Chapter 10 - Retirement Planning Considerations Flashcards
Accumulating pension funds - Reviews - how to deal with shortfalls
- contributions, retirement, expectations, funds and work
Reviews can be used to identify shortfalls and can deal with this by;
- increasing contributions if affordable
- delay retirement to give fund time to grow
- decreasing expectations of income or downsizing home
- switch to more aggressive fund strategy
- continue to work part time in retirement
Asset Allocation - Cash - Suitable for as part of pension investment - good for what, avoids what and interest rates
Fixed interest securities or bonds - what are they and why suitable as part of pension - secure, capital value, term, safety, annuity rates, income
Why they are suitable as part of pension investment;
- cash deposits are readily realisable therefore good for providing PCLS, UFPLS or income/lump sum from drawdown.
- using these funds avoids cashing in equities when value is low (reverse pound cost averaging).
- better if interest rates rise compared to fixed interest.
Loans issued by Gov, companies and are suitable as part of pension investment as;
- gilts are secure investment as guaranteed by Gov
- capital value is protected if held to redemption
- term of Gilt can be matched to policyholders term to retirement
- safe haven in time of stock market uncertainty
- good to hedge against movements in annuity rates close to retirements
- provide guaranteed level of income.
Asset Allocation - Equities - suitable as part of pen inv as (performance and term) and therefore suitable for drawdown policies as (timescale, charges + drag)
Property - suitable as part… - risk and why, long term and if SIPP or SSAS can do what
Suitable as part of pension investment as;
- can outperform cash and fixed interest over long term and is therefore suitable for drawdown because
- investment timescale could be significant
- charges for drawdown are higher than annuity therefore need investment return to cover them. This is the same regarding mortality drag.
Property - suitable as part of pension investment as;
- overall risk of portfolio can be reduced as movement in prices not correlated to movement in equity prices.
- over long term, can produce positive real rate of return.
- if have SIPP or SSAS, can invest in property for benefit of business.
Life styling - overview (equity fluctuations and what is it)
Disadvantages - annuity, early retirement, FAD, ATR and switching times
Short term fluctuations associated with investing in equities can reduce overall fund and cause annuity purchased to be reduced. To deal with this, life styling moves member away from equities and into cash and fixed interest inv the closer they get to retirement.
Disadvantages to life styling;
- works on basis crystallise bens of retirement date, take PCLS and buy an annuity.
- if retiring early then may have high exposure to equities which will reduce annuity and increase number of units needing to be crystallised to provide UFPLS.
- if retire later or in FAD then investment opp may be lost
- ATR may change over term
- switching occurs at pre-set times so does not account for market conditions ie equities are depressed.
Self-investment - SIPPS can be used to… (invest in x2 and purchase what), member can choose to…
Limits on investment in sponsoring companies - total value of shareholding’s held in what (2) are limited to (2), when is % calc’d, restriction on shares and dangers of self-investment by schemes (risk, conflict and illiquid)
SIPPs can be used to invest in shares and bonds, purchase shares in own business and invest directly in property. Can mange own portfolio or appoint an investment manager to do it for them.
Total value of shareholding’s that can be held in SSAS and TB SIPP are limited to;
- under 5% of scheme assets in one sponsoring employer
- under 20% of scheme assets if more than one sponsoring employer
% of value is calc’d when scheme pays for shares and not retested later unless further shares are acquired. No restriction on % of shares held in one company as long as meets above rules.
Dangers of self-investment by schemes;
- high risk as employees would rely on emp for pension and earnings so could lose everything if insolvent.
- shareholding’s in employers company can create conflicts of interest.
- for unlisted companies, shareholding’s will generally be highly illiquid.
