Seven Winning Strategies

These are a few of the strategies I have been discussing at recent Pensions by Candlelight dinners.

  1.   Look for cheap State pension Top Up opportunities

Where you either have fewer than 10 qualifying years or some recent part years

  1.   Stagger Private Pension Withdrawals 

Use your annual tax allowances!!!

  1.    Think Carefully About Where You Take Your Income From

Consider drawing income from your ISA and leaving your pension for the kids

  1.    Expressions of Wishes

Use them to save your children tens or even hundreds of thousands of pounds in inheritance tax

  1.    Give while you’re still alive

Equity release with a fixed-rate lifetime mortgage and gift the proceeds.  Not for everyone, but can work in the right circumstances

  1.    Planning for the Terminally Ill

Capital gains liabilities disappear on death, whilst assets can be left inheritance tax free to a partner.

  1.    Marry Your Daughter’s Boyfriend

A very high risk strategy to use the spousal exemption from inheritance tax!!!!!!

Take care out there

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A little capital gains example for you

Peter bought a holiday home in Cornwall in 1995 for £50,000, which he has just sold for £250,000.  He paid £1,000 in legal fees when he bought the property and incurred £2,500 in legal and estate agent fees in selling it.

Peter can calculate his taxable gain as follows:

Base cost = £50,000 + purchase cost (£1,000) = £51,000

Sale price less costs = £250,000 – fees (£2,500) = £249,000

Net Gain = £249,000 – £51,000 = £198,000

For the year 2016/2017 Peter has a capital gains allowance of £11,100, whilst property capital gains are taxed at 18% for basic rate taxpayers and 28% for those on the higher rate.  Peter has no other income this year (or is lucky enough to work for a supranational institution, where his earnings do not constitute taxable income).

Subtracting his annual capital gains allowance from his net gain = £198,000 – £11,100 = £186,900.

The first £32,000 is taxable at 18% = £5,760

The remaining £154,900 is taxable at 28% = £43,372

Total capital gains tax payable £49,132

 NB: Non property gains are taxed more leniently (10% for basic rate taxpayers and 20% for higher rate).

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Government rolls out new state pension forecasts

It’s been a long time coming, but at long last it is possible to go online and discover what your state pension entitlement is currently and what it might be by the time you reach retirement age.

If you already file tax returns online you will be familiar with the Government Gateway and you can use your existing User ID and password to proceed.   If not the process of registering is relatively simple, if somewhat convoluted.

Once you have entered your password, HMRC will then send an access code to your nominated mobile number, which will allow you to see your pension forecast.

It’s advisable to have your passport handy the first time you do this as I was asked to provide some details from it to verify that it was indeed me requesting access.

Unfortunately you only get two numbers.   The first is your entitlement based on your contribution history as of 5th April 2015.  The second is the amount you may get to if you continue to contribute. 


Disappointingly, although the numbers take into account wrinkles such as “contracting out”, the actual calculations are not presented.

If you are interested in some of the finer details Age UK has published an excellent document answering almost every conceivable question.

Take care out there



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Ending higher rate BTL mortgage relief will hit many basic rate taxpayers

Not quite the snappy title I’d hoped for!  However, such is the confusion about the impending changes to BTL mortgage tax relief that I thought it was worth tackling one of the more major misconceptions.

In this regard I am very much the bearer of bad news.  Many currently basic rate taxpayers will end up paying higher rate tax on their rental income thanks to the change.  It is entirely false to suggest that this will only affect those already paying tax at 40% and above.

Here’s the science.  To be phased in by 2021, mortgage interest will no longer be allowed as a direct deductible expense.  Instead a basic rate tax credit will be added back only after the “profit” figure has been calculated.

For anyone with a mortgage there will be a large optical increase in taxable profit.  Take the example of a retiree with no other income, but £50,000 in rental receipts and mortgage interest of £30,000. Previously their marginal tax rate would have been 20%. Under the new regulations, however, the profit rises from £20,000 (£50,000 – £30,000 mortgage interest) to £50,000 (assuming no other expenses to keep things simple).  Their marginal tax rate would immediately jump to 40% and only then would the 20% mortgage interest tax credit be applied.

In this example the pensioner with no other income pays £1,880 in tax currently, but would pay over £3,400 under the new regime.  That’s an 80% increase in the tax bill of a formerly basic rate taxpayer.

Calculations available upon request.

