are now and life expectancy was a lot lower. The guaranteed annuity rates are therefore likely to be better than any that are on offer today.
Many of these guaranteed rates only apply at specific ages and for specific types of annuity. Check if your policy has them and take advantage of them, even if it means taking the benefit earlier or later than you intended or the escalation rate you want is not available. Make adjustments to your other policies if necessary so that the overall effect on your pension arrangement is minimised. The financial benefit is generally worth it. See also the comments on tax-free cash below.
The disadvantage of these policies is that the death benefit before retirement can be very poor and may only be a return of premium. If you are retiring now the lack of death benefit is irrelevant but if retirement is some way off you may want to consider the options.
Tax-Free Cash When to take it and When not to take it!
For most pension policies you can take a quarter of your pension in the form of tax-free cash. Given the choice of whether it is better to take tax-free cash or a taxed pension the obvious answer is to take the tax-free cash. Certainly if you intend to travel the world you will need some money to pay for it.
Even if you have sufficient capital and wish to maximise your income, taking the cash is generally the best option. You can take the cash and use the money to buy what is called a purchased life annuity. These are taxed differently from a pension annuities, as part of the income is treated as a return of your capital and is tax-free. You will therefore increase your net income this way. However, it may have Inheritance Tax implications as, for tax purposes, you will in part be living off capital.
However it is worth being aware that sometimes it isn't beneficial to take the cash and you need to check that does not apply to any of your own pension entitlements.
One possible exception is if you are a member of a company final salary scheme. In this case your basic entitlement is a pension, which you can commute. Although in general commuting to the maximum extent is still the best option whether it is in fact the best option depends on the terms of the commutation. If commutation rates are laid down in the scheme rules, or they are not be on market terms for some other reason, you might be better off taking the pension.
The other situation is where you might be better off taking the pension is if you have an old policy with guaranteed annuity rates.
In either case it worth making a rough check
1) Look in the financial press for an annuity rate at roughly the right age and on roughly the same terms as you want.
2) Find the difference between the full pension with no cash sum and the reduced pension with the cash sum.
3) Multiply the reduction in your pension by the annuity rate and reduce the result by your tax rate (i.e. take 80% or 60% of it) and that is the rough value to you of the pension.
If the cash sum is not significantly greater than the calculated value of the pension reduction, get get advice on what you should do.
Inflation
Actuaries talk about inflation, so do insurance companies and financial advisers and even governments but generally in terms of a percentage rate of growth. In truth the future rate is uncertain. When you were a teenager, a boy could take a girl to town on the bus, take her to the cinema, pay for fish and chips or a drink afterwards and bring her home and get change from a ten bob note. Ten bob is now 50p and doing the same thing today would probably not leave much change out of £25.
That was forty or fifty years ago but assuming you are healthy you might expect to live for 25 or 30 years or half that period of time. Of course inflation has varied a great deal over the last 50 years. It has been as low as 2% a year and has gone over 20% a year. It was thought that inflation was almost dead but it seems that like Mark Twain "Reports of its death have been greatly exaggerated".
Inflation creates winners and losers. The winners are people who borrow. When I took out my first mortgage interest rates were almost 20%. It was a real struggle to save the money and then service the mortgage but pretty quickly my salary rose with inflation and the cost of servicing my mortgage fell rapidly. The really big winner is the Government. The real cost of servicing its huge debt falls, interest rates rise and the tax collected on the interest rises with it. Savers have to pay tax on their interest and so the real value of their savings falls and they lose out. The big losers though are pensioners whose fixed pension, which had provided them with a good standard of living, falls in value and life becomes a struggle.
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