So, you have heard about pensions and suspect you should probably have one, but you have never done anything about it because you didn’t want to ask stupid questions.

This article will give you the opportunity to find out the basic facts so you can start funding your retirement lifestyle.

What is a pension? 

A pension is a tax efficient means to invest your money for the long term so that it can provide you with an income when you retire.

By tax efficient I mean that contributions you make receive tax relief of 20% . Tax relief is a supplement paid by HMRC to the pension provider on your behalf and is intended to act as an incentive for people to save for their retirement.

If you pay higher rate tax you can get further tax relief by notifying HMRC of the pension contributions you make. This can either be done via your annual self assessment or by having them adjust your tax code.

Once your money is invested any investment growth is free from capital gains tax and income tax (with the exception of dividend payments received from UK shares you own within the pension fund).

Other people can also invest in your pension on your behalf. This may be your employer but could also be a parent who wants to gift you money or your spouse or civil partner; anyone in fact.

How does that provide me with any income in retirement?

When you decide you want to stop working or reduce the work you do you will need to replace your earnings with other income. You can do this a number of ways with your pension fund.

Most people purchase an annuity with the value of the fund. An annuity is simply a guaranteed income for life, the income you receive will depend upon your age, gender, health and also gilt yields. With the exception of the latter the annuity rate you will receive (the income as a percentage of the pension fund you have) will be linked to your life expectancy; the shorter your life expectancy the greater the annuity rate.

Another popular option people take to produce an income is known as Income Drawdown or unsecured pension. With this method your pension fund remains invested (so there is a chance that it can lose value) and the income you receive can be altered. The maximum income is similar to that of an annuity but you have not committed to a single rate for the remainder of your life.

Any income you receive is taxed as income at normal income tax rates. The good news is though that you don’t have to use the whole fund to purchase an income; 25% of the value of the fund can be taken as lump sum tax free.

How does it grow?

The extent to which your pension fund grows will depend upon the degree of investment risk you are exposed to. The rule of thumb is that, over the long term, the more investment risk you are exposed to the greater the return you can expect to receive.

You can read more about investing your pension fund in this article.

How much can I invest into one?

There are limits on how much you can contribute to a pension in a tax year. This limit is known as the Annual Allowance and is the lower of £50,000 and 100% of your earnings.

If you have contributed more than £50,000 in the current tax year it may be possible to contribute more if you did not use your full allowance in either of the previous three tax years (this is a simplified explanation so you should get advice before you contribute any more than £50,000).

Over the lifetime of your pension fund there is a limit on the total pension pot that you can accrue and maintain the tax efficiency. This is known as the Lifetime Allowance and from 6th April 2012 it will reduce from £1.8m to £1.5m.

How much do they cost?

Pension funds used to be expensive but since 2001 they have become more competitively priced. For a basic pension you should expect to pay a single annual management charge (amc)which will vary between 0.15% and 2% of the value of your fund. The large variance is because the higher charges will bundle three separate costs; the cost of administration, the cost of the fund management and the cost of the advice.

Other administrative costs may apply depending upon the type of pension you have. SIPPs (Self Invested Personal Pensions) may have annual admin charges and transaction charges on top of the amcs so, if you have a SIPP, you should check you are not paying charges for services you are not using.

All I hear about are people striking over pensions. Surely this means they are no good?

People are striking because their work pensions are being closed or the benefits are being reduced. Typically these are Final Salary schemes that provide a retirement income based on the time you have been working for the company multiplied by a factor linked to your final salary.

They are closing because they are costly for companies to run; they are obliged to pay workers the pension for the entirety of their retirement, often increasing in line with inflation and providing an income for the ex-employees spouse when the employee dies.

Anyone who has a Final Salary scheme pension is very fortunate and today they are as rare as hen’s teeth with companies regularly announcing the closure of their schemes.

This does not mean pensions are bad. They are a very tax efficient means of investing and if we wish to enjoy a particular standard of living when we retire we will need to generate an income somehow. Pensions enable us to do this.

Are there any disadvantages?

Pensions do have their disadvantages. The major one is that it is not possible to access the fund until age 55 at the earliest and even then only the 25% tax free lump can be accessed as capital, the balance has to been taken as a taxable income.

