Planning for Retirement

Mr0

Hello.

I recently had a serious talk with my parents and am concerned about their retirement plans, or rather a complete lack of one. I don't think they are doing too bad financially but I am just worried about any risks that we are not aware of, or if there is a different and more efficient way of doing things.

They are both aged 57. This is their situation.

Mum: Works part time earning ~£10k p/a.
Dad: Was self employed until recently. Looking to work part time, but will not go back into business for himself.
Dad owns a commercial property/flat worth £300k which he rents (to me, so rent is pretty much garunteed) for £15k p/a. Most of the time he refuses to take the money as he has enough to spend, so I set this aside to repay his mortgage when fixed rate ends. I do not plan to use this property long term, and dad wants to rent this out as a source of income rather than sell, expected rent is about £15k aswell.
Dad also have a house which they used to live in value over £550k which is rented out earning £30k p/a. Only recently rented out as they couldn't afford the mortgage when he stopped trading. Current mortgage outstanding is £110k, repayment is at ~£24k, capital repayments are at ~£20k. The current plan is to completely repay the mortgage in 3-4 years with alot of overpayments.

So total income is ~£55k, actual amount they have to spend is about £20k after mortgage, and tax. There are no dependants financially.

Dad has a private pension with Abbey Life of £11400. They sent a statement to him last week and there are two values. One for the fund value (£11400) and one for transfer value (£10600). As the pension is a small amount he wants to take the whole amount out when he turns 60. Does this mean that when he wants to withdraw the money the pension provider will take a cut from it? Sorry if it sounds silly, I haven't dealt with pensions before. From what I understand the amount is taxable as income, and as he it will partly fall in the higher rate band, he will be taxed at 40%.

I had a state pension forecast for both parents sent to them, and have 31-33 years of contributions on record, and as they will most likely get a few more years of work before 66 they will likely get the full state pension. A rough estimate of the state pension in 9 years will give £9k each. So their income will increase by £18k when they reach 66.

So assuming mortgage gets paid off in 4 years, and that they continue to rent out both properties, they will have an income of £45k (mum will stop working by then) and this will jump to £63k in a further 5 years. So they do have income in retirement, though I have to say that none of this was planned.

Would the fact that they have most of their wealth and income stuck in property be seen as too risky. If both goes empty they don't really have a backup plane (i dont think state pension alone will cover rent, food, travel etc, and that doesnt come in until way later). Looking on these forums the on annuities and such, would it be a good idea to cash in one of the properties and go for one of these products? I don't think the cgt position would be that big because he used to live in the property so has ppr relief and ran his business from there so he qualifies for the lower rate of 5%. On the other hand the recent news suggests that rates are terrible. Also property values and rents could increase (though they could decrease too). I don't have any experience with financial products.

Also I have suggested that they consider actually retiring early when their mortgage is repaid. They are not big spenders and the money they have would be sufficient to maintain their current standard of living. They might have to rent a smaller place to live, maybe somewhere nicer than the noisy city. Would this be a good idea, given the uncertainty of the income, with no state pension?

Would any other products be more suitable, something that gives a steady income. I don't think investing medium term in something like equities would work for them.

Very long post, and apologies for that. Is there anything else they should be looking out for? I don't think there will be any changes to the financial situation in the near future but it is better to be prepared.

Thanks in advance.

jamesd

There's no posibility of them getting a full state pension. That's about £250 a week for a high earner, about £190 a week for a minimum wage worker, assuming a full working life and counting both the basic and additional state pensions. They will perhaps get the full basic state pension and some additional state pension. To find out how much of each they should ask for a state pension statement.

Are they deducting the mortgage interest cost from the rental income when calculating the taxable income? This is also one reason why it's not usual for buy to let owners to repay capital, since that reduces their tax deductions and they can instead keep their other income instead of clearing the capital, leaving them with a higher income.

A difference between fund value and transfer value probably means that the investments are in with profits funds. If so, the real value is the transfer value. The fund value includes fudge factors that ignore reality, while the transfer value is the real value after paying any market value reduction - the correction that's used to get rid of the fudge factor and get to the real value if people want to sell.

Having so much income coming from so few properties is not a good thing. What happens if one burns down? Or if a tenant stops paying and makes them go for six months without rent while they get them evicted? If they want a high concentration in property they should at least look to diversify into more properties, perhaps by selling the ones they currently own. Highest incomes tend to come from two bed properties.

One nice thing about the £550k property is that since it was lived in by them it'll have principal private residence relief for capital gains for the time they were living there plus three years, then letting allowance for other times. So this may well eliminate all of most of the capital gain whenver it's sold.

Buying an annuity is poor value, so not really a good idea. That applies particularly at their relatively young ages.

Where do they live? You've mentioned two properties and at least one mortgage but neither seems to be their home.

As a rough guide it's possible to get 4-6% of capital as income from investments. With property values of £300k and £550k less a mortgage of £110k that's £740k of capital that can generate from £29.6k to £44.4k of income. If in a stocks and shares ISA that income is tax free. The 4% to 6% range depends on how important it is to avoid capital reduction, 4% is quite cautious, 6% is quite likely to have some gradual drop.

Add state pension income of perhaps £12,000 a year and that's around £56k a year of income before tax, around £49k after tax, assuming no ISA use and income divided between the two of them to fully use a pair of about £10k personal incoem tax allowances. Or add another 11k after tax totake higher investment income. Easy enough in theory to use capital drawdown to top up the income to that level before the state pensions start.

So my main concern at the moment is that they have quite reasonably the ability to have an income of £60k after tax but don't seem to be inclined to do that. Surely there are some things that they might want to do that cost money, perhaps travel?

