In Focus - Autumn 2021
Welcome to the latest issue of In Focus, your quarterly financial planning newsletter.
<b>Your quarterly financial planning<br> newsletter | Autumn 2021</b>
<i>In this issue: </i>
• Avoiding a common pension trap
• The gender pension gap
• Investing for your children
• Retiring abroad: things to consider
Find out what's in this issue
Welcome to the latest issue of In Focus, your quarterly financial planning newsletter.
In this edition of In Focus, we offer four new articles to inform and inspire your thinking.
We hope you find this content helpful and invite any questions you may have on these topics, or regarding your own case.
How to avoid this common pension trap (the MPAA)
How to avoid this common pension trap (the MPAA)
Have you ever considered “dipping into” your pension to plug a fall in your income? One study shows that, in 2020, about 5,000 people per week did this - but triggered (likely unwittingly) the Money Purchase Annual Allowance (MPAA) rules in the process. This can have disastrous consequences for someone’s retirement savings, since it effectively reduces the tax-relieved amount you can contribute into a pension each year by up to 90%. We want to help inform and protect people from making this mistake. In this article, we explain how the MPAA rules work and explain some ideas for navigating them effectively.
More than 1,000 pension savers every working day became subject to the strict Money Purchase Annual Allowance (MPAA) last year by taking their first taxable pension payment from a defined contribution fund
How the MPAA works
Most UK residents are allowed to contribute up to £40,000 per year tax-free into their pension scheme(s) - or up to 100% of yearly earnings (whichever is lower). This is called the “annual allowance” and it provides a strong level of flexibility for the majority of pension savers, who can also make use of unused allowance from the previous 3 tax years.
These limits are in place mainly to stop wealthier people from amassing “pension fortunes”, due to the attractive tax reliefs pensions offer. Currently, a Basic-rate taxpayer only needs to put 80p into his/her pension to contribute £1 (20% tax relief), whilst someone on the Higher-rate need only put in 60p (40% relief). However, the UK government also wants to limit people from gaining unfair advantage from the tax system - i.e. by drawing from a pension whilst also continuing to work (and potentially still, contributing into a pension). This is where the MPAA rules come into play - brought in with the 2015 Pension Freedoms.
When triggered, these rules reduce your annual allowance to £4,000 - lowering the amount you can contribute to a pension and earn tax relief. Once activated, the MPAA cannot be undone in an individual’s case. So, it is crucial to make sure that you only trigger it when you are ready. Frustratingly, however, the rules can be complex and difficult to understand - making it easy for unwary individuals to fall into an “MPAA trap”.
Common MPAA triggers
A range of events can activate the MPAA rules, but there are eight in particular that tend to be most prevalent.
- The first involves drawing an income from a “flexi-access drawdown” (FAD) pension. In simple terms, this involves taking bits of your pension as income (when needed) and keeping the rest invested.
- The second is when you take an income from a flexible annuity (a financial product which generates a guaranteed income in retirement).
Many of the other triggers start to get more complicated, which is partly why they are activated inadvertently.
- The third is when you take a lump sum via an “uncrystallised funds pension lump sum” (UFPLS). This relates to your lifetime allowance (outlined above). When you take a pension benefit, your pension becomes “crystallised” to measure its value. This is then deducted from your lifetime allowance to determine how much of it you have left.
- The fourth refers to a specific case where one type of pension (called a “capped drawdown” scheme) is converted to a “flexi-access drawdown” scheme (the FAD scheme, mentioned earlier).
- The fifth trigger relates to this, where a person takes out more from a capped drawdown scheme than the maximum permitted.
The remaining three triggers are also quite specific.
- The sixth trigger happens if you were a member of a “flexible drawdown” plan prior to April 2015.
- The seventh occurs when you receive a pension income from a “final salary” scheme which has fewer than 12 members.
- The eighth and final trigger is very specific indeed. This activates when you (as a scheme member) receive a stand-alone lump sum, where the rights (after the 6th April 2006) exceed £375,000 and where you have “primary protection”.
Navigating the MPAA
As you can see, these scenarios are difficult for most people to know intuitively. Many people simply want to start taking some of their pension income after the age of 55, to supplement their employment income (perhaps as they slowly wind down their hours). This can be a good option for some people, provided they have first understood the MPAA rules.
So, how can you ensure that you don’t trigger the MPAA by accident?
It is always best to seek financial advice for absolute peace of mind. However, a good principle is to not exceed your 25% tax-free lump sum withdrawal after the age of 55. For instance, if you have a £500,000 pension pot then you could withdraw £125,000 usually without fear of triggering the MPAA.