Additionally, the income that is available via annuities and income drawdown is on a downward trend. This is because, as a population, we are living longer and also the gilt yields that back the annuity rates are currently at historically low levels.

However, as highlighted above pensions are an important means of providing an income in retirement.

Can I get advice about them?

While this is intended to give a summary of what pensions are they can be complicated investments, particularly if you have accrued a number of pension funds over time. It is therefore sensible to get advice from an independent pension expert before taking any action. Fortunately, you can do so here: http://www.icl-legal.co.uk/contact-us/.

If you are going through the divorce process it is essential you and your solicitor seek independent financial advice relating to your pensions (or pension benefits you may receive in the settlement) as early in the process as possible. Here is why:

Pensions are  extremely complicated, regulations surrounding them have changed many times over the years so they don’t always do exactly what they say on the tin. It is not as simple as aggregating pension values with other family assets and dividing the value of one spouse’s pension benefits in two because:

- Benefits may be restricted to be taken at a certain age.

- Guaranteed annuity rates may be present for older contracts which would significantly increase the income available compared to current rates.

- The tax free lump sum available from the pension fund may be greater than the standard 25% currently permissible.

- There may be significant penalties applicable if a pension fund is transferred away from the incumbent pension provider which will impact the retirement income available to the recipient spouse.

- Where there is an age gap between the two parties an equal capital split is likely to create a disparity in income (though this may cease to be the case in December following European Court rulings on gender discrimination).

- Pension benefits accrued before marriage may have a unequal split negotiated.

- There may be administration costs levied on the receiving spouse by the pension provider that would reduce the  value of the pension fund received.

- The assumptions used in working out the present value of capital needed to produce a future income can give significantly different results.

- How and where the pension share is invested following the implementation of the order is as important to future income as the pension sharing order negotiation.

An independent financial adviser’s experience in dealing with the many different pension providers and the multiple different types of pension contract can allow you to decipher the jargon and technical data to ensure you negotiate a fair split.

It is important to follow the right process and obtain all the relevant facts regarding pension entitlements. It should be the case that the Pension Inquiry Form (Form P) is issued at the start of proceedings in all cases but in reality this is not often the case. Form P will help the adviser determine the detail of the pension entitlement in each case.

In my last article I wrote that I prefer to buy funds rather than invest in individual shares and finished with the suggestion that there is a school of thought that believes active fund managers do not provide any value so investors may as well pay lower annual charges and get an average return. So is there any benefit in doing this?

Passive Investing

Passive investors are those that believe the charges for an actively managed fund are too high (typically between 1.5% and 2% pa) and do not provide any long term value because the average fund manager fails to beat the index in which he/she is investing in (the FTSE100 or S&P500 for example). Instead they believe that index tracking funds that have annual charges as low as 0.15% provide a better long term return.

Index tracking funds hold every share in a given index and so the fortunes of the investment is directly correlated to the performance of the index.

Active Investing

Advocates of active investing, on the other hand, state that passive investing ensures underpeformance after charges relative to a stock market index. They believe fund managers that take active decisions do provide greater long term returns and with less volatility because the expert fund manager can make informed decisions on which companies to avoid and which to buy using the resources available to them.

I believe that there is actually a middle ground, that there is a case for both investment styles within your pension, ISA or unit trust portfolio. There are some markets where it is very difficult for any fund manager to add value because the market in which he is investing in is very efficient; there is a lot of information widely available and so opportunities to invest in companies that are unknown or unseen by others is rare. A good example of this type of the market in the US; it is easy for investors to gather information on any company and to buy or sell shares.

On the other hand markets such as the emerging markets and the Far East provide expert fund managers the to chance uncover information about companies that may be missed by other investors. This allows them to steal a march and buy in early at a low share price (or sell early at a higher price). Equally, within Europe an active fund manager can decide to avoid certain economies (Greece, Spain and Italy for example) but invest in others (Germany, France and Scandinavia) whereas the peformance of an index tracking fund will be influenced by the performance of shares in companies in all Eurozone economies.