Take care out there


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Comment on recent FTAdvisor article on pension freedom

FT Advisor last week published an editorial about how Pension Freedom was “not working”.  In the comment section I ventured that Independent Financial Advisors might be leaving themselves vulnerable if they have a policy of always declining transfers from Defined Benefit (final salary) schemes into Defined Contribution arrangements, such as a SIPP.

Most people would be best advised to stick with their final salary pensions.  However, if leaving an inheritance is important to you, and, crucially, you have sufficient other resources from which to draw an income, a transfer could make sense.  This is because a defined contribution pension, in many circumstances, can be left to descendants free of inheritance tax and now, thanks to Pension Freedom, without paying the 55% Death Tax.

By systematically denying pension savers this opportunity, IFAs will almost certainly be giving their clients advice they know to not be in their client’s best interest.  See the article and my comments (stuarttrow) at



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A Bird in the Hand

Two recent pension surveys caught my eye last week.  The first suggested, somewhat unsurprisingly, that retirees prefer a guaranteed income to an equivalent sum of savings.

 The report was based on lifestyle survey data and the analysis contained a lot of squiggly charts and tables of data.  The upshot though is that increasing guaranteed income appears to encourage social participation (and other activities associated with the feeling of wellbeing) to a degree not matched by merely increasing wealth.

The survey was conducted specifically to investigate issues relating to the pension freedoms introduced in April of this year.  These gave many retirees an alternative to simply purchasing a guaranteed income in the form of an annuity.  Effectively the freedoms present investors with a choice between a fixed income for life (an annuity) and investing, at their own risk, to provide an uncertain level of income.

It’s not hard to see where the stress comes from.  Producing an acceptable income from savings has always been a challenge, one that eludes many “professionals”.  The current low rate environment exacerbates this problem.  Add in a generalised lack of financial self-confidence, not to mention the intimidating “mystique” surrounding investment, and it’s easy to see why most pension savers are happy to let others take responsibility for their retirement income.

However, even leaving aside the emotional and educational aspects, uncertainty creates real risk and people are prepared to pay significant sums to avoid it.  Indeed the entire premise of insurance industry is that people will pay more in premiums than they’ll ever claim from their insurance policies.

Another way of looking at this is from the perspective of an annuity provider.  Previous blog entries on this site have illustrated just how expensive it is to buy an indexed-linked pension compared with a level annuity that pays a fixed income for life.  Adding indexation sees the provider assume the risk of protecting their clients from future inflation.  Even ignoring inflation, providers still run the unquantifiable risk of longevity.  It is this, combined with current low interest rates, that make annuities appear such poor value.

Another survey indicated that typically only 6% of retirement income comes from savings.  48% comes from benefits or the state pension, whilst private pensions chip in 42% on average.

These two surveys would appear to support each other inasmuch as savers’ lack of comfort with cash, as opposed to a secured income, suggests that they “value” savings less.  Of course there may be practical issues that limit an individual’s ability to save.  However, it is a shame that the flexibility of savings is underappreciated.

The slight irony is that the various regulatory developments that have occurred since the vast majority of these private pensions were accumulated have indeed made private pensions a more rational choice as a means of long-term saving.  With the 55% Death Tax removed, pension pots can be passed on intact and sometimes entirely tax free.  That is a significant advantage  compared with seeing your entire pension pot disappear upon the death of you and your partner, simply because you wanted to remove all income uncertainty from your life by purchasing an annuity.

The inescapable, and somewhat unfortunate, result of all this is that pensions have become even more complicated and daunting than ever.  Annuities remain an option, but the opportunity cost of buying one has increased substantially now that pensions can be spent or passed on at the pensioner’s absolute discretion.  In many ways a pension is better than a trust.  The pensioner remains in control of the funds for their lifetime, but can pass them on to their direct descendants tax free.

Ironically this inheritance tax advantage may cause investors to leave their pensions intact and instead rely on non-pension savings for their retirement income.  Which neatly brings us full circle to people’s aversion to saving!

Take care out there


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The meek shall inherit the earth (if their parents are rich enough)

Until relatively recently the tide had been running very much against inheritance tax planning.  Successive governments had closed loopholes and negated time-honoured strategies to make what was once dubbed a “voluntary” tax more and more difficult to avoid.  Over the past year though those lacking the gift of immortality have been presented with two very valuable estate management tools.

