The need that most of us have to increase savings in order to close the much-publicised gap is well known. The need for many of us to work longer than we originally planned if the gap can't be closed sufficiently to enable us to live as we would wish in our dotage (assuming that we are not prepared to get by on less than we would like) is not hard to understand, although many will fail to consider this seriously until only a short time from retirement. It is, after all, very easy to defer the pain of facing up to financial realities. This is the pension equivalent of throwing unopened final demands into the rubbish bin.
For those who can face the pain and realise that they have to do something (putting aside any thoughts about the detriment to the economy and quite possibly the value of their investments that the resulting reduction in expenditure will precipitate) more pain lies around the corner – the pain associated with having to choose. And the harder and more complex the choices, the greater the pain.
Advisers can help here as a form of financial planning analgesic. Determining how much to save to close the gap is the first step. It will bring into sharp focus the extent of the challenge and the adviser role is essential here. The need to “get specific” as a second step (the first is, of course, realising that there is a problem in the first place) is essential to the process of creating a solution.
Many excellent tools exist for determining precisely, based on whatever set of assumptions are made, how much needs to be saved to hit the required target.
After recovery from the shock of the financial challenge that is often revealed there will be a need for the would be investor or gap-closer to clarify just when and how, that is, in what form the benefits he accrues are to be accumulated. This process is becoming known as “wrapper choice” to those in the industry. And there are many wrappers to choose from. More pain – more analgesic required.
The choice of wrapper or wrapper combination is determined by many factors but one of them is tax. The adviser needs to ascertain to what extent the investor values or needs:
Tax relief on the investment.
Tax freedom on the funds and income.
Answering these two questions should not be hard. It is better to have tax relief and tax freedom than not have it. However, when it comes to tax incentives, it pays to remember that they are usually introduced to encourage or influence a particular type of activity.
For a tax planner, it is comforting to see that the Government still see the offering of tax incentives as an important influencer. There are many examples of this being so.
The point I raised in last week's article about the acceptance, in the second consultation document on corporate tax reform, of the need to retain the ability to offer accelerated capital allowances even if there is a coming together of accounting and tax practice in this area is one such example. The tax regime for approved pensions is another.
Tax relief and tax freedom abounds but there is a price to pay in that benefits have to be taken in a very particular form and funds – once saved – are not accessible until a particular time.
These are perhaps the two main (but by no means only) detriments to pension savings. They are, in effect, the price to be paid for the tax relief.
The question for the investor, once they are aware of this “price”, is to decide whether they are prepared to pay it. Many do not even consider it and it is an almost Pavlovian reaction that if there is a need for retirement saving, then an approved pension arrangement is the wrapper to use. And for many it will be. It is just that there should at least be some thought given ahead of the investment.
Those who have the benefit of advice should be able to make a better, more informed choice than those who do not.
From our experience of supporting advisers with clients who are high-net-worth or affluent and especially those who are business owners, it is clear to us that a thoughtful client-centred approach to wrapper selection is one that is highly valued and potentially highly remunerative.
Even though the main characteristics of the primary retail investment wrappers are not too difficult to understand (although justifying the plethora of different rules, with the benefit of hindsight, is a little more so) the evidence is that insufficient attention is given to pension alternatives when making wrapper choice.
With any degree of thought, most advisers would agree that a pension alternative should be considered across the spectrum of investors. This is not to say that a pension alternative will always be chosen, just that it should at least be considered.
The value of advice and trusted guidance in making these choices really cannot be underestimated. As long as advisers are conversant with and able to confidently and clearly articulate the implications of the various options then giving advice on wrapper choice can be reduced to a formulaic process.
Matching wrapper or wrapper combination to the expressed required outcome will be a valued but not necessarily costly service. The adviser will secure the benefit of leverage or scale on the investment into acquiring the intellectual capital necessary to deliver the service. In other words, they will secure the benefits of “mass customisation” – a goal that is very close to our hearts at Technical Connection.