So, at risk of sounding like I am sitting on the fence, it is worth paying the higher annual management charges for funds in certain regions but in others you are better off simply replicating the performance of an index for lower annual costs. But, if you are opting for active managed funds you will need a research process that determines which funds provide consistent returns without taking too much risk.

I’ve said before that to get long term returns above the rate of inflation on your money you need to invest in shares (equities) so why am I saying it is bad for your wealth now?

This is because I believe buying and holding individual shares is not appropriate for most people. I believe this for the following reasons:

1) Understanding which company shares are good value and provide opportunities for growth requires a lot of time, a lot of information and a lot of knowledge on how to interpret that information (detailed company accounts etc).

2) Once that information has been digested and a decision has been made to purchase the shares they need to be continually reviewed as new information comes to light that will impact the share price.

3) To have an appropriately diversified portfolio you will need to hold a large number of shares across a wide range of sectors (mining, retail, banking, pharmaceuticals etc). This means you will have to multiply the work involved to research and review one fund by a least ten to have a well diversified portfolio of shares.

4) There is no such thing as a ‘dead cert’. Financially sound companies that are darlings of the stock-market can very quickly lose value, if not vanish entirely. Think of BP and Lehman Brothers as recent lessons.

If you thought by the title that I didn’t believe investing in shares at all I (intentionally) mislead you. If you are looking to invest for the long term (longer than five years) investing in shares to some degree is an important way to receive real returns. But, rather than buying shares directly, I prefer to invest in investment funds (also known as collective investments, Unit Trusts and OEICS (pronounced “Oiks”)).

Funds provide the opportunity for investors like you or I to pool our money and have a fund manager make decisions on our behalf on which company shares to buy and which to avoid. These fund managers and their teams have the expertise, experience and resources at their disposal and so, in return for an annual management charge (which should be between 1.5% and 2%), we may expect them to get a better return than by doing it ourselves.

You have the option of choosing a number of fund managers who specialise in investing in the different asset classes and geographic regions so that you can further diversify your portfolio.

Of course, the fund manager you employ can get it wrong so it is important you conduct some research ahead of making an investment and review your portfolio of funds at least annually. You should look beyond merely performance but also at the fund objective, the risk that is being taken to achieve the returns and charges amongst other factors.

There is a school of thought that believes that all fund managers underperform over the long term so you are better off tracking any given index (also known as passive tracking) but this is for another blog.

How do the following statements relate to you?

• Only 19% of people believe they are saving enough for their retirement
• 47% of Brits are not confident that they’ve saved enough to live comfortably when they retire.
• 14% have never made any pension contributions and a further 31% are not contributing to a pension plan of any sort.
• 66% of women and 54% of men say they worry about money either always or most of the time.
• 77% believe they would be happier if they had more money.

Welcome to 2012, the year that the Olympics come to London!!

What Olympian efforts are you going to make that you will look back on in December with pride and joy?

Will you have earned more this year than ever before?

Will you have got promoted or won that longed for pupillage or training contract?

Perhaps you will have fulfilled a personal achievement away from work; ran a marathon, climbed a mountain, got engaged, got married or had a child.

Perhaps you have decided this is the year that you will follow your heart and dreams and decide to plough a new furrow that will leave you more fulfilled.

What ever you decide to do in 2012 make sure you are committed to it and have a plan to get you there. Break the goal down into small bite sized chunks to diminish the size of the task you have set yourself.

Most of all, believe in yourself and reward yourself  when your goal is achieved.

Good Luck for a prosperous and successful 2012.

Picture courtesy of tsuacctnt via Flickr.com

My blog is going on it’s Christmas break from this week so this post is a summary of my best blogs from 2011. They are those that have had the best response, have been shared the most or sparked the most interest and debate.

This comparison of ISAs and pensions  had the most visits.

The decision around overpaying your mortgage or investing your spare capital was also popular.

Given the parlous state of the economy this article on planning for redundancy was also ranked highly.

There was also interest in my blog on how financial planning can help you become a partner.

My article on why I chose to turn down £21,000 created the most buzz and attracted some press attention.

And finally, Kate Ginty’s guest post on why she decided to leave the law was by far the most popular guest blog.

