personal finance: early retirement osborne pensions
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Martin Lewis, he of moneysavingexpert fame, considered the pension changes “both wonderful and horrid“. Wonderful, because you now can take it all in one go subject to normal income tax rules, without all sorts of restrictions that mean you have to drip out the money over 20 years or so. And horrid – because you now can take it all in one go, so people may blow it all on this sort of thing
as the pensions minister quipped.
Extreme wealth warning – everything to do with pensions is hard, counterintuitive and needs careful consideration
You’re on here because you have an interest in personal finance, right? Most people consider it dull as ditchwater – indeed I only sharpened up my act when I realised that getting my skull round this would enable me to quit an increasingly toxic workplace. Before then I was happy to rock up and work, do a reasonably interesting stuff in return for beer and toy tokens. The Grauniad delivered this quite astonishing piece by Joanna Moorhead saying
When it comes to pensions, choice is not necessarily desirable – especially for those of us burnt by endowment mortgages
WTF? It is precisely because I was burnt by endowment mortgages (though reinstated) that I don’t trust insurance and life companies and was grateful that in pension provision I never had to think about them. If I had to manage a DC pot I would now be deeply grateful to Osborne for letting me escape the clutches of this dodgy bunch of charlatans.
Of course, there are people who enjoy the personal finance sections of newspapers, and who love nothing more than poring over the small print of different finance options on offer, but I’m not one of them. I’m the woman looking for the switch for “financial autopilot”, and right now, with the changes to annuities, that looks suspiciously as though it might have disappeared from my dashboard.
Money is crystallised power, a claim over human work. All power stores are dangerous if you don’t think about them. It’s why people don’t carry petrol around in open buckets and you learn something unique and instructive if you drop a spanner across a car battery. Endowments were the autopilot choice for a young ermine and it appears a young Joanna. The older ermine learned from that when his career flicked out of autopilot, and so should you, Ms Moorhead. ‘Cos the ground is never far away, and it has an unhealthy attraction for things above it.If you fail to plan, you plan to fail.
Thinking is about ten times as hard with pensions than ISAs because of the decades it takes to get into them, and the hopefully over decades they will serve you. The Grauniad seems to be in jealousy mode all round at the moment, as they are bitching that you need a salary of £125,000 to make any use of the the New ISAs. FFS people – I have never, ever, earned anywhere near that much and I have zero income at the moment but I am damn well planning on using my full NISA allowance over the next few years. Dear Guardian, have you ever heard of that antiquated notion, spending less than you earn and saving money? You guys should try it sometime, instead of sipping your cappucinos and griping. No, if you spend your nice Guardian salary on consumer shit then a NISA is no use to you, but you get lots of lovely toys. Each to their own.
small changes make big differences
You don’t see an awful lot about pensions on PF sites because they’re hard, they are built up over secular 1 timescales in general and small changes can make mahoosive differences. Let me illustrate this with an example. In 1988 I joined The Firm’s final salary pension scheme. It had a simple proposition – every year you accumulated entitlement to 1/60th of final salary, with a normal retirement age of 60. In practice than meant if you worked for The Firm for 30 years you would get half your final salary as a pension. The Firm expected pensioners to die at 80 on average, thus paying out for 20 years. You could retire at 50, in which case they would pay out over 30 years, 10 years longer than planned so they would actuarially reduce your pension by 50% – you lose roughly 5% for every year drawn before normal retirement age (NRA) of 60.
The Firm decided it wanted to reduce costs, so it closed this scheme to new entrants in 2001. In 2009 it decided it wanted to save even more money. It appears UK law doesn’t permit firms to claw back pension entitlements already earned because they are part of your pay so they have to contractually honour previous years agreements. But they can change things going forward. So The Firm changed three things, and very few people spotted how much damage was done to their pensions. The Firm
- changed the NRA from 60 to 65
- changed the accrual from 1/60th to 1/80th
- changed the accrual from final salary to career average (each year’s entitlement is based on the inflation adjusted salary for that year)
Three small changes – HR obviously wept the usual crocodile tears and said it won’t make much difference for people retiring soon, and allowed people leaving up to three years from 2009 (just excluding an ermine – I was six months out of the grandfathered rights date 🙁 ) to leave under the original terms. Now who is most interested in pensions? Old gits, who are about to leave. So HR shut them up by grandfathering them.
