How to bridge a gap

Rob Howe's pensions represent only 13% of his earnings
Click to follow
The Independent Online
NAME: Rob Howe

AGE: 28

OCCUPATION: Planning surveyor in the construction industry.

BACKGROUND: Rob has been working for his current employer since last November. His earnings, including part-time sports editorial work, are about pounds 16,000 a year.

Rob is buying his home with a pounds 36,000 mortgage with Alliance & Leicester, fixed at 7.45 per cent until this November. He has free shares, worth about pounds 1,430, from his former membership of the society. He has two endowments in conjunction with his mortgage. His projected expenditure budget suggests that he has about pounds 1,500 a year potentially available for investment. He is reasonably cautious in his investment strategy.

Rob is not eligible to join his employer's pension scheme for two years but does have generous preserved benefits from his previous employment. He is considering getting married in three or four years.

THE PROBLEMS: Rob's most pressing issues revolve around planning for retirement and whether the current endowment policies he has will return sufficient funds to repay the mortgage in 20 years.

THE ADVISER: Geoff Kangley, of Kangley Financial Planning, in Sheffield (Tel 0114-235 3555).

THE ADVICE: "I have studied Rob's projected annual expenditure budget and employment contract.

One striking thing is that his contract states that during the first year of employment his entitlement to sick pay is 23 days on full pay plus 23 days at half-pay within the first 52 weeks. After the first year, this doubles to 46 days on full pay and the same on half-pay. Thereafter statutory sick pay of pounds 54.55 a week will be paid up to 28 weeks.

He has insurance covering the cost of mortgage repayments in the event of redundancy, illness or accident. But Rob would still suffer financial hardship in the event of being off work through accident or illness.

Rob should consider permanent health insurance (PHI). He could restrict the premium cost by deferring the date when income benefit becomes payable. If Rob wanted PHI cover worth 50 per cent of salary payable to age 65, the premium would range between pounds 18 per month for level benefit payments deferred for one month, to pounds 35 per month for escalating benefits, deferred two months.

I would also recommend critical illness (CI) cover for not less than his mortgage loan. CI cover pays out on diagnosis of a range of serious diseases, including cancer and heart attacks. The cost would be about pounds 10 per month, including waiver of premiums in the event of prolonged illness.

With the possibility of an increase in interest rates, Rob ought to find out whether there is a redemption penalty on his mortgage. If not, he should lock into a lower fixed rate. As for his endowments, Rob should obtain projections from the life companies of how much they will pay out at maturity. If a shortfall is identified Rob could consider bridging that gap by way of monthly contributions to a personal equity plan (PEP).

An independent financial adviser can identify the monthly contribution level into the PEP by working backwards from the value of any shortfall, after assuming growth of, say, 9 per cent.

Rob's free shares can be placed into a PEP (on top of any other PEP limits) within 42 days of issue. However, unless he intends to hold those shares in the long term, given that he is a base-rate tax payer, the effect of PEP charges could outweigh any tax advantage.

As for his pension, unfortunately, Rob will not become eligible for scheme membership with his current employer until April 1999. If he remained in employment until 65, he would accumulate a maximum pension entitlement of 57 to 64 per cent of his final pensionable salary. A lump sum death- in-service benefit is provided of two-times pensionable salary. The scheme appears to make no provision for inflation-linked escalation of pension payments. If he were to be absent and sick pay had ceased, pension contributions may be suspended for the remaining period of such absence. He should, however, still join if possible and also pay additional voluntary contributions when he can afford it.

With regard to the retained pension benefits from Rob's previous employment with Henry Boot, a construction firm, that company operated a "humdinger" of a final salary scheme, providing benefits on an "n/45ths" basis. This scheme means he required only 30 years' service for a maximum pension. At today's value, his pension will be worth pounds l,517 per annum.

I have asked the trustees to give me a transfer value on his fund. My provisional estimate suggests a return of between 6 and 8 per cent will be needed to match the value of benefits given up on transfer. Before he decides whether to do so, much depends on his - presently cautious - attitude to investment, plus assumptions of future rates of interest and inflation.

Looking ahead, let's assume that Rob might not remain with his employer until retirement. If they parted company in, say, four years, he would have been in scheme membership for only two of them.

By my calculations, the total of the two preserved pensions he has would represent only 13 per cent of his current gross earnings or, by viciously pruning his costs, some 24 per cent of his spending in retirement. Clearly, there is a substantial gap.

Rob ought to think about investing an amount similar to the 5 per cent he will be expected to pay as a personal contribution on to his employer's pension scheme in two years. This could be made into a PEP giving him greater flexibility in the event of a house move or his future marriage. Any such PEP investment could also establish the base for his "flotation shareholding".

Looking for credit card or current account deals? Search here

Comments