Finally, thank you to all of you who read, contributed to or shared my blog posts this year. I look forward to sharing more insight and expertise with you next year. If you have any topics you wish to have covered please do let me know.

Have a great Christmas and successful 2012!

If you would like to receive financial planning advice to understand how you can pursue your passions in life click here.

If you found this article of interest more can be found at www.icl-legal.co.uk. If you have friends and family in the law that would benefit from this or any other articles produced on this blog please do forward it on.

You can subscribe to receive these articles to your inbox automatically by providing your email address in the ‘Receive our Newsletter’ box at www.icl-legal.co.uk

I thought of this title when thinking about the well known saying “why put off until tomorrow what you can do today?”. Sure, my version is not the most catchy nor the most profound but it helps to make a point.

I have spoken before about the opportunity cost of spending money on luxury and discretionary items and this is really a variation on that theme to emphasise the point that the decisions we make today will affect our financial futures.

I met with a new client the other day who was in a very well paid position, well paid enough to be a 50% tax payer but he had become acutely aware that he and his wife were “living for the now” and had missed out on a numbers of years to secure their financial futures and was now faced with a decade to make up for lost time before his earnings power would reduce.

A decade may sound like plenty of time but think of what you would have missed out on by not starting sooner, the benefits of compound interest for a start.

Sure, I know fast cars and expensive holidays are more exciting than pensions, ISAs and offset mortgages but what price self actualisation? The knowing that you have the finanical freedom to do what you want when you want to, to work because you enjoy it, or don’t work becuase you don’t have to. The feeling created knowing that you have no money worries. That you have financial independence.

Spending on the nice to have products and services will provide a temporary high but there will always be come down. The realisation, as my client had, that there was little to show for the enjoyment. This may come soon after the enjoyment or at the end of your career when it really is too late to do anything about it.

I’m not saying that money is not to be enjoyed, we all work hard after all. My message is that it should be prioritised. The satisfaction will be so much greater in the long term.

Financial Planning can help you with your decisions by analysing what actions you need to take with your money to achieve your life priorities. It may be that you can’t achieve your goals immediately but if you know that your money is working hard enough to help you achieve them the working day frustrations may just diminish.

If you would like to receive financial planning advice to understand how you can be financially free click here.

If you found this article of interest more can be found at www.icl-legal.co.uk. If you have friends and family in the law that would benefit from this or any other articles produced on this blog please do forward it on.

You can subscribe to receive these articles to your inbox automatically by providing your email address in the ‘Receive our Newsletter’ box at www.icl-legal.co.uk

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A friend of mine received an inheritance the other day which was a substantial sum of money. Due to the source of money they wanted to use it appropriately but not knowing much about the world of investments they didn’t know where to start.  It is understandable that they didn’t want to fritter the inheritance away but investing it could have the same outcome if it was not done appropriately. This article is a summary of what I suggested.

First of all think about what you want to achieve with the money.

It may be that you want to use some of it to buy a permanent reminder of the loved one you lost. After that think about your goals and divide them into short term, medium term and long term. Capital intended for the short term should be left in cash (but look for the best savings rate you can get and review it regularly). For longer term goals you can afford to tie the money up and take some investment risk in order to get a (potentially) higher return.

The following list may act as a useful checklist which you should approach in an descending order of priorities:

- Do you have any debts you need to clear?  There is no point investing with loans outstanding.

- Do you have enough savings available to you to cover living expenses if you are out of work for a period of time? 3-6 months of expenditure available in an emergency fund is a common rule of thumb guide.

- Do you own a home currently? If not and you would like to, an inheritance would make a useful deposit. If you are looking to buy a house within 5 years keeping the money in savings where it won’t lose value would be sensible. If you have more than £85,000 you should spread it around a couple of banks so you have full compensation cover. If you do own a home you may wish to pay off or reduce your mortgage.

- Have you put enough away for your retirement? The sooner you start the more you will benefit in retirement. Current rules allow for a maximum of £50,000  (or 100% of salary if lower) to be contributed to a pension each tax year.

- Rather than, or in addition, to pension contributions, you should also consider ISA contributions. There are some distinct differences between ISAs and pensions. Whether you prioritise one over the other will depend upon your goals. Ideally you will do both.