Let’s take a look at what that did to me
Now I obviously surrendered some pension accrual leaving 8 years early, but the changes made that easier to do – I was giving up less. It’s also relatively simple to see that the total change is about 25%, which coincidentally happens to be the amount I was able to save in AVCs and will take tax-free as a pension commencement lump sum and invest myself in my ISA, effectively creating a tax-free DC pension to compensate for the loss due to retiring early. I will still have less because I will draw the pension a little early, though part of the reason for writing this is that has changed with Osborne’s changes. I may defer it for another year or so and use a personal pension, because as a non-taxpayer I can get a free 20% bump up on £2880 or ~£5700 and getting a 10-20% ROI on cash is difficult to ignore in a ZIRP environment 🙂 It isn’t a lot of money, but it’s worth thinking about.
Now imagine a 10 year younger ermine, entering The Firm just before the portcullis closes on the final salary scheme.
The poor bastard takes the same hit as the old Ermine, but he has to suck it up to 60 to get the same amount as the old Ermine who pulled the big red ejector handle it in his early fifties! Now the younger ermine probably takes an even greater hit because of the career average change, which reduces the base salary on which the pension is calculated. And The Firm was craftily shifting more and more pay from consolidated rises to bigger bonuses, and bonuses weren’t pensionable.
Now the proposition of a final salary pension scheme is simple, so if small changes can make that sort of effect, the sort of thing the Chancellor has done can make even more effect on a DC pension. Let’s take a look.
Osborne’s Budget changes
To a first approximation, he’s lifted the restrictions on what you do with the money once you reach 55. The Government’s own summary is pretty good. People younger than 42 should beware that this age will be dragged up
this consultation also includes a proposal to raise the age at which an individual can take their private pension savings under the tax rules from 55 to 57 in 2028, at the point that the State Pension age increases to 67.
so if you are younger than 42 be careful. If you are much younger then expect this to be drifted up to 60. That is the evil heart of pensions – governments can change the rules after you have locked the cash away. If I personally were younger than 42 than from a purely financial POV I wouldn’t touch pensions with a bargepole, except enough to get any employer match, and perhaps to lose any 40% tax. But that’s me – YMMV. That’s not saying I wouldn’t save for retirement, but I’d use ISAs for that. However –
There are some things only pensions can do
This judgement isn’t as simple as it seems, however, because one of the advantages of a pension is that it can’t be seized by most creditors or held against you for many benefit claims. You may be doing fine and swimmingly at the moment, but globalization and technology are shifting the balance towards capital and away from labour. Pensions help you build capital safe from the backdraft of this. If I were a younger Ermine in my 20s but with the older head of now, from what I have seen I would not expect even a good job to last for 30 never mind 40 years. The power is shifting away from workers, the pace of change is too high and increasing, and the winner-takes-all effect is too high. Tyler Cowen’s Average is Over shows the way – reveiwed in The Economist. I would place greater effort on escaping the rat-race earlier and owning capital rather than relying on my rapidly depreciating labour. The time for consumer frippery and shitloads of debt is over. I have no desire to live like a Transnational – I am not ambitious enough and probably not bright enough.
Many people my age have been caught on the hop by this – the increasing routine and rottenness of my job, and the micromanaged incentives are the first reaches of this shift of labour to capital. When I see a business card that says ‘Consultant’ and I see grey flecks in the hair of the holder I mentally translate into ‘Unemployed’ – because so often it’s true 😉 It heartens me to see that in the UK PF community there are more and more people who are looking for financial independence at much younger ages than I am. I think these are cleverer people than I was, who are picking up the straws in the wind of the incoming shitstorm for jobs. Get on the side of Capital, because Labour is losing the fight, unless you can get on the side of the 1%, and let’s face it, the odds aren’t great 😉
Society will eventually have to shift. Look at some of the changes coming – the increase in the personal allowances, meaning an increasing number of voters will not be taxpayers. They will, of course, vote for jam today and for somebody else to pay. Look at the stats on tax income – over two thirds of the income tax take comes from people earning 32,000 and above. These are people who individually earn more than the median net household income for families with dependent children 2 in the UK
Pensions can help you with this, basically by locking up money against the incoming shitstorm and throwing the key out to your future self many years in the future. You can hitch a ride for your future self on the side of Capital (if you use equities rather than cash) that, in current legislation, can’t be taken away from you 3 and it doesn’t impair your ability to claim benefits 4. Whether that is attractive to you depends on your view of the world and where it’s going, and to some extent your rate of discount of jam tomorrow compared to jam today.
So what did Osborne change?
