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Retirement income balancing act

Planning retirement and relying on expert advice is more important than ever

Zoltan Molnar
Zoltan Molnar, Independent financial planner, WH Ireland

Given the current and proposed restrictions on tax relief and contribution limits, many people are even more reliant on a holistic approach to ensure that the right strategy is adopted in order to meet retirement goals in the most tax-efficient way.

Planning ahead has never been more important and with tax rules changes on a regular basis, it has never been more important for clients to be able to rely on advisers’ expert advice and their ability to develop detailed cash-flow analysis. Furthermore, building up a tax-efficient portfolio of assets will not only allow clients to secure their own future but also help fund their children’s retirement years.

Once advisers have ascertained the degree of risk that a client is willing to take and, more importantly, what losses can be tolerated along the way, a detailed proposal can be put together outlining what needs to be done in order to achieve a client’s goals.

In today’s political and economic environment, the first step to structure a retirement plan is often making the client aware that retirement funds can (and often should) consist of other components than straightforward pension funds.

Pension funds are an efficient way of saving for retirement as they offer tax relief on contributions and growth within the fund. However, once the taxfree cash has been extracted, the income that follows is liable for income tax. This is where the flexibility of being able to take tax-efficient income from other investment sources becomes paramount to the overall plan.

In order to get to this stage, building up a variety of investment “pots” at the outset of the client’s financial plan will give them the most flexibility when they get to retirement.

By using Isa allowances to the full each year and building up a tax-efficient port-folio through a combination of Oeics, unit trusts and direct investments, the clients get to diversify their investment types.

Most clients will not receive £10,100 of “tax-free income” each year by using their annual capital gains tax allowance in retirement. In order for this to work efficiently, investments subject to CGT and not income tax, need to be inclu-Building up a tax-efficient portfolio of assets will not only allow clients to secure their own future but also help fund their children’s retirement yearsded early on in the financial plan.

If a higher-net-worth couple invests £20,400 annually in Isas from the age of 40, given an average growth of 7 per cent a year, this could result in a flexible tax-efficient fund for their retirement years with a value of £1.17m by the age of 65.

Additionally, should they invest a similar amount into a pension fund and receive just basic-rate tax relief, figures from Sippcentre show this could result in a further fund of more than £1.46m. This gives the adviser and client many options as to how they receive their income in the most tax-efficient manner.

An ideal retirement portfolio will have a spread of investment assets, of which pension plans will play their part.

Successive budgets have started to rein in the tax relief given on contri-butions being made by high-net-worth individuals and are unlikely to be reversed in any near future, thus reinforcing the importance of finding alternative retirement strategies. Reading between the lines of the latest HM Treasury consultation on removing the need to annuitise at age 75, one cannot help but sense the concern that people in unsecured pension (drawdown) arrangements might exhaust their pension pots and end up relying on the state in later retirement.

This is demonstrated by proposals for a minimum income requirement which, if a client can secure the MIR, offer a much more flexible approach to taking income and would be per-missible under a new flexible drawdown product.

Building up a taxefficient portfolio of assets will not only allow clients to secure their own future but also help fund their children’s retirement years

Although no level has been set for the MIR and no clarity has been provided on what would be deemed accep-table to secure this, the premise is simple – show us you have enough income so that you will never fall back on the state and we will leave you alone.

For clients who cannot do this, capped drawdown is the alternative. This would be similar to the existing drawdown (unsecured pension) arrangement but with suggestions that income limits need to be tightened to avoid clients exhausting their pension pots too early.

This fear has become heightened by the increased prospect of people using a drawdown strategy beyond 75 (few people currently use the alternatively secured pension option due to the inflexibility and draconian tax charges), meaning the possibility of running out of income is greater.

This concern regarding exhausting drawdown funds is not a new theme. For many years now, drawdown has been seen as a risky option.

This concern is not without foundation – and I am not advocating that drawdown income rules should be relaxed or that drawdown is right for everyone but some of the rhetoric which accompanies the concern does need to be looked at in context. My favourite is the debate around the minimum fund size appropriate for drawdown.

Most guidance talks about drawdown being unsuitable for those with small funds and no other assets and income to fall back on. The Pensions Advisory Service website goes further, stating that “it is generally agreed that a fund should be at least £100,000 before income withdrawal is a viable option”.

Unfortunately, it is this warning which seems to have been adopted by many compliance teams up and down the country as the suitability benchmark. Providers (my own company included) often quote this “gen-erally agreed” figure in literature, advisers often find that when their cases are vetted by network comp-liance teams that the £100,000 figure is a significant barrier to writing drawdown business.

My concern is that by applying arbitrary benchmarks, we are in danger of disadvantaging some people who may find that drawdown is perfectly acceptable simply due to the fear that a small fund might be exhausted.

There will be many examples where small drawdowns can work. For example, clients who may be using income drawdown as part of a wider package of retirement planning tools, perhaps using a cocktail of products including annuities or fixed-term annuities to put in place specific income/growth strategies. Or those with other sizeable assets providing income in retirement, meaning that the drawdown is less significant in income terms. Those not requiring an income may also benefit from drawdown – this will provide the opportunity to take tax-free cash but without the need to draw an income.

The selected investment strategy and the costs of running the draw-down plan need to be carefully ana-lysed to ensure that the plan is offer-ing both good value and meeting other client objectives possibly around security of capital – but again one has to question whether an arbitrary limit is the best way to police this type of situation.

Given that the alternative to drawdown, in the form of an annuity, also has risks and provides little or no flexibility through the retirement journey, then the use of arbitrary limits around drawdown can also expose the client to risk simply by removing choice.

The outcomes of the consult-ation will be interesting, in par-ticular, seeing how much the concerns around inappropriate use of drawdown feed through into restrictions around product design.

The danger is that we end up with a regime which dictates that only big is beautiful in this area. This would be a retrograde step and would mean that many advisers and clients would be unable to plan for retirement in a way which best meets individual client needs.

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