I went to see a prospective client today and that meeting brought home the complexity of choice that now faces someone aged 55 with some private pension provision. Before Pension Freedoms various issues conspired together so there were few decisions to make before you took an (inadequate) annuity at State Pension Age. Not all changes are down to Pension Freedoms, the removal of a compulsory retirement age means that normal pension ages of 60, 65 or 75 have less meaning and there are more people still working in their 70s and 80s.
So, imagine you are Pete Evans, recently 55 years old, a builder earning £27,000 per year and you have an old conventional personal pension with £75,000 accumulated, a small deferred civil service pension and a current workplace pension on stakeholder terms in the default fund. You were divorced about 10 years ago and still have some debts, £15,000 at an average APR of 15% and a modest mortgage of £30,000 at 4.9% APR. You have got some arthritis in your joints and manual work is becoming a proper “pain”, so much so, that going part time or taking a lower paid office job is looking attractive.
Before Pension Freedoms, your choices were rather limited; there was no access to capital, so “soldiering on” and paying interest on debt was close to compulsory.=
So, what are some of the options today?
I’ll do nothing. Just carry on as before, servicing expensive debt and work full time up to your State Pension age, if you can.
I want it all, now! Take the tax-free cash and the net amount, after the tax man has his share; pay off the loan and the mortgage and blow the rest on a cruise. He pays off his loans and mortgage, leaving £13,740 for a posh cruise. All of the £75,000 is used up; £16,260 goes to the taxman and nothing is left in this plan for retirement.
I want to pay off all my debt now. He takes all of the tax-free cash and enough of the taxed money to clear off all debt, leaving £24,750 still invested in the pension.
I want to pay off the really expensive debt now and chip a little off the mortgage. He takes the tax-free £18,750 and pays off the expensive debt and a little off the mortgage. He leaves the remaining £56,205 invested to give him an income at retirement.
I want to pay off all my debt and take drawdown on the rest. Take the tax-free cash and sufficient to pay off the mortgage, leaving about £24,750 and take a drawdown of 4%, or £82.50 per month as additional income, leaving the remainder invested.
This is not an exhaustive list; I have not explored the annuity options at all, but they are all possible and, if one is executed, Pete will have to deal with the consequences, for good or ill, for the rest of his life.
So, how do you chose? Option 1 is not sensible; pain can blight your life, so early retirement or the ability to take lower paid employment would make a big difference. Hopefully, you will see option 2 as a trap; paying the tax man £16,260 to spend your own money seems crazy to me. Anyway, if you blow all of the £75,000 now, what are you going to live on in your “actual” retirement?
Option 3 makes more sense, as clearing the expensive debt and the mortgage will save around £3,720 per annum in interest costs. Even paying the taxman would be offset in less than 2 years; the danger here is what will the £24,750 left in the pension be worth in the future as an income stream?
Option 3 might make even more sense if the old pension scheme is not producing a good investment return. £3,720 is a return of just less than 5% on £75,000, so unless the old scheme is producing a better return than that regularly, there is a good economic argument to pay debt down now, rather than later, as you would probably still be better off in retirement.
The big question for Pete is “What do you need to live on in retirement?”
State pension will kick in at 67 for him and will be worth around £8,000 per annum, assuming no dramatic changes in government policy. If Pete can live on £10,000 per annum, once his debts are paid down, then option 3 might allow him to retire 2 and a half years early, as he still would have £24,750 in the pension. Good investment returns might bring that up to 5 or more years, especially if he uses the income not spent on servicing interest costs on more pension premiums.
Option 4 might allow him to retire 5 or more years earlier, depending on investment returns on his remaining pension fund and what he does with the £2,250 per year he saves from paying off the expensive debt in one go. Checking investment returns and paying for investment advice makes more sense when you can see how it will get you to your goals early.
Pete now needs to decide what his priorities are and as an adviser, I need to understand what the civil service and the workplace pension may be worth at various points in the future. Having access to more money in your pension future allows you to live it up a bit more, or start retirement earlier.
Sometimes choice can be empowering, but sometimes it can be dangerous; there are still too many people going for option 2 and to hell with the consequences! For Pete, retiring 5 or more years earlier is likely to be very attractive; the physical pain of a manual job in later life can take the “colour” from the rest of your life.
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The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of UK legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly, no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.