Open letter to George Osborne and Steven Webb (pensions minister)

Dear Chancellor of the Exchequer & Minister of State (DWP),

I am writing to ask you to stop pension savers from being exploited by insurers under the upcoming pension freedom changes by introducing a single change in the budget.

Under pension freedom rules pension savers will from April have the opportunity to access their pensions via flexi-drawdown or lump sum withdrawals (UFPLS - uncrystallised funds pension lump sums). 

The insurers and other pension providers are not required to offer these facilities in recognition of their ageing technology not being able to facilitate these changes. 

The insurers will allow savers to transfer to modern schemes that can facilitate the transfers.  Herein lies the problem! 

Nearly all personal pension contracts written since the 1970s, up until the implementation of the FSA retail distribution review in 2013 have punitive exit penalties.  These are contractual penalties that significantly reduce the value of the pension savings (typical penalties are thousands of pounds).  The money taken from savers by insurers becomes profit for them and acts as a disincentive for them to facilitate the new pension freedoms. 

I propose the following simple rule change that will protect pension savers, increase the tax take and boost consumer spending without costing the government anything:

“For all pension contracts over 5 years old the transfer value of the pension must be equal to the value of the investments held.”

This will ensure pension savers can access their pension savings under the pension freedoms without being unfairly penalised because of very expensive old fashioned pension contracts. 

I urge you to act now to make this change in the 2015 budget and ensure that pension savers get a fair deal rather than insurers making profits at their expense.

Best regards,

Simon West

Why I'm not buying Woodford

Neil Woodford is a greatly respected manager.  
Many people are rushing to buy his new fund launched under his new eponymous investment brand.  I'm not. I'm recommending my clients don't either.
The long history of Mr Woodford at Invesco Perpetual (IP) is well documented and his track record is impressive. He has a well defined investment philosophy and he sticks to his guns in good times and bad. All admirable.
I have supported his funds heavily in the past.  So why not now?
Performance - Well, the mantra goes "past performance is not necessarily a guide to future performance".  Former glories are not certain but even when Mr W had free rein at IP, his last 3 years were lacklustre.  So, why support a star manager whose sparkle is questionable? Also, the new fund has no history at all! Implied history is not the same as a proven years results.
Distraction - His name's above the door, this is reassuring.  However, remember he's moving away from the large support base and research teams at his disposal when at IP, to much smaller infrastructure.  I cant help but worry his eye will be half focused on other things besides investment decisions. 
Liquidity - Undoubtedly the fund will attract huge inflows of cash.  The hardcore Woodford fans will folllow him everywhere 'Life of Brian' style, pilling in their cash without a second thought.  Not to mention the cash that will follow huge advertising campaign undertaken by Hargreaves Lansdown and other direct sales brokers.  Neil's investment preferences are well known, his preferred stocks understood; this will count against him when trying to access the market.  There could even be hedge fund managers out there trying to make a margin on the back of these purchases.   All in all I have concerns that there may be issues for him accessing the market at the right price. It's already been muted he would try and do a deal with IP to buy some shares off them. 

I have no doubt that these issues will pass and Mr W will be worth buying in a year or two.  Until then there are lots of other funds out there with proven track records and none of these concerns.

What's the deal with Pensions anyway?

Ok, so there’s been a lot of talk about pensions since the budget.
But many people may be thinking "what’s the deal with pensions anyway?" Let me explain:

The government wants you to look after yourself in your retirement.  There's the state pension as a back up, but ultimately they want you to put money aside to fund your retirement.  
The idea is that money put away for your retirement is deferred income.  For this reason the fine fellows at Her Majesty's Revenue and Customs (HMRC) let you off paying tax on the money you save into a pension pot*.  The money invested in your pension pot is then allowed to grow free of taxes** until you get to your chosen retirement date***. Once you decide to receive the money from your pension pot the payments to you are treated as earned income and taxed accordingly****.  

You see simple isn't it!  This is the deal with pensions:

1. Save money into a pension pot and don't pay income tax on the bit you save. 
2. Your pension pot money grows in a tax favoured environment.
3. When you take money out of your pension pot its taxed as income. 

The keen eyed among you may have spotted the small asterix-fest above.  Like all good stories the devil is in the detail (see below).  Some of these rules are due to change over the next year, watch this space!

* Well, they give you tax relief at source up to 20%, which means they add on the tax you've paid to the money going into your pension pot (e.g. £80 contribution becomes £100). If you're a higher or additional rate taxpayer, you have to claim the further 20% or 25% tax relief back via your tax return.  Not all income counts though, it has to be relevant UK income to get tax relief. This typically means income from employment or a trade. You are allowed tax relief on the first £2,880 of contribution even if you don't have relevant UK income (if resident).  There are technically no limits as to how much you can contribute although you can only claim tax relief on 100% of your relevant earnings capped at the annual allowance of £40,000.  Exceeding the annual allowance means you are subject to the annual allowance charge - this effectively means the excess contribution becomes taxable at your highest marginal rate.  Phew!

