UK pensioners are increasingly being forced to draw on their savings, as the rising cost of living has cut their pension income by over £700 a year in the last 2 years.

New research by Age UK is based on a new inflation measure, dubbed the ‘Silver Retail Price Index’ or Silver RPI, which shows that pension income is particularly badly hit by the ongoing rises in inflation, as pension incomes tend to be spent on those basic goods most affected.

The implication for younger pension savers is that forward thinking, good pension advice, and retirement planning is now needed, to ensure that pension funds are well invested to provide the best possible returns on retirement.

Ordinary savers also affected

Ordinary savers in the UK are also under pressure, with the average household now needing an additional £1,100 to maintain the same standard of living they had two years ago.

Figures from Sainsbury’s Finance showed that inflation has cut deep into the resources of Londoners in particular, who now would need to find an extra £1,342 a year to restore their standard of living to 2008 levels, while in other parts of the UK the typical figure would be around £951 (the figure for the North-East).

Consumer price inflation in October was 3.2%, according to the Office for National Statistics, driven largely by rises in fuel costs.

Consumers seeking ways to minimise the impact of inflation on their income can seek independent financial advice on tax-advantaged savings options, such as ISAs, from their independent financial adviser.

The rise in the general state pension age to 66 by 2020 could cost today’s over-50′s up to £14,000 in lost pension income, according to figures from the Department for Work and Pensions (DWP).

The lost income consists of payments of the basic state pension that will be lost during the extra time working.

This will be increased by the pension savers’ inability to save enough to keep their pension income at the same level as it would have been, without the changes.

As the state pension age rises, some 4.5 million men and women will be forced to work a year longer than they previously would have.

The figures have provoked a critical response from industry experts, who claim that the workers worst affected could lose 9% of the total pension they could previously have expected to receive.

Women in particular will be adversely affected by the changes, according to Ros Altmann, a former government pensions adviser and now spokesperson for the over-50s group Saga.

“These changes are dramatically unfair and completely unacceptable. They penalise at least half a million women, making them wait an extra two years for the state pension, and even the Government itself admits they will not have time to prepare ….. a rethink is essential,” Ms. Altmann said.

The report has highlighted again the need for pension planning and good pension advice for all those affected by the ongoing review of workplace pensions in both the public and the private sector.

The changes will be part of modifications to the ‘age 75 rule’, which had required pension savers to purchase a pensions annuity by that age. Savers will now be free to leave their pension funds invested in the stock market, taking (or ‘drawing down’) an income that can vary each month. Income drawdown is, therefore, well-suited to those whose monthly need for pension income may vary, for instance if they continue in part-time work.

Details of specific figures for the drawdown limits have not yet been revealed.

ASPs, which provide a similar arrangement of income drawdown within set limits, will now be abolished, and ASP holders will be automatically switched into capped drawdown after April 2011.

Government emphasises that income drawdown within set limits is a way of giving pension savers greater flexibility. However, the annual cap is also designed to help ensure that their pensions income will last longer, and reduce their potential reliance on pension income from the state. The UK was recently highlighted as having one of the lowest and most meagre state pensions in the EU.

The flexible drawdown arrangement (different to the capped drawdown) will allow access to unlimited lump sums, subject to a minimum income requirement (MIR).

Advantages of pension income by income drawdown

The advantage of income drawdown is that you retain possession of your pension savings, rather than handing them over to an insurance company to purchase a pensions annuity.

Whereas funds transferred from an ASP to the holder’s dependents upon his death were previously subject to charges totalling 82% of the funds, the government now proposes that this be replaced with a new 55% ‘death charge’.

The pensions income of a typical middle-class UK person with a private pension could have been based on pensions savings that would have been up to £100,000 larger, had these hidden charges not been taken over the years. The comments were made this week by David Pitt-Watson, a senior exective of Hermes Fund Managers, and a consultant to the BT pension, the country’s largest company pension fund.

Mr. Pitt-Watson said that if a typical British and a typical Dutch person save the same amount of money for a pension, the Dutch person will end up receiving up to 50% more in pension income upon retirement.