The first I have already discussed at length.  Abolishing the so-called pensions “death tax” allows pension funds to be passed from generation to generation, only being taxed at the beneficiary’s marginal income tax rate when cash is withdrawn.  Technically a pension fund could always be passed on free of the reviled IHT.  The problem was that the so-called death tax (arguably the ultimate exit charge) of 55% more than made up for the IHT exemption.

Last week’s budget though added another tool to the estate planner’s armoury, namely the potential to shelter the family home from IHT.  Currently we all “enjoy”, although I’m not quite sure that is the correct verb, an IHT allowance of £325,000.  For a couple that sums to £650,000 with a relatively recent innovation being that that allowance can be passed on to the surviving partner upon the first partner’s death.  Thus, combined with the fact that trusts tend to be less favourably treated these days, the default option for many married couples is to leave everything to the surviving spouse who will then proceed to give away as much as possible once their own needs have been met (utilising gifting rules and seven year potentially exempt transfers).

What Mr Osborne added last week was a further IHT allowance per person specifically associated with the family home.  This will start at £100,000 in 2017 and steadily rise each year until it reaches £175,000 in 2020/21.  Thereafter it will rise in line with the Consumer Price Index.  When complete it will exempt a £1,000,000 family home entirely from IHT, although everything else will then be taxed at 40%.

The tax planning opportunity comes where people have more modest homes and are relatively cash rich.  Granted this doesn’t apply to everyone.  However, if you are looking to leave a little something to the kids or grandchildren, it might be worth considering “upsizing” the family home if that is an option.

Let’s put some figures on that.  A married couple with a home worth £650,000 could upsize (or at least upvalue) to a pad worth a million.  Think luxurious penthouse apartment with a stunning cityscape view!  This would potentially save their heirs £140,000 in inheritance tax by sheltering an additional £350,000 in the family home.

Those still looking to downsize will be able to do so by utilising another innovation, the “inheritance tax credit”.  This preserves the new allowance for those downsizing so long as the bulk of the estate is left to direct descendants.  The hope is that this will encourage retired individuals to free up larger houses for growing families.

It’s only fair to point out that once the family home reaches beyond £2,000,000, the additional allowance is withdrawn at the rate of £1 for every £2 of value.

Additionally you will not be surprised to hear that not only does the Chancellor giveth, but he also taketh away.  The cost of all this IHT largesse is that those earning more than £150,000 will see their annual pension contribution allowance stepped down in increments from £40,000 to £10,000.

The upshot though is that families now have two new and very powerful tools to shelter considerable funds for future generations: private pensions and the family home.  The caveat, of course, is that the law is so fluid that any beneficial change could easily be reversed with expensive consequences.  I suspect though that these two particular changes will be preserved going forward, even if future governments feel the need to temper pension freedoms generally going forward.

Take care out there



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Is it better to go for an index-linked pension or a steadily rising annuity

As I discussed last month, people often underestimate how much it costs to protect your pension from the ravages of inflation.  We saw, for example, that a £100,000 pension pot might typically buy you a level annuity of £5,448 a year.  This would remain constant for the rest of your life, which could easily be another 30 years.  If, however, you wanted your income to increase by 5% a year, your starting annual income would almost half to £2,815.  To put that into perspective, you would have to live until you were 90 before you broke even on your decision to opt for a 5% annual escalation.  That is six and a half years longer than the current male life expectancy.

However, a 5% annual increase is actually considerably above the current inflation rate.  Indeed over the past year the Retail Price Index has increased by just 0.9%.  Even if you go all the way back to 1981, the average only climbs to 3.85%.  In view of this, if you merely wanted your pension to increase by the rate of inflation, rather than a fixed 5%, you might expect that your starting level would be higher.  And you would be correct!  Instead of starting at £2,815 and increasing by 5% a year, you would start at £3,294 and rise in line with inflation.

Of course we’ve got no idea what inflation will be over the next few months, let alone the next 30 years.  However, if you assume that inflation going forward will be the mirror image of what it has been over the past 25 years, i.e. starting low and then building to peaks to reflect the spike in prices in the early 1990s, you come up with some interesting figures.  You would, for example, have to live until 97 before you would have been paid as much by an RPI-linked annuity as by the level annual payment.  A clearer indication of just how expensive it is to protect yourself against future inflation is that you would only have to live until 78 (having retired at 65) to be better off opting for an annual 5% increase rather than a rise based on inflation.

This illustrates two things.  Firstly it is very expensive to provide an escalating pension, especially one linked to future inflation risks.  This is because you are asking the annuity provider to effectively “insure” you against unknown future price increases.