Another idea could be to cash in pension pots each valued under £10,000 (although a limit of 3 non-occupational plans applies). In many cases, it is a good idea to consolidate multiple pensions for ease of management. Finally, remember that the MPAA rules only apply to pension schemes involving a “pot” of money. The rules are not triggered if you start accessing benefits from a final salary pension (or defined benefit) scheme from the age of 55.
For many people, pensions and the rules around them can be mysterious and intimidating- leading them to put off planning for retirement. But it needn't be this way. To get you started, why not read our complete guide to a pension plan - covering what it is, and how it can help to meet your retirement goals.
Read the guide
The gender pension gap: what women need to know
The gender pension gap: what women need to know
Increasing attention has been given to the UK gender pay gap in recent years, which stood at 7.4% in April 2020. Yet there is also a significant overall difference between women’s income in retirement compared to men’s. The COVID-19 pandemic has widened this gap dramatically - to nearly £200,000, according to the Centre for Economics and Business Research. In this article, we explore why this gender pension gap exists, why COVID-19 has made things worse and how women can take action to protect their retirement goals.
Why is there a gender pension gap?
To answer this question, it is important to separate the state pension from workplace pensions. The former is the income you receive from the UK government at your state pension age, which largely depends on your National Insurance (NI) record. To get the full new state pension of £179.60 per week in 2021-22, you need at least 35 “qualifying years” of NI contributions.
This starts to show why many women have a lower state pension than men. Historically, women have taken more responsibility for raising children and have taken time out of their careers to do so. Over these years, you can keep building up your NI record when you claim Child Benefit - but only until your youngest child is 12. Many women have also not claimed, believing they are not eligible - or it is not worthwhile - since their household income exceeds £50,000 (the level at which an individual would become liable to pay tax on the benefit). There is also an ongoing battle by many women born in the 1950s to get compensation for the rising state pension age, which now stands at 66 for both men and women.
The gender inequality between workplace pension savings is somewhat different because it relates to the gender pay gap. In short, the amount an employee saves into their workplace pension is usually a percentage of their salary - and, historically, there has been a wide gap between the average salaries of men and women. Additionally, 38% of women in 2020 were working in part-time employment (often to allow for caring responsibilities) which reduces the amount they may feel able to contribute to a workplace pension.
The impact of COVID-19
According to the Financial Times, the gender pension gap for over-55s widened by 17% in 2020 as the COVID-19 pandemic hit household finances. This is despite the fact that women, on average, tend to contribute more into their pensions than men – 5.1% and 4.8%, respectively.
The data is still emerging about why this has happened. Part of the reason may be that women are over-represented in sectors hard-hit by the pandemic, such as hospitality, retail, leisure, tourism and the arts. Another likely factor is that women are more likely to occupy precarious, low-paid jobs, leaving them more vulnerable to getting furloughed or losing their jobs. With more children also needing to engage in online learning from home during the lockdown months, this increased childcare burden has also largely fallen onto women. A March 2021 study showed that among parents, women are ‘much more likely to say that they were the ones most responsible for childcare or home schooling when schools were closed due to the COVID-19 pandemic than men, with 71% saying so compared to 26% of men’. This further impacts on women’s ability to earn and save into a pension.
Another possible factor is the impact of divorce. Whilst relationships are not always meant to be, divorce puts the separating parties under more financial pressure. According to Age UK, the result is usually harder on women’s income in retirement because entitlement to their husband’s private pension is rarely brought up in the divorce proceedings.
What women can do
This paints a bleak picture for women so far. Fortunately, there is much that can be done to help improve your retirement prospects. For younger women, a simple starting point is to contribute to a pension as early as possible. With more time on your side, your pension investments have more time to grow through the power of compound interest.
If you are working, make sure you are opted into your workplace pension scheme (it’s likely you’ll have been automatically enrolled into it, but worth checking to make sure). If possible, you could approach your employer to ask them to match your workplace pension contributions (they are required to put in a minimum of 3% of your qualifying earnings).
For women in relationships, be careful about passing total responsibility to your spouse or partner. Make sure you have a stake in the household finances. Not only is this empowering, but knowing what assets are held also helps protect you financially should a divorce ever occur. If this ever does happen, keep pensions in your mind - since these are often the second-highest valued asset, after the house (if you’re a homeowner).
If you are on maternity leave or are taking a career break to care for children under 12, check your eligibility for National Insurance Credits. This could help you get Class 3 Credits towards your state pension whilst you are not working. If there are gaps in your NI record and it looks like you will not gain the full 35 qualifying years you need before you retire, consider paying voluntary National Insurance Contributions (NICs) to plug “gaps” in your record. You can check your record quickly online using the UK Government website.