This, he said, was due to the more transparent and efficient architecture governing Dutch pensions savings. The likelihood of UK pension savings being whittled away by fees and levies was a particular problem in higher-cost personal pensions and was, therefore, most likely to represent a problem in pensions planning for middle to high earners.

As an example of how the fees in private pension schemes make a difference to pensions planning, Mr. Pitt-Watson used the scenario of a 25-year-old who starts with pensions savings of £1,000 per year, raising that by 3% a year as he goes to account for inflation.

Assuming a 6% annual return, that would result in  pension savings at age 65 of £248,170 providing pensions income for the next 20 years of £16,080 per annum.

However, if the same saver had kept their pensions savings in a scheme charging a fee of 1.5% a year, his pension income would be 60% lower, at only £9,900 a year.

This means that nearly a third of UK pensioners retire with no substantial savings or personal pension income, according to the Office for National Statistics, which this month has published new figures, showing a snapshot of the year 2007-08.

Pension income for those pensioners is currently £132.60 per week for a single person or £202.40 for a couple, including pension credits at the full rate. The single person’s pension income here consists of the Basic State Pension of £97.65 plus pension credits of £34.95, while the couple’s pensions income includes Basic State Pension of £156.15 plus pension credits of £46.25.

Workers have been urged by pensions experts to take more control over their pension planning, considering the likely effects on pension income of market trends and budget cuts in the coming years. The current overhaul of pension rules has left even the Revenue Commissioners HMRC in some confusion, and some pensions providers have said that the Revenue is struggling to deal with the many changes contained in new pension rules. The ongoing pensions review also raises questions as to whether it is wise to rely on the Basic State Pension, for your pension income, if your retirement is still several decades away.

A recent report from Sun Life claimed that the UK is gradually shifting responsibility for your own pension income from the state and private sector to the individual.

As a state, the UK is now Europe’s leading ‘pensions miser’, with the lowest state pension income in Europe, compared to average working pay. The pension income from the Basic State Pension is now just 30.8% of average working pay, compared with an EU average of 60% and far behind the generous levels offered in Spain (81.2%), the Netherlands (81.9%), and Luxembourg (88.3%).

In the private sector, 90% of the generous defined benefit or final salary pension schemes are now closed to new members, again placing the onus on the individual to make provision for his own pension income.

With a national deficit of £155bn and only £6.2bn of savings already clearly earmarked in the budget proposals – what can you expect, when the chips go down on Tuesday 22nd June?

Here is our roundup of budget changes already announced, of budget proposals that appear likely, and of other possible government budget cuts to come.

Pensions: removing compulsory annuitisation, gradually increasing the current retirement age, improving occupational pension schemes and restoring the link between state pensions and earnings.

Government has quoted figures from the Office for Budget Responsibility to show that the costs of expensive public sector final salary pensions schemes, such as those in the civil service and other public bodies, will more than double to £9bn by 2015. Calling these ‘unreformed gold plated’ pension schemes ’unfair’ and ‘not affordable’, a review has been promised as a matter of priority.

Government may be planning budget changes to scrap compulsory annuitisation, removing the legal requirement to buy an annuity with your pension savings by age 75.  This will give those with large pension pots of £100,000 or more the option to hold on to their money, perhaps leaving it invested in the stock markets in an ‘income drawdown’ arrangement, rather than hand it over to an insurer. Realistically these budget changes will make little difference to the average punter, whose pension pot of £50,000 or less is still most likely best used to purchase a lifetime income through an annuity.

Basic State Pension – restoring the link to earnings will help ensure that the Basic State Pension will increase ahead of inflation, and in line with the national average wage. The state pension is guaranteed to increase in 2011 in line with prices, earnings or 2.5%, whichever is the higher.

Pensions Tax Relief: those paying tax at 40% or 50% on parts of their income can currently regain that as tax relief on pensions contributions. If you pay tax at 40% and invest a £6,000 lump sum as pensions savings, you could receive £4,000 in tax relief. A 50% taxpayer investing £5,000 as pension savings could get tax relief of £5,000 (subject to anti-forestalling rules). This may all change with the budget changes on June 22nd, as higher-level tax relief is seen as a primary target for government cuts.

Income Tax: government has pledged budget changes to help lower earners by increasing the personal allowance i.