Alternatively, if they are more concerned with inehritance planning, why not do somethign about that now, like making a gift of a property to you or any others that they might wish to benefit, to eliminate inheritance tax potential on the gift?

Before looking at investments it's probably best to point out that they do have that sort of income level available if they want it and ask them to consider what they want to do to use that money to improve their quality of life.

Assuming they have any use at all for the money, they can stop the mortgage overpayments, or sell the property and switch to investments or some investments and maybe a couple of lower cost properties. Or of they are really into using residential property, into a mixture of ivnestments and 5-8 properites purchased with mortgages, which would provide more sensible property incoem diversification than what they have at the moment.

Mr0

Thankyou Jamesd for the reply.

I actually meant the basic part of the state pension only. I am not sure of how the second state pension worked but I assumed that it didn't matter because he has mostly been self employed, and wouldn't be eligible anyway, also that it is being phased out in a few years, so wouldn't apply to them. I base my estimate on the current level of £145 p/w adjusted for inflation of 2% for 9 years. Is is too generous an estimation? My mother also gets the basic element only based on the forecast sent this month.

It does seem risky to me too, but as I said, none of this was planned. If anything, he would like to keep the house as his 'trophy' if you like, something to show what he achieved over his working life, even if it is used as a source of income. We encouraged him to stop working self employed because of health and stress caused by the lowering general outlook. He has since been happier but still worried about finances from time to time.

They lived in the house until they rented it out 2 months ago. The mortgage payments are getting too high and ate into most of his cash savings. One thing I did not mention was this business, which still has value, but is not selling due to the recession. I am quite confident that when the economic situation improves, a buyer could be found. He wishes to sell the business leasehold and to rent out the property to them. I am not sure if this is common practice but my dad seems to think so. This was how he started. He bought the business and signed a lease on the building for 15 years paying £10000 per year (1996 prices). The freehold was purchased within 2 year so he saved quite alot of money on rent over the years. The reason why he is overpaying his mortgage is because he is not certain that he will get a good price. He told the mortgage providers that that was his intention when arranging for consent to let. They have now moved into the flat above the commercial property.

I am still new to the income tax side of things, but am quite confident that I got it right. I know that mortgage interest is tax deductible, but not repaying it sooner is not an option. If the provider withdraws consent to let and force him onto a more expensive product, this will be alot more expensive. I have some savings of my own which I will he happy to help them pay it when they need it, so am quite sure that the mortgage shouldn't be that big of a problem. I have looked briefly at the inheritance tax position. Ideally we could transfer the properties to mine and my bother's name and avoid iht completely after 7 years. But I am concerned about the gift with reservation of benefits provision. Since the properties are used as a source of income for them. It seems wrong if the deeds were transfered but they still get to keep the benefits (the income) generated. Would HMRC see this as tax evasion? I do think that he wants to keep the house in the family.

In terms of spending in retirement. I do expect them to enjoy life a bit more with more holidays, maybe to visit distant relatives and old friends in other countries. I think £60k a year is a decent amount to aim for. I don't see them buying any more properties due to their age. I certainly don't think he will support an aggressive plan involving more bank borrowing and having to micro manage several properties.
If they do not want to go back to their house they own now, it is likely that they will rent a smaller place. Or move in with me later.

Having been reading the forums for a while now I understand that equities are better in the medium to long term. But I don't really know where to start with them. My father does have a Cash ISA which I arrange for him each year, using most of his allowance, but it only has £5,000 in it now as he used most of it to repay his mortgage at a higher rate. Maybe I am being too cautious with investing because I don't want to make mistakes. He will not want to deal with any financial matters personally, and since it is all his money that he built up over many years, I do not want to risk it. If it was my money.. maybe but.. If he was to start dabbling into funds, would this have to be through an IFA? I have read some articles about the basics, but where do I go to actually find these products. I would like to look into this further as an option as I still have a few years to help him get ready for retirement. As he would not want to sell his house, if this is a suitable investment, he could potentially sell the commerical property and put the proceeds into these investments. Is £300k a decent amount to invest in the long term? How much micro management would be required and given our very limited knowledge on this would we be overly reliant on advisers and liable to huge fees in the process?

Thanks again.

xylophone

current level of £145 p/w

Basic state pension is currently £110.15.

However, it is about 9-10 years until your parents reach SPA and it is anticipated that the 'single tier pension" regime will commence in 2016.
http://www.bobneillmp.co.uk/news/single-tier-state-pension

You are currently saving the rent you would otherwise pay to your father and plan to give him this money in a lump sum to pay off his mortgage - this would be a gift with possible IHT implications for your own estate.http://www.bobneillmp.co.uk/news/single-tier-state-pension

In view of the large sums involved. would your parents not be best off obtaining qualified professional advice pertinent to their situation?
http://www.unbiased.co.uk/find-an-adviser?gclid=CPzQp4X27bYCFU3KtAodQmgASA
http://www.step.org/

Mr0

Well he doesn't spend the money, but I still give it to him. He usually spends cash and doesn't touch his bank account. Any amount which he doesn't spend is transferred to his bank account. The mortgage over payments will be made from his account. I will be preparing his tax returns so everything will be declared.
Also, I am 27 with hardly any money (nowhere near the nil rate band), so not really concerned with my own IHT position at the moment.

When the time comes I do think financial advice would be beneficial. My main problem is how do I convince them that they need to make proper plans in good time without being too invasive. They are very capable of making decisions for themselves but are not financially aware, if that makes sense.