Financial Makeover: Norman's wisdom

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The Independent Online

Norman Butler is a widower, and has a grown-up son who does not live at home. Through prudent saving over many years, he has built up several pension policies with four companies. He has also built up a portfolio of shares, gilts and unit trusts, and he now needs to maximise his income from all of these sources.

Norman approached the companies directly but found the array of available options highly confusing. Then he looked for an independent adviser to help him. He also wanted advice on his other investments, so he looked for a company which he believed would offer impartial advice and help on everything.

The adviser: Gareth Tregidon, Financial planner at Chartwell Investment Management Ltd, 9 Kingsmead Square, Bath BA1 2AB (01225 321700)

The advice: Norman has identified that he needs advice on two main aspects of his finances, namely the conversion of the pensions into an income, and an analysis of his existing investment portfolio.

The pensions he holds are mainly Retirement Annuity contracts taken out before the newer Personal Pension Plans came into being in 1988. The first step is to ascertain whether or not any of them had a "Guaranteed Annuity Rate" attached to the benefits. In previous years, to help in the marketing of their products, some insurance companies provided a guaranteed minimum income from a pension plan invested with them.

This contrasts with the more recent trend which does not guarantee any particular minimum payment, and simply relies upon the investment performance of the funds and the annuity rates available at the time an income is required.

The rates which were guaranteed were far lower than annuity levels being offered to people taking their pension benefits at the time, and the companies believed that the guarantees would never be required. As annuity rates have fallen so significantly over the last few years they have fallen below these guaranteed levels in most cases.

On further review, of the four plans held, only one offered a guaranteed annuity rate, and this was significantly higher than the rates available elsewhere. Two of the other companies' rates were not competitive, and the fourth company was offering a competitive annuity rate themselves.

For Norman, his best option is therefore to leave the first plan with the company which issued it, in order to obtain the guaranteed income level, to transfer the second and third plans to another annuity provider, and to leave the final plan with the company concerned, due to their higher annuity rate.

But as complicated as this might at first seem, there was another element which needs to be considered. At retirement most pension funds offer a tax-free lump sum payment in addition to the pension income, and all of Norman's plans do this.

We therefore need to consider whether it would be beneficial taking these lump sums and reinvesting the money. Bearing in mind Norman's requirement to maximise his income, it is therefore worth considering taking the cash and using it to take a Purchased Life Annuity. Purchased Life Annuities are similar to the annuity bought with the pension funds, with the exception of the way they are taxed.

The Inland Revenue treats the monthly income partly as interest and partly as capital, and tax is applied only to the interest element. This means that income derived from a Purchased Life Annuity tends to be higher than from a pension annuity, which is all taxable.

For Norman, it was beneficial for him to take the lump sums from two of the plans. These sums can be reinvested to generate a monthly income payment for the rest of his life. The net effect of looking in detail at all of these options would be to increase the net monthly income by around 20 per cent per annum.

In comparison, reviewing Norman's investment portfolio was a simpler task. The main changes we suggest are due to the emphasis he has on a small number of key holdings, which account for over 60 per cent of the total.

This reliance upon just six companies, as good as they are in their own right, brings with it a greater degree of risk both in terms of the capital value and the dividend income derived from them.

In general, Norman has held these shares for some considerable time and built up sizeable capital gains. He does want to simplify his investments over the next few years, so we would recommend a structured program of realising some of the profits as and when we are able to minimise the potential Capital Gains Tax.

This will take time. But the end result will be a more manageable portfolio, spread more evenly and invested to generate a high but sustainable income well into the future.