There’s a common belief that you had to purchase an annuity with a define contribution pension but that was never true until you reached 75. Those with £20,000 of guaranteed pension income could take any amount of their money subject to tax and those with less than that amount of guaranteed income could draw down their money at a rate determined by annuity rates in capped drawdown. What he’s essentially changed is that anyone over 55 can take as much of their pension capital as cash, subject to normal income tax as opposed to the punitive 55% rate it used to be. But if you are taking £150,000 from your pension for that Lamborghini then you’re paying 45% tax on all of it, bud, so you better strike a deal for no more than £82,500. Previously it would have been 55% taxed, so you’ve have got 67,500. Put that way it isn’t such a stupendous change for high-rollers, though £15k probably gets you the walnut trim or the gold-plated gearshift knob.
The rate you get for an annuity rises as you get older – annuity rates for people at 75 are much better than for those at 60 or 65 because they’ll be paid for less time. There is much to be said for starting off in drawdown and switching to an annuity later on. Most people haven’t saved enough into a DC pension, and this gives you a better chance of a decent lifestyle even now – the annuity is not dead at all. Once the annuity return beats out the return you get on equity investment it makes sense to switch 5.
People hate annuities because they can’t leave them to their kids among other reasons…
But you don’t get to leave it to your kids. What seems to be behind a lot of the rumbling about annuities is that they die with you (they can look after a partner at some cost but that’s it). So the children get n’owt. Now the whole issue of capital and inheritance needs sorting out by some future British government, and it won’t be pretty. I’m personally of the opinion that inheritance is an abomination in a notionally democratic and meritocratic society. It harks back to older societies where capital accumulated very slowly so it was the only way to build a business – over generations, and it all smacks of the privilege of kings and nobles. There were no startups before fossil fuels. It may be the most natural thing in the world for parents to want to favour their children, but IMO a 100% inheritance tax where the entire estate escheats would be an incentive for those parents to sort their shit out while they are alive, and it would go some way to not embedding privilege. But I can say that because I am child-free, if that weren’t the case I would probably line up right behind the old buffers of the Torygraph who think that inheritance tax is a terrible thing, because having children does that to you 😉 Somehow society needs to sort this out in a world where it is increasingly difficult to make your fortune in a working life, because increasing inequality lets the 1% bid up the price of essentials like housing. God knows what the right answer to that looks like, but it doesn’t seem to me to be the direction we are going. History shows that aristocracy does work, but needs a lot of serfs…
It’s important to note that one of the reasons annuities looked such horrible value in the last five years is that the Government’s policy of printing money and keeping low interest rates meant annuity providers couldn’t offer decent rates – the underlying gilts just didn’t give people the returns they wanted at 55 or 60. Osborne’s been a good guy in not forcing you to take an annuity, though remember you didn’t have to do that anyway. But he hasn’t improved your ability to get a low-risk income at a price you want to pay. You can stay in equities, as you always could with drawdown. But you are still SOL if you want to avoid the volatility of equities. You are going to run out of money if you didn’t like the annuity rates on offer when you retired and you can’t stomach the rollercoaster of the stock market. There ain’t anything better on offer at the moment 6 – as a cautious saver you have to do Your Bit to pay off the National Debt.
NASA tells us we are doomed
There’s a NASA report that paints a bigger picture, basically they are of the view we are Doomed
…. appears to be on a sustainable path for quite a long time, but even using an optimal depletion rate and starting with a very small number of Elites, the Elites eventually consume too much, resulting in a famine among Commoners that eventually causes the collapse of society. It is important to note that this Type-L collapse is due to an inequality-induced famine that causes a loss of workers, rather than a collapse of Nature
The bit they seem to be missing is that the Elites are busy eliminating the need for a lot of the workers… The Ermine is not an optimist by nature, but I have learned that the bear case always sounds smarter. This is because things go titsup in a big way, and they can be imagined – at the moment it’s robots and globalisation stealing out jobs, climate change, it’s easy to picture them. What is harder to see is that people chisel away continually at improving the upside. 99% of them fail, but the incremental up-shifts add up, but they fly below the radar because they individually don’t look that much. Who would have guessed that improved computer networking would spawn whole new industries like web designers and security experts and MOOCs and improved living standards for what we used to call the third world by letting them work for us 7, and high-frequency trading etc? After all, we had networking before – I recall Novell Netware, where the piss-taking bastards at Novell would charge you a licence per connection 8, and added a piece of code to explicitly kick people off if more people connected to a server. Then TCP-IP came along, eliminated such monopolistic gouging and ate their lunch. Then in ’94 Berners-Lee developed the WWW and here we all are. None of those developments looked earth-shattering at the time.