Loans to sponsoring employers from occ schemes - can loan to what type of scheme (2) and not
subject to what conditions - limit at what date, secured against, interest rate and how rounded, max term and add if needed, repayments and if don’t meet the above is becomes what and scheme could be…
Taxable property - regs set out what and if they do…, taxable property includes (2) and not
Rules allow loans to SSAS or TB SIPPs but not CB SIPP, subject to conditions;
- must not exceed 50% of scheme asset at date loan is granted
- be secured on assets that are valued equaled to loan + interest
- carry min interest rate of 1% over average base rate rounded up to closest 0.25% if not a multiple of it.
- max period of 5 years and can rollover for another 5 years if having trouble repaying.
- be repaid by equal annual instalments of capital and interest.
If the above not satisfied, classed as unauthorised payment and scheme could be de-registered.
Taxable property - regulations set out certain assets schemes should not invest in and tax penalties that apply if they do. Taxable property includes residential property and personal chattels (antiques, art and cars) but excludes business assets valued at no more than £6k.
Borrowing by a scheme - what schemes (2)can borrow funds for what purpose, total borrowing limit per scheme and existing borrowing
Example - £200k fund and scheme has already given £30k
Both SIPPs and SSASs can borrow funds to use for investment purposes.Total borrowing by a pension scheme is limited to 50% of schemes net assets before loan. Where a scheme has existing borrowing, 50% remains but total of all borrowing is limited to 50%.
E.g. SIPP has already lent £30k - max borrowing if £200k fund = (200k-30k)*50% = 85k - 30k = 55k
Cash flow modelling and stress testing - involves assessing what (3) whilst allowing for (2), can forecast… (2), CFM particularly important for what as withdrawals are, should take into account (2) and should be what to reflect what (2)
Pound cost averaging - what is it and effect when withdrawing + known as, what it can lead to
Sequencing risk - what and when can create what?
CFM involves assessing current and forecasted wealth + income and expenditure whilst allowing for inflation and varying performance levels. Can be used to forecast fund size and work out withdrawal rate each year. Amount chosen will be based on circumstances, objectives and capacity for loss.
CFM particularly important for those in drawdown as withdrawals are higher than the level of natural income (dividends, interest etc) achieved by the fund. Should take into account various ages and a range of realistic returns. Should be updated annually to reflect change in circumstances and review assumptions used.
Pound cost averaging - dip in fund prices causes contributions to get more units in return for contribution. But opposite when taking withdrawals = reverse pound cost averaging and can lead to rapid reduction of the fund i.e. process exaggerates effects of volatility.
Sequencing risk - risk that poor investment returns happen early in retirement can create a drag on investment growth achieved.
Safe Withdrawal Rate - what is it, US and UK SWR, designed to endure what, model needs to be what for each client and x2 examples (longevity and asset allocation) and how can fund depletion help be avoided
It is the highest % of initial pension portfolio adjusted for inflation which can be taken without the client running out of money over a 30 year period. US study found that 4% whilst UK 3.7% (60% equities) and 3.4% (50% equities). The SWR has been designed to endure an economic climate that future market conditions would have to worse than they have ever been to make the model unsustainable.
Model needs to be adapted as per client;
- longevity - model only assume 30 year period
- sensitive to asset allocation and acceptable rate is based on portfolio and ATR.
Likelihood of fund not being depleted can be improved by dynamically adjusting withdrawals to market and portfolio conditions.
CFM stress testing - what should be considered (assets, income, ad hoc, inflation, longevity and returns)
CFM inflation - why should it be considered
CFM reviews - why is it important to reviews and what must it take into account (easy)
CFM should be stress tested regularly and following should be considered;
- sudden or permanent loss of assets eg stock market crash
- need to increase the income taken from portfolio
- need for large ad hoc withdrawal
- future inflation is higher than historically expected
- living longer than expected
- future returns lower
Inflation - can have a significant effect on living standards over time so must be considered.
Reviews - ability to increase/decrease amount of withdrawals or take lump sums emphasises importance of reviews and must take into account circumstances, tax status, changes in legislation etc.