If you see yourself not working for a while (to help look after dependants over 12), then consider speaking with your spouse about paying voluntary NICs each year you will not work, using the household finances. It will benefit you both in the future if you both have a full state pension to draw from, and it will help protect your retirement finances if you ever divorce.
Should I save or invest on my<br> child's behalf?
Should I save or invest on my child's behalf?
We all want the best possible future for our children - giving them a better start, financially, than perhaps we had ourselves growing up.
Yet how do you decide on the best way to save or invest for your son or daughter?
In this article, we explain how cash savings (including NS&I Premium Bonds) are suitable in certain situations, whilst investing through certain tax-efficient “vehicles” (e.g. a Junior ISA or pension) is typically better in others.
The simplest way to save for a child, of course, is simply to open a regular savings account and put aside cash - perhaps a small amount each month. Here, you have the advantage of keeping control over the account. However, interest rates are poor in 2021. Some banks now offer 3% or more, but come with stringent conditions (e.g. a £50 maximum monthly deposit and you must also have a current account with them). Most other options, however, rarely beat 1% on their variable rates.
The Bank of England (BoE) has a target of 2% on inflation, so if this target is met over your child’s first 18 years then these accounts would lose 1% each year (in real terms). Where cash has a clear advantage over investing, however, is its stability. Investments can go up and down with the stock market, whilst cash does not. If you are looking to give wealth to a child soon, therefore, it may be best to hold it in (or move it into) cash. A popular option here is the Junior ISA, which lets you save up to £9,000 each tax year on your child’s behalf. The rates on these accounts are better than those on regular accounts and adult ISAs. Another option is buying NS&I Premium Bonds for your child. This gives them the chance to win up to £1m in a prize draw, with the chance of winning highly influenced by how many bonds you buy (you can purchase up to £50,000). However, bear in mind that the odds of winning are still low, so you need to weigh this against the guaranteed interest rate you might get on cash in a Junior ISA. Another factor to consider is that Premium Bonds can be signed over to a child from age 16, whilst for a Junior ISA your child takes control of it from age 18.
Investing for a child
Saving cash for your son or daughter is not the only option. Investing can open up opportunities to grow wealth at a faster rate (albeit with higher risk). Consider, for instance, that the S&P 500 has delivered an average return of nearly 10% since the 1920s.
However, multiple stock market crashes have also occurred over this time. This is why investing for a child is usually better for longer-term financial goals, such as building wealth from a child’s birth until they turn age 18.
If one or more crashes occur during this timeframe, there should be time for the investments to recover and even outgrow their previous highs.
A popular option to consider here is a Junior Stocks & Shares ISA. Here, you can invest up to £9,000 per tax year on your child’s behalf (up to their 18th birthday) and generate dividends and capital gains tax-free.
The returns you make will depend largely on the shares, funds and other investments chosen, as well as their cost and performance. For instance, providers may charge a platform fee (e.g. 0.15% per year) and an ongoing fund charge (e.g. 0.50%). You might also be charged when you buy and sell investments. A financial adviser can help you sift through the many ISA options to find one that suits your goals, offers a good range of investments and at a good cost. Your high street bank may not be the cheapest - or best - on the market.
The above approaches can be great for short-medium term financial goals for your child, such as saving or investing for a future wedding, house deposit or university living costs. Yet if you are thinking of helping your child over the longer term, then setting up a pension for them may be a good option. A Junior SIPP is a popular option here (self-invested personal pension).
This lets you save up to £3,600 each tax year on your child’s behalf, and also claim 20% tax relief. For instance, if you put £800 in the pension then the government will add another £200. The pension passes to your child at age 18, but they cannot access it until at least age 55 (soon to rise to 57). This might sound restrictive, but it unlocks amazing growth potential for your child through the power of compound interest. In short, the more time your child’s pension investments have to grow, the more growth potential there is. For example, suppose you invest £3,600 in your child’s pension at their birth (£2,880 from you, £720 from the government via tax relief). At their 65th birthday, this amount could grow to nearly £117,000 after fess (assuming 5.5% growth per year, and not accounting for inflation).
Saving and investing for a child are noble aims. Yet parents should also recognise the value of bestowing financial wisdom to a son or daughter, so they are more able to make good money choices in their adult years. This will look different for every family. Some parents will want to give their child an increasing stake in their own finances - perhaps via an allowance or through encouraging a bit of part-time work alongside their studies. The tools mentioned in this article should also be considered in this light. For instance, a Junior ISA may suddenly bestow a child with a large amount of money (all of a sudden) on their 18th birthday. Building the character and knowledge to spend this wisely will help them learn to be good savers and investors, too.
