Pension novice poses question

annie42

Hi - I'm as green as grass when it comes to pensions and would appreciate some help. I am nearly sixty but have no pension. In the next tax year I will have to pay at 40% although this may not be the case in subsequent years. I understand that if I invest in a pension I can avoid paying as much tax by claiming back a quarter of what I put in straight away. I think if I paid in 12k and didn't make any more contributions it would hopefully provide around £500 a year. I like the idea of saving tax but I have to decide if it's worth parting with 9k to get £500 per year back in return. If I were to incur a tax bill at 40% in future years can I add to my pension again and avoid the higher rate tax.

EdInvestor

You have to look at both the tax saved while working and your tax position after retirement.

First you need to tell us how much state pension you will be getting and when - and when you plan to stop work.

Get a state pension forecast here:

https://www.thepensionservice.gov.uk

What other savings/investments do you have which will produce income in retirement? This is also relevant as some income is taxable and some not.

annie42

Thanks for your reply. I run a small Limited Company and aim to retire in 2015 with a state pension of 94% which is around £80 but I think there are some rule changes about contributions coming into effect which may mean I get 100%. I have 27k in cash isas, around 20k in stocks and shares isa, 33k in building societies and I own four rental properties with interest only mortgages. At todays prices if I sold them and paid off the mortgages I would have 340K. I intend to use up my stocks and shares allowance for 08/09 and am wondering about drip feeding a stocks and shares fund also.
I have what was a PEP in New Star but they seem to be struggling. I know I'm not covered if the companies they invest in go bust, but does the FSA coverage extend to investment companies going under.

EdInvestor

Here's the tax position after age 65

The tax free allowance goes up substantially, shortly it will be at 10k.So you can earn up to that level in income without paying tax.

Counted in taxable income is:

Pensions, including state pension
Rental income
Savings interest

Not included in taxable income is:

Anything in ISAs
Dividends on shares (as long as you pay basic rate tax)
Premium bonds etc.

*Once you have earned 21,800, your tax allowance is reduced at the punitive rate of 33%*

At the moment, ignoring your savings and investments in ISAs, it would seem you are likely to have taxable retirement income of

5k state pension
18,650 (savings interest/rental income)

So your total income of 23,650 (if invested as above) is already non optimal as it will result in the clawback of your age allowance. You do not need to generate additional income of the taxable variety.

IMHO you should
a) use your 7,200 stocks and shares ISA allowance fully from now on
b)Stash cash savings in tax free NS&I index linked certificates (excellent return for HR taxpayers)
c)Investigate ways of investing so as to receive dividend income from equities once you are retired (a directly-held portfolio of diversified blue chip household name divi-paying shares is the lowest cost method with the least hassle.Open account at a low cost broker for this.)

You could consider getting a small pension to soak up your HRT this year, with the aim of getting oit back in cash after you turn 60 under the "trivial commutation" option. This involves making sure it doesn't amount to more than 16,500 (currently - figure is index linked) including growth and tax relief by the time you want to extract it. Also assumes you have no other pensions (other than state). That would be a better arrangment than the one you have outlined.

annie42

Many thanks for the information. A figure of £18650 sounds a bit optimistic as, after mortgage payments and maintenance, the surplus rental income before tax is only around 8k. I don't know whether that affects anything you've said? Are NS & I index linked certs still a good idea if in subsequent years I may not hit the higher tax band. I style show homes for the housing industry and you know how well that is doing! Also would around 12k invested now in a small pension now keep me under the trivial commutation sum of £16500 by 2015. Re: investigating ways of receiving dividend income after I've retired, it sounds as though this is something I should do myself rather than through a financial advisor? Sorry if I sound dumb. As I once read "it must be hard to soar like an eagle when you're surrounded by turkeys"!

EdInvestor

annie42 wrote: »

Many thanks for the information. A figure of £18650 sounds a bit optimistic as, after mortgage payments and maintenance, the surplus rental income before tax is only around 8k.

Sorry, the figure is based on interest income @5% on the net value of your letting property (340k you said, or have I misunderstood?) reinvested in cash plus your existing cash deposits.

Are NS & I index linked certs still a good idea if in subsequent years I may not hit the higher tax band.

Yes, because you need to boost tax free income (you can put away up to 30k a year in these certs.

Also would around 12k invested now in a small pension now keep me under the trivial commutation sum of £16500 by 2015.

Suggest you cut it back to give yourself margin for extra growth.

Re: investigating ways of receiving dividend income after I've retired, it sounds as though this is something I should do myself rather than through a financial advisor?

Yes.

annie42

I have four properties with an annual rental income of £28800 but after mortgage payments and maintenance costs I am left with around £8000. If I add that to the state pension that's around £15000 plus interest and dividends on my savings and investments.
Would 10k be a more sensible amount re a pension. Do I understand you correctly, I can invest it straight away, claim back 25% and claim it all back under the trivial commutation rule after I turn sixty?

EdInvestor

annie42 wrote: »

I have four properties with an annual rental income of £28800 but after mortgage payments and maintenance costs I am left with around £8000.

I assume you will be selling some or all of these properties at or before retirement and reinvesting the net capital in more efficient ways.So I calculated using the 'rule of thumb' of a 5% net return on capital invested.That's what you should expect to get.

Would 10k be a more sensible amount re a pension.

Yes

Do I understand you correctly, I can invest it straight away, claim back 25% and claim it all back under the trivial commutation rule after I turn sixty?

Not quite. If you claim back 25% now (this is called an "immediate vesting pension") , you will not be able to get the rest out, except as a pension income.

Under trivial commutation, you can claim it all back (subject to tax on 75% of it the 25% being tax free}, after you turn 60.

MrMicawber_2

Your position looks very complex. Have you considered paying for independent financial advice to really work through your options.

shaunrc

Hi Annie42

Firstly I am an independent financial adviser but please do not take this posting as advice as it has a specific meaning for someone who is regulated.

There are questions around a pension for someone of your age who has never paid into one but from your posting and likely rental income etc. it would appear that they do not apply to you. However as you have a limited company you should pay any contribution directly out of it if you can. You need to find someone who specialises in this as I come across a lot of people who miss this point ( including Ed. it would appear ).

It is extremely efficient to pay directly out of a limited company into a pension and you can save much more than the 40% tax. To give a precise number I would need to do a proper financial advisers fact find.

Good Luck.

annie42

The Limited Company was only set up this year and the bulk of the cash in it has come from the business. The 40% tax liablity will be based on the earnings of the business last year. Thank you Shaun for the advice on making any pension payment out of the Company. The Company is tiny, I just subcontract when necessary and hold my Christmas party in a telephone kiosk as there's only me! It was set up just before the current crisis errupted when business was much better so perhaps I should follow Ed's advice and not claim back 25% straight away. If I am unable to add to the pension in future years I can opt for trivial commutation. Hope I have interpreted all the advice correctly?