Recycling excess pension income - does not fall foul of what, if no LTA issues than what does REPI create, as above for annuity income + what else and example and who gets a cash flow disadvantage doing this and why
Income recycling does not fall foul of anti-avoidance provisions as these apply to PCLS. If don’t have any LTA issues, recycling pension income rather than reducing income creates a further source of PCLS.
If receiving fixed income ie from annuity then recycling gives the above and could improve death benefit options available following the members death. E.g. if annuity provides survivors annuity but spouse dies, no bens will be payable but adding income into private pension means can be left to nominee.
Cash flow disadvantage for higher and additional rate tax payers as they have to wait to get tax relief via self-assessment
IHT - funds in drawdown can…, DC generation tool and this makes it… (2)
Importance of nominating ben - scheme admin and rules, nomination form and paid to someone else then how can funds be taken, if member dies without completing nomination form (surviving dependant and no surviving dependants)
Funds in drawdown can be passed down free of tax if dying before 75 + any beneficiary can continue to draw income. Therefore DC funds good intergenerational wealth tools. Makes it more likely to think about funding a pension and use other sources of income in retirement so this is passed on.
Importance of nominating ben - Scheme admin can ignore nomination and pay bens to anyone who is permitted under scheme rules. If nomination form exists and bens paid to someone other than nominee, can only take funds in form as lump sum.
If member dies without completing nomination form;
- with surviving dependant - scheme admin can only nominate dependant to receive income and if anyone else must be a lump sum.
- no surviving dependants - admin can nominate anyone to receive funds and can be paid as income in this instance.
ISAs - death bens and will form part of estate unless (2), if die spouse able to claim what and allowance and is the greater of (2)
ISA cannot be placed in trust so will form part of individuals estate unless;
- AIM shares that qualify for business property relief
- surviving spouse/civil partner
If ISA holder dies, spouse is able to claim APS and is in addition to own ISA allowance. For deaths post 04/18 it is greater of;
- valued of deceased ISA at time of death
- value at earlier of completion of estate, closure of ISA account or third year post death
Alt sources of retirement income - Residential property - pen flexibilities allow for what and bens (2, mortgage and loan) and drawbacks (value and IHT)
Buy to let - pen flex allow for what and what may provide income, when a good choice and bens to this approach;
- significant fund value
- longevity and health
- depletion
Pension flexibilities allow member to repay mort or make home improvements via PCLS or UFPLS. Bens for this are;
- no mortgage payments in retirement and could be used to recycle back into pension (although careful not to trig PCLS rules)
- wont have to take out expensive loan for improvements + increases value.
Drawbacks;
- value of fund reduced and t4 income available in retirement
- pension does not form part of estate whilst house does so higher IHT on death
Buy to let - can take fund all in one go and rental income + capital on sale can provide income in retirement. This may be a good choice if they feel as though value of property will increase quicker than pension fund. Bens to this approach;
- if fund significant, may be possible to just use PCLS to purchase or deposit which would mean no income tax if taking all of fund.
- good for those in good health and long life expectancy as investment leveraged.
- once purchased income + capital value can reduce risk of depletion.
Alt sources of retirement income - buy to let cont -
Drawbacks;
- salary, interest rates and yield, diversification, costs, ongoing, refurb, no tenants and capital asset
Tax implications;
- tax band, triggered, income tax, CGT, IHT
Drawbacks of buy to let compared to pension fund as follows;
- if newly retired, wont have a salary to fall back on if goes wrong
- if mortgage taken out less likely that interest rates will increase in future which will reduce overall rental yield + more difficult to get mort in retirement
- all or most of pen capital tied up in single investment
- initial costs of purchasing house are high e.g. solicitors and stamp duty 3%
- needs ongoing management and maintenance
- may need refurbishment work before renting
- periods of no tenant therefore no income
- property bought with pension fund is capital asset and t4 may be compelled to use for cover care costs.
Tax implications to consider;
- although 25% TFC, rest is likely to go into higher or additional tax rate
- MPAA triggered
- rental income subject to income tax
- CGT payable when selling if over exemption amount
- value of house forms part of estate on death
