Planning for retirement just got much easier
A simplified, flat-rate state pension should help you prepare, but what steps should you take now, asks Chiara Cavaglieri
Sunday 20 January 2013
It's been coming for some time, but the Government has finally unveiled plans to move towards a flat-rate state pension of £144 a week for all by April 2017. The current system is so complicated that calculating accurately how much you might get from the state on retirement is nigh on impossible, so a move towards a simplified system is a huge help to financial planning.
It's not all good news, however, as the number of qualifying years on National Insurance contributions or credits will rise from 30 to 35 years and the coalition has also reintroduced the minimum qualifying period of between seven and 10 years. But, by and large, this will be an improvement for women, low earners and the self-employed – who often lose out under the present system.
"The new flat-rate, single-tier pension will make calculating and understanding entitlements far easier and remove the complex spider's web of means-tested benefits and multiple-tier benefits," says Danny Cox of independent financial adviser Hargreaves Lansdown.
The flat rate of £144 a week is worth £7,488-a-year in today's money and will be a welcome safety net, but for most people it will not be anywhere near enough to enjoy retirement, so you still need your own savings plans.
To get a sensible plan in place, Chris Wicks of Bridgewater Financial Services says you first need to decide when you want to retire and then determine the income you will need to maintain a comfortable lifestyle. Start with your current expenditure, remove mortgages and other payments such as education and children, and add any additional leisure activities or travelling that you plan to undertake in retirement.
"In the longer run some sort of allowance needs to be made for the cost of long-term care but this is very unpredictable. Once you have worked out what you need, compare this with what you can expect from savings and pensions and work out the difference. This is what needs to be funded," says Mr Wicks.
The earlier you can start saving, the better – and by some margin. A 25-year-old, retiring at age 68, for example, would only need to save £270 a month to accrue a pension worth £10,512 (£18,000 with the state pension), based on 6 per cent investment return and 2.5 per cent inflation.
A decade later, a 35-year-old retiring at 67 would need to put away £445 a month to achieve the same pension pot. At age 45, you would be looking at monthly contributions of £770.
As well as starting early, you should focus on finding the most efficient ways to reach your target which means maximising your tax-free allowances. There is something of a pension versus ISA debate, but it's more likely that a combination of the two is the most effective strategy.
For serious retirement savings, advisers favour pensions as they qualify for tax relief at your marginal rate of income tax. This means that for every £80 you pay into a pension, £100 ends up in the pot and if you pay tax at higher rate, you can claim an extra 20 per cent through your tax return.
Pensions are also tax-free as your money grows but you don't escape tax altogether – you will pay when you take out an income, subject to an optional 25 per cent tax-free lump sum from age 55. This would cut your pension income but could be useful to pay off debts, or to invest independently.
This perhaps explains why ISAs are so popular. As well as being easier to understand, they are more flexible and have no withdrawal limit. The current allowance is £10,680 (of which £5,340 can be placed into a cash ISA) and rises in line with inflation every year. It will be £11,280 from 6 April.
"It doesn't have to say 'pension' on the tin," says Kim Barrett from Barretts Financial Service. "ISAs don't get tax relief going in but you can take the whole fund out tax-free as opposed to only 25 per cent."
That said, if you are already, or about to be auto-enrolled into a workplace pension, you should think twice before opting out because you will miss out on contributions from both your employer (paying a minimum of 1 per cent of your salary, rising to 3 per cent by 2017) and the Government (offering a further 1 per cent in tax relief).
If you are arranging your own personal pension, options include stakeholder pensions and Sipps (self-invested personal pension). With the former, there are limits on annual management charges and no penalty fees if you need to stop or change payments. But if it is control you're after, the Sipp is far more flexible with a broad range of investment options ranging from individual shares, funds and commodities.
Whichever you use, long-term saving is where risky asset classes such as commodities and emerging markets come into their own. While you can expect volatility, they help diversify your portfolio, for example, gold has historically been held as a hedge against inflation. They also have great potential to outperform safer investments over a long period, so if you have time on your side, you may want to take a punt on high-risk, high-reward sectors with part of your portfolio.
"If you approach a pension at 21 you can take a more relaxed view on risk, looking to emerging markets and such like to pick up the potential returns," says Mr Barrett.
As you get closer to retirement, you should shift your portfolio into more stable asset classes such as lower-risk bonds and cash. Tread carefully and ensure you understand exactly what you put your money into. If in any doubt, seek independent advice.
On reaching retirement you still need to be careful: if you're taking out an annuity, always shop around to get the best rate and investigate if you qualify for an enhanced deal.
Remember you will still enjoy tax allowances. The current allowance for over-65s is £9,940, rising to £10,500 in April, so you could put your pension savings in both your name and your spouse's for maximum benefit.
The white paper
From April 2017, the current basic and earnings related state pension system will be replaced with a single tier pension for all.
Based on 35 years of National Insurance contributions (NICS ) or credits the single state pension is worth £144 a week (although this will probably be worth around £162 by 2017).
The minimum state pension will be based on seven to 10 years of NICS so anyone with less that this will not be eligible.
The State Pension age will increase to 66 for men and women by 2020 and to 67 between 2026 and 2028.
Only new pensioners will be eligible, so existing pensioners and anyone who qualifies before 2017 will continue to be paid under the present system, worth £107.45 a week, which can then be topped up to £142.70 a week with pension credit and the State Second Pension.
Independent Partners: Get your free guide on the Top 10 tips for retirement
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