**You don't pay income tax or capital gains tax on pension pot assets.  Advance corporation tax can no longer be reclaimed thanks to that nice Gordon Brown. You will pay stamp duty when purchasing shares or property and VAT is charged on some fees.  There is a general exemption from inheritance tax on death.  You have pretty good exemption from bankruptcy, you're not safe from divorce though (controversial!?).  

*** Taking your pension pot is called crystallisation.  This happens when you buy an annuity, go into drawdown or take tax-free cash.  There are 11 events in all that crystallise your pension pot and make it potentially liable to tax.  These are called benefit crystallisation events (BCEs to their mates). 

****You can normally have 25% of your pension pot as a tax free lump sum (wahoo!)(occasionally more than 25% if you're lucky - double wahoo!).  The remainder is taxable as earned income.  That is whatever provider pays you the money puts you in the PAYE system (pay as you earn) and pays tax at source based on the tax code they have for you.  You get P60s each year showing how much income tax you've paid.  The government loves rules so much, they made one up called the lifetime allowance.  This means if you have a large amount in your pension (more than £1.25million on 2014/5) then you have to pay extra tax called lifetime allowance charge, this is 25% for income you take and 55% for lump sums. 
Once you've converted (crystallised) your pension pot and gone into drawdown, if you die you have to pay tax at 55% for the lump sum paid to your beneficiaries (other options are available).

5 Good reasons not to convert your Pension Pot to cash

Whilst the budget may be seen as encouraging people to cash in their pension pots, there are some good reasons you might want to think carefully before doing so:

1. INCOME TAX - You can normally have 25% of your pension pot as a tax-free lump sum. The amount you draw is treated as earned income (PAYE) and will be added to the rest of your income for calculating income tax. This means you will pay income tax at your highest marginal rate, and it will be deducted at source. Want to become a higher rate taxpayer? 
2. MOVING INTO TAX – Maybe you think it would be nice to get control of your money away from the insurance company? Want to choose how to invest your own money?  Well apart from the income tax issue above, you’ll move from a pension environment free of income tax (IT), capital gains tax (CGT) and inheritance tax (IHT), into one where all these apply. If you want more control then transfer to a pension account on a wrap platform. You will have a full range of investment options available to you and after April 2015 can draw capital as you need it and control when you pay income tax.
3. DEATH BENEFITS – A pension pot that is uncrystallised (i.e. you haven’t taken any income or tax free cash) is the most tax-efficient plan on death. You get 100% of the pot, tax free, passed on to your beneficiaries free of income and inheritance tax. Once converted to cash you’ve paid the tax and its now part of your estate for IHT. 
4. GUARANTEES – That old pension you've got may have very valuable guarantees as part of the contract that are in effect funded by the insurance company. Are you giving up a 12% guaranteed return for the rest of your life? Think of it this way, you might need double the size of the pot to buy this level income on the open market.  Any pension pot you have needs to be checked to make sure you're not giving up valuable guarantees. 
5. FLEXIBILITY – you’ll have lost options and control over when and how much tax you pay on withdrawal and death. Take advice from a financial adviser and consider what’s right for your circumstances.

Pension pots: What's happened and what does it mean?

On 19th March 2014 in the Budget, George Osborne radically changed the pension landscape!
For everyone with a private pension or a defined contribution company pension scheme the rulebook has been ripped up.

The main change is a shift in power from the insurance companies to you. The changes come into effect from 27th March 2014 and will be in full force in April 2015.

Until now investors wanting to take an income from their pension pot largely had the choice to buy an ‘annuity’ or keep their money invested and draw a regular income – ‘drawdown’.

Because of the regulations and industry practice, drawdown was mainly reserved for investors with more than £100,000.

This means up until now investors with small pension pots had no real choice and had to buy an annuity from an insurance company. In the budget these rules are being relaxed and then removed:

From 27th March 2014 until April 2015 the rules on your pension are relaxed:

1. If you have 3 pension pots of up to £10,000 each and you’re over 60 you can take the full amount as cash – this is Small Pension Fund Commutation.  
2. If the total value of your pension pots (including those already taken) is valued at less than £30,000 and you’re over 60 you can take the whole lot as cash – this is called Trivial Commutation or Triviality. 
3. If you have a guaranteed income of £12,000 per annum and you’re over 55 you can convert any amount of pension investments to cash and draw it – this is Flexible Drawdown.

From April 2015 the proposed rules on how you draw your pension are largely removed. This means in effect everyone over 55 can draw their pension as a lump sum if they choose to.

So now what? If you are at, or approaching the point at which you want to draw pension income you almost certainly have new options. If you thought you had to buy an annuity, you almost certainly don’t have to. You should consider your options and get some professional advice from a financial adviser. 

The gut reaction for those with small pension pots (under £30,000) is probably to see if you can get your hands on the money. If you want that once in a lifetime holiday or new car then maybe this is a good option. If you need this money to fund your retirement then it probably isn’t.

Next post: 5 Good reasons not to convert your pension pot to cash.

Hello blog world!

Hello all,

I've decided to enter the blogosphere to air some views on matters relating to my work.  Specifically, investing, personal finances and financial planning.  

I'm a professional financial adviser and my business is Hulbert West Limited in the middle of Norfolk, in England.  

The views here are my own. Hopefully informed and topical, but I'll let you decide.