The even more significant risk that all annuities insure you against is longevity risk.  That is the risk that you live longer than you or your annuity company have budgeted for.  An annuity will, generally, keep paying out until you die, whether that is at 66 or 106.  It is true that you can pay extra to have the income guaranteed for a minimum period of 10-years.  This means that your beneficiaries don’t lose the value of the entire £100,000 if you drop dead far sooner than you might have hoped.  However, this generally doesn’t cost that much (but I will cover this in another update).  By far the greater cost to your annuity provider is if you live on to a ripe old age.

The point is that the “insurance” element shouldn’t be underestimated, both in terms of its cost, but also in terms of its value.  One way of appreciating how much you are being charged is to consider that the average male life expectancy is 83.5 years.  If you were simply to keep your £100,000 pension pot and take an income of £5,448 (equivalent to the level annuity and assuming no investment growth whatsoever), your pot would last until you were a little over 83  years and four months old.  Basically the price you are paying the insurance company for agreeing to sustain your pension until you die is equivalent to every last penny you may have earned on your £100,000 for almost 20 years.

This is not to say nobody should buy an annuity, or that they shouldn’t have it inflation-linked.  What it is saying though is that these things cost money and you can only really appreciate how much if you delve a little deeper.

Take care out there


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Keeping your options open

A recent study by Friends Life indicated a significant shortfall between the income people expected to need in retirement and what their savings were on track to deliver.  The study broke the numbers down on a regional basis and showed that savers in the North East and South West were likely to be the least disappointed.  Nationally though people expected to need £409.10 per week, but were likely to have to make do with far less than that: £312.40 to be precise, a shortfall of £96.69 a week.

The more encouraging survey finding though was that people were planning to accumulate a “basket” of products and sources of income to fund their retirement.  Whilst the recently introduced freedoms have made pensions significantly more attractive, the lesson of recent history is that a variety of income sources provides the best chance of optimising your affairs to provide the most resilient and tax efficient income in retirement.

Indeed I touched on this a couple of months ago when discussing “Taking a tax-efficient income in retirement”. So when 29% of pre-retirees surveyed indicated that they intend to supplement their retirement income with a savings account and 18% plan to use a cash ISA, this is an indication that people are thinking flexibly. ISAs share a number of the tax advantages of pension. Crucially, even though the inheritance tax advantages are far more limited, ISA withdrawals are free of income tax. This makes them excellent vehicles to top up income if your level of pension drawdown is close to pushing you into a higher tax bracket in any given year. Indeed ISAs the arguments for drawing down ISAs first are persuasive precisely for the reason that they are income tax free, but aren’t easily passed on the future generations.

One particularly interesting aspect of the survey is that whereas 17% of people approaching retirement were thinking in terms of either downsizing or selling their property to unlock funds, only 4% of retirees have actually used funds from this source.

This would rather suggest that most savers will be a little more circumspect about investing their hard-earned pension pots in buy-to-let properties than the recent hype might suggest. BTL though might be a viable proposition for excess funds not already enjoying the tax advantages of a pension. That though is a story for another day.

Take care out there


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What price an index-linked pension?

People are often shocked at just how much an index-linked annuity costs relative to one that pays a level income for life.  Imagine if you will, you have a £100,000 pension pot that you are seeking to convert into pension income.

According to the Daily Telegraph, Aviva will exchange your £100,000 pot for a lifetime annual income of £5,448.  However, if you were to require a 5% increase each year, your starting income would be just £2,815, almost 50% less.

That begs the question, how long would you have to live before you “broke even” on your decision to opt for the escalating income?

A simple spreadsheet shows that you would have to live until you were 90 to have been paid as much from an escalating pension as you would have received from the level annuity. By that point though the escalating pension pays you an annual pension of £9,532, whilst the level annuity would, of course, remain at £5,448.  Thereafter the escalated pension moves ahead quite quickly. Indeed by the time you receive your telegram from the Queen (or King) on your 100th birthday, you would have received a total of £73,000 more from an escalating annuity.

For context the average male retirement age is 64.6 years and life expectancy at that point is 83.5 years.

Of course the real world isn’t quite this simple. Inflation, for example, invariably means that a pound received early on is worth more than one received twenty years later. Also most annuities make some sort of provision for surviving spouses. Over the next couple of updates I will delve into a few of these complexities. Even if you don’t intend to buy an annuity, inflation is still something that you will have to take account of to ensure that your savings last for your entire retirement.

Take care out there



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