- Do you want your children to go to private school and/or university? Investing some of this capital efficiently, perhaps in Junior ISAs, would be a good use for some of the capital.

- After going through the above list you may have some inheritance left.  You can invest in products such as investment trusts/OEICS/Unit Trust which provide the same investment options but are not tax advantaged; i.e. you will pay tax on income and capital gains.

- Do you want to make a charitable payment? You may wish to pass on some of your inheritance to those less fortunate than yourself. You many prioritise this over some other options listed above.

Dealing with an inheritance is an emotive issue but the donor would, more than likely, want to see it help your financial future. Having a proper plan and investing the money with a goal in mind can make sure this happens.

Once you have decided whether you have enough inheritance capital to invest in pensions, ISAs or the other investment options you will need to decide how much investment risk you wish to take. Your risk profile will have a bearing on the assets in which you invest.

If you would like to advice an inheritance click here.

If you found this article of interest more can be found at www.icl-legal.co.uk. If you have friends and family in the law that would benefit from this or any other articles produced on this blog please do forward it on.

You can subscribe to receive these articles to your inbox automatically by providing your email address in the ‘Receive our Newsletter’ box at www.icl-legal.co.uk

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“I took out an endowment to ensure I could pay off my mortgage at the end of my mortgage term but I keep getting red letters in the post warning me that it is not going to be big enough to pay off my mortgage. What should I do with it?”

At Informed Choice we hear this regularly. Endowments were (are) a great idea in principle; you save regularly into a tax efficient investment plan which is targeted to produce a capital value at the end of the mortgage term. The monthly contribution set out at outset varied depending on the expected growth rate,  future capital sum  needed and mortgage term.

The problem with endowements is that the projections applied were done during the boom times when markets were going up and up. As soon as they fell post the dot.com bubble and following 9/11 it soon became apparent that the annual growth needed was not likely to be achieved.

As a result many endowment customers are faced with a shortfall. This may be a real short fall if you still have an endowment and are relying on it to provide capital at the end of the term or a paper shortfall if you have been able to repay your mortgage debt through other means.

You have four options with what to do with your endowment:

1) Do nothing. Continue to make the regular payments and wait to recieve the capital sum on maturity. The capital sum you receive will depend upon the growth rate you ‘enjoy’ between now and then.

2) Stop paying contributions but keep the plan invested. This will create a capital value at the end of the term, albeit a smaller one than if you continued to make contributions. Doing this will enable you to use the money you were paying away each month in contributions more effectively. This may be to repay capital on the mortgage or other debt or perhaps to make ISA or pension contributions instead. On this point, don’t think just because your endowment has performed badly any investment is pointless.

3) Surrender the plan and take the value now. Your endowment will have a surrender value. This will be the value of the units you hold and you can elect to take this capital sum. Again, this could be used to repay debt or re-invest.

There are potential downsides to surrendering early however. You may be paying a penalty known as a Market Value Reduction (MVR) to surrender it or giving up a bonus, known as the terminal bonus, that may be applied at maturity. Additionally, you may be giving up an important death benefit. Endowments will often pay out a capital sum on your death that is greater than the surrender value and you would have to pay additional premiums to cover this through a life assurance policy.

Surrendering and re-investing the capital also does not guarantee a higher future value.

4) You can sell your endowment on the traded endowment market. This could get you a higher value than the quoted surrender value but the re-sale value you are quoted will differ depending on the ‘quality’ of your endowment. You may also find that after charges and administration the extra value is negligible. Selling your endowment has the same potential disadvantages as mentioned in point 3 above.

If you still have a mortgage and you do decide that maintaining the endowment is not for you it is important that you do have a plan in place to cover the outstanding mortgage debt at the end of the term. This may be by re-investing the capital and saved premiums or by asking your mortgage provider to convert it to a capital and repayment mortgage.

If you would like to advice on your endowment click here.

If you found this article of interest more can be found at www.icl-legal.co.uk. If you have friends and family in the law that would benefit from this or any other articles produced on this blog please do forward it on.

You can subscribe to receive these articles to your inbox automatically by providing your email address in the ‘Receive our Newsletter’ box at www.icl-legal.co.uk

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