Posted on Jan 12, 2019
Following recent high profile collapses such as BHS and Carillion it is not surprising that more people should question how vulnerable their pensions are. But do the majority of people really have an understanding about the threats to their retirement futures or just blissfully ignore it and hope for the best while sleepwalking into potential impoverishment? - writes Steve Tuson.
It is estimated that the total cost of workplace and state pension liabilities in the UK stood at approximately £7.6 TRILLION in 2015 – more than four times the size of the whole UK economy. Risk manager Cardano has put the total deficit of UK final salary (defined benefit) schemes at over £780 billion. Such figures vary depending upon the source but the problem remains very real.
“The truth is we don’t actually know the situation for most pension schemes and the time has come for a reconsideration of the standards of corporate governance and stewardship by pension trustees” – former pensions minister Ros Altmann
WHY ARE SO MANY SCHEMES IN DEFICIT AND WHAT DOES IT MEAN?
The primary unstoppable driving factor is that we have a longer life expectancy than previous generations – ergo a pension must provide income for 10 or 20 years longer than envisaged, while life expectancy continues to increase. This problem is compounded by the ageing demographic meaning that more older non-working people will have to be funded by a smaller working population.
At the same time we are now at the end of a 40 year interest rate decreasing cycle meaning that the government bonds that schemes would typically buy to guarantee income offer historically low returns. To put that in context then 20 years ago £100k would buy you an annual income of £15k, whereas currently it will only buy you at best an income of £4k. In other words 20 years ago it would cost a scheme in the region of £250k to buy a £30k (plus indexation) retirement income annuity from an insurance company, whereas now it would cost a scheme an unsustainable £1 million. Once a scheme purchases an annuity income then the capital value is itself lost and irretrievable.
The third major negative factor is that most final salary schemes are (understandably) closed to new members to try to slow the problem from mushrooming further. If pension liabilities make up 30%+ of a company value then it can impact the viability of the whole company. If a company goes bankrupt then pensioners can forget about receiving what income they are expecting from a scheme as after all how exactly would that long term liability then be financed? Even avoiding bankruptcy then without new money coming in to the scheme there is a huge question mark over the long term future of most final salary schemes – particularly if you still have a number of years until your retirement date and considering the current very high cost these schemes incur when buying annuities from insurance companies to finance retiring employees.
SIPPs and QROPS
Some people are aware that you are entitled by UK law to transfer your frozen UK pensions to a UK SIPP (Self Invested Personal Pension) or outside the UK to a QROPS (Qualified Recognised Overseas Pension Scheme). The question about whether transferring to a private scheme makes sense is very specific to an individual person’s case. It would include considering factors such as other pension schemes, savings, capital investments, property assets or income as well as the time left to retirement date. Beyond that there are other reasons such as currency if retiring outside the UK and taking control of your pension capital & investments, lifetime allowance (LTA) as well as providing a higher level of spouse pension (100%)while leaving any residual capital to your family. In contrast in a final salary scheme the typical spouse pension is 50% and there is no residual capital to pass on to your beneficiaries as it has gone to purchase the annuity.
Currently with the rock bottom interest rates then many schemes are offering record high transfer values on final salary schemes. The reason is simple – the company wants to reduce its pension liabilities and so offers an attractive cash equivalent value as an enticement to transfer.
Lifetime allowance (LTA) is also becoming an issue for people with pensions. The LTA has decreased from £1.8m in 2006 down to just £1m today – with some speculation that it could fall further again. The value of (total) pensions above that sum will be taxed heavily above that sum. £1m sounds like a lot but in an era where there are record transfer values and £1m only buys an income of circa. £30k then the LTA is likely to affect a lot more frozen UK pension-holders and is a factor that for the vast majority is largely unknown and consequently rarely considered. However, once a pension is transferred out of the UK in to a QROPS then the LTA tax limits no longer apply and there is no limit as to the size the pension pot can grow to without being subject to an avoidable punitive tax.
Brexit and QROPS: A window of opportunity
In the Spring Budget in 2017 the Chancellor of the Exchequer placed a 25% tax charge on transfers to non EEA QROPS schemes and non EEA residents. They were unable to put such a tax charge on EEA residents and schemes as the UK is a member of the EU. However, with Brexit many things remain unclear and once the UK is no longer in the EU then the UK may well be able to impose this 25% tax charge to all transfers outside the UK. While the 25% tax implication for a large transfer is clear, you could argue that it is even more of a problem to smaller pension pots. After all this capital is supposed to provide income for your later years and taking 25% off an already small pot before it can then grow further until retirement makes life even more difficult. To demonstrate this consider a pension transfer value of £200,000. If that grew at an average of 5% for 10 years it would be worth about £326,000 and £416,000 after 15 years. Conversely if the 25% tax charge was taken then those figures would drop to £244,000 and £312,000. So simply transferring outside the UK before Brexit to avoid the potential tax can mean a huge difference to your standard of living after retirement.
In short taking in to account the poor outlook for pension schemes generally and the unclear Brexit situation then the message is clear: for any person living in the EEA and looking to retire outside the UK then the clock is ticking to look in to their pension situation properly while the tax position is clear. With terrible annuity rates and record transfer values currently as well as the possible tax threat then now - up until Brexit is completed - is the best window of opportunity people will ever have to transfer before that window closes. It could be one of the most important financial decisions you will ever have to take and should certainly not be taken lightly.
Steve Tuson is a qualified financial adviser based in Brussels. If you have any questions on this topic then feel free to contact him on +32 473392691 or email: email@example.com
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