At the moment the Chinese are working on thorium nuclear reactors that address many of the the hazards associated with nuclear power, though they will no doubt have problems of their own.It may or may not go somewhere, but if it does, then it will be a win for energy and for knocking back global warming, simply by taking out a lot of China’s coal-fired power generation. In general, positive change comes in small chunks that steadily mesh together and add up, whereas things that go wrong come in great big unexpected lumps that generally give us the feeling of OMG we’re all going to DIE. And the atavistic caveman in us looks at the great big shadows of our fears cast against the wall and it makes better copy. Bad news sells, and nobody’s managed to ever sell a good-newspaper yet.
Pensions get a lot more interesting when you get past 45
One of the primary risks younger people face in using pensions is that they’re saving a lot of wealth is a locked-up place that Governments can easily target, since Government sets the rules. A future Labour government could go back to annuities – I’m not saying they have thought of it, but them might. There is a general downdrift of the amount you can contribute to a pension (£40k if you earn more than that) and there is also a general downdrift of the total amount you can save in a pension and get tax relief, the Lifetime Amount which is currently £1.25 million. That sounds a lot, and I, for instance have nowhere near that much but for someone in their 30s now it’s not unreasonable to aim for, because the value of money roughly halves every 15 years. In thirty years’ time that would be worth about £312500, at a 5% withdrawal rate that would be a pension of £15625 p.a.
You can see the direction of travel of pension allowances at HMRC, and it’s not positive. A whole lot of these problems go away as you get closer to drawing the pension, because, recognising that people can’t take money out of a pension to conform to changing legislation, they often let you protect your savings against changes. The quid pro quo for that is that you stop saving into a pension. Totally and for the rest of your life. That’s not so bad if you are in your late 40s or fifties and drawing at 55, after all HMRC indicate you are limited to a pension of about 56k at 65 so you are hardly on the breadline, you just have to stop paying into your pension for a few years, pay a bit more tax and use ISAs but if you are a young buck at the top of some financial institution, Doing God’s work, say, then your dreams of retiring to round the world yachting and golfing will need you to find some other way of saving for retirement. If you are that rich you’re not reading this, and anyway, you can afford to pay for the relevant financial advice on what to do.
taxpaying wannabe early retiree old gits, your boat’s come in
If you are a taxpaying old git, however, you are all of a sudden much better off, particularly if you have savings or are prepared to borrow money. Drive your salary down to the personal allowance by putting everything above that into a personal pension. Do that for a couple of years, and then when you stop work extract this money but leave your main pension deferred (ie still in accumulate mode) – the first £13k a year is tax-free 9. Obviously you need a big spreadsheet and do a lot of what-iffery to play off any loan/mortgage not paid off against the tax bung, and it only works if you can slow your rate of withdrawal to less than the personal allowance. There’s no point in saving 20% tax to pay it again later.
ageing 40% taxpayers and child benefistas – this one’s for you
However, if you are a 40 or 45% taxpayer than you can make out like bandits – squeeze yourself down to the 40% tax threshold and accept you pay 20% tax on the way out. It’s free money 🙂 Well, it isn’t, it’s a way to stop the Government stealing your money, and I wish I’d had this available to me. Fill your boots, and if you are a child benefista than you can go get that too. It’s welfare for the better off…
one of the obvious things for a non-taxpaying old git to do
Is save £2880 into a personal pension, saved as cash. In a curious fit of minor generosity, HMRC then up this to £3600. In my book that’s a profit of 25%. Do a couple or three of years of that and you end up with a profit of about 10%, because inflation will knock off about 5% of the return. And my DB pension gets 5% bigger because I draw it less early. I initially started looking at this to see if I should do some of that this tax year, but there isn’t enough time to see what exit charges are like – all the pension providers’ websites seem to be based on annuities and the like. So I will forego my free bung of £720 for this year from HMRC because a few days isn’t long enough to get this right.
I researched pension costs at Cavendish Online which seemed to be an often suggested good value broker on MSE. For a simple and quick in-out you will probably favour a stakeholder rather than a personal pension, because costs appear to be lower, and non-taxpayers are going to be playing with £3600 a year at most. A personal pension gives you some more flexibility of investment choices, and a SIPP is the most flexible. You pay more charges are you go up the hierarchy. What I couldn’t determine was the exit charges.
There is still a while till I get to 55. After than an immediately vesting pension plan (IVPP) seems explicitly designed for non-taxpayers, and hopefully by then these will return 75% of the capital as cash, rather than as an annuity. To be honest I would expect some future Chancellor to block that particular loophole. Unless they take pity on all us impoverished non-earners on the assumption that we are all poor, rather than enterprising – once I discovered how much income was taxed turning it into wealth before it got stolen became a priority.
I don’t have enough expertise to know much about the issues for younger folk – the big risks of Government fiddling are high, but on the other hand the protection from creditors is a great plus point. Shit happens in a working life – the big ones of Redundancy, Divorce, Disease are always with us. Death hopefully less so – one of the reasons the retirement age is drifting up is because you young’uns will live 10 years longer than me, and probably in better health.
These pension changes are particularly transformational to wannabe early retirees – ie those who want to retire in their mid-fifties rather than at 60 or 65, and particularly those who are paying 40% tax. If this includes you, you would do well to try and look at these changes from every angle to see how they could help you reduce your tax bill or delay the point at which you take you main DC pension. I haven’t had time to give this enough thought. Unlike Joanna Moorhead, I’m prepared to put some thought into how to make this work for me.
What about those Lamborghinis and BTL sky-rocketing house prices then?
There are two dark fears raised. One is that people will blow their money on frippery, and the other is that people will charge into BTL and jack up the price of houses again.
Lamborghinis, cruises, consumerism gone wild
Guess it’ll help the economy in the short-term ;). I’ve always been puzzled by how people go mad when they retire normally (60/65) and spend on a big blowout holiday. Your capital is at its highest potential at the point of retirement, a lot is going to change and you don’t know how it will feel to live off capital. That 25% PCLS is part of your overall wealth – it isn’t ringfenced for stupid spending. It’s a very, very different feeling to living off income. Blowing a lot of it at that point always struck me as a really strange thing to do – if you wait a year then you will have chilled, plus you’ll actually know whether you really want to spend a lot of money on the extravagant dreams of a cubicle slave thinking ‘Anything but this’. Booking the cruise while you’re still working seems odd. But I am different from other people. According to the BBC it appears not to be too bad a problem in Australia where they have this sort of thing already
Hordes of greying BTL investors jacking up house prices.
The average DC pension amount at the moment is £17,700 and about 320,000 people a year currently start drawing DC pensions. It’s probably not enough to seriously shift the needle on the dial, compared to daftness like Help To Buy
Final wealth warning
I’m not a pensions expert, and indeed had to research all this about DC pensions since the Budget because there seemed to be an opportunity. I can afford to screw up there, because this is only a small piece of my retirement planning to try and bag some free money. This post is tossing out some ides. Some may turn out to be hogwash. For God’s sake take advice if changing anything about pensions, or very, very seriously DYOR. After all, I bottled on £500 of potentially free money because I came to the conclusion I don’t understand the opportunities yet. That’s okay. It’s hardly a life-changing sum and it’s better to get it right that save £500 and pay £600 in charges! Be careful out there. I am sure that somewhere in this septic isle there is a bunch of ne’erdowells crafting a website with a dodgy proposition to separate these newly freed pension amounts from their rightful owners…
- in finance secular means over periods longer than the typical boom/bust business cycle of about five to ten years ↩
- ONS Statistics on the average family income, UK ↩
- Divorce is one exception to this ↩
- I believe this was not necessarily the case for Universal Credit. However, it looks like Hell will freeze over and the devil will learn to dance before Universal Credit is launched, so I’d lump that in with the general uncharaterised risk of Government Fiddling ↩
- as is usual with pensions there is a whole shedload of issues that complicate this in favour of annuitising earlier, in particular your attitude to risk and your health ↩
- You need to learn or take advice about getting the mix of asset classes right because the volatility of a 100% equity allocation is probably bad for the old ticker of a retiree 🙂 Although mathematically it gives you the best chance giving some of that up with a stocks:bond mix for a smoother ride is probably called for. ↩
- that’s hellaciously First-World centric, and it’s transiting to we will all work for our Transnational Corporate Overlords, since the erstwhile Third World is busy taking the fruits of their labour and turning into Big Capital. The First World’s first-out-the-gate advantage is being competitively thinned out. ↩
- or you could be fleeced per server. Either way they had you by the short and curlies and needed to be destroyed by the Invisible Hand ↩
- That’s £10,000 personal allowance plus ~£3k tax-free PCLS ↩