Note: Investments and the income from them can go down as well as up and is not guaranteed at any time. You may not get back the full amount you invested. Information on past performance is not a reliable indicator for future performance.
Retiring abroad? Tips to consider
Retiring abroad? Tips to consider
Have you ever dreamed of living your “after work” years in another country - possibly one with a lower cost of living, better climate and great food? Many people dream of retiring abroad, but face several key questions they need answers to before doing so – one of the most significant of these being “how will my finances work?”
In this article, we explore the financial planning implications of an expat retirement.
Using pensions abroad
When you retire in the UK you can expect to receive a state pension (from your state pension age) and income from workplace and personal pensions that you have accrued over a career. These will likely be handed to you in GBP. When living overseas, however, you not only must ensure that you can access your pension benefits from there - you need to be able to convert these into the local currency. The good news is that you can claim the new State Pension in most other countries. However, you will not receive a yearly increase under the “triple lock” system unless you live in the EEA (European Economic Area). This exception is not guaranteed over the long term, however. So you need to factor this possibility into your long-term financial plan.
With your workplace and private pension(s), you will likely need to seek financial advice about how best to manage these when moving abroad. In some cases, you can “take your pension with you” by transferring it to a QROPS (qualified overseas pension scheme). However, quite often it will be necessary to keep your pension(s) in the UK and transfer money overseas to your local bank account - incurring fees (e.g. currency exchange) in the process.
For those retiring in the UK, most of a person’s retirement income will be subject to income tax rates (after your £12,570 tax-free allowance is used up). If you live in another country, however, then you also need to consider how you are impacted by local tax laws.
Could any of your pension income be subject to both UK and local taxes - resulting in “double taxation”? In many cases, this can be avoided by living in a country where the UK has a relevant tax treaty. A qualified tax adviser can help you determine whether this is the case, and how the intricacies work.
Watch out for inheritance tax
There is a common misconception that you can avoid inheritance tax (IHT) by moving overseas. However, this is untrue. In fact, the assets you leave to your beneficiaries may become liable to IHT in both the UK and your country of residence when you die. The laws work differently in each country, but generally IHT applies on the value of your estate over a certain threshold (e.g. £325,000 here in the UK). In France, for instance, transfers between spouses and civil partners are not liable to IHT. Yet in Spain, on the other hand, partners and spouses must pay IHT - but 95% of the value of the family home is exempt under certain conditions. New Zealand and Australia do not charge IHT at all.
For the UK’s tax laws, your “domicile” will matter hugely. If you are deemed “domiciled” in the UK when you die then your entire worldwide estate will be subject to IHT in the UK. If you are “non-domiciled” then only your UK-based assets are taxed, but this status is difficult to achieve (and not always desirable).
Health & housing
For most people, health problems will become more pressing and complicated in older age. You must, therefore, factor the local infrastructure and costs into your decision to retire abroad. Most countries will not offer universal healthcare (free at the point of use) like UK residents have with the NHS. Lots of countries will offer a basic level of state-provided care, with the option to go to private hospitals. The latter should offer better facilities, staff and resources to patients, but likely come at a higher cost. Your retirement plan should factor in the cost here - in particular, whether insurance is available and how much this expense is likely to be.
Shelter will also be key: can you buy a property in your desired country of residence? If so, what are your rights of ownership and what are the likely costs? Bear local laws closely in mind. In Vietnam, for instance, foreigners can buy “dwelling houses” but cannot purchase the land on which these are built. If you are currently a UK homeowner, do you plan on retaining your property (perhaps renting it out) or selling it as part of your moving plans? If you ever need to sell your overseas property, how easy will it be to achieve this quickly?
What if it all goes wrong?
Even the best-laid plans can go awry. When retiring overseas, it is crucial to have contingency plans ready in case you ever need to move home (e.g. to care for a terminally-ill relative). This may affect your decision about moving your pension(s) overseas. Perhaps you might want to keep most/all of your income-generating assets in the UK, unless you have a strong safety net in your new country (e.g. lots of relatives living locally, who could take you in).
It’s also important to recognise the possibility of needing to enter care in retirement. Here in the UK, the average stay in a care home is about 19 months and at least 838,530 adults receive publicly funded long-term social care. If you find yourself needing care when retired overseas, what is the quality and cost likely to be? Each country’s care sector will differ depending on its politics, economy and a host of other factors. Might you need to move home to get the care you need? If there is a chance you might, make sure you have not completely cut yourself off from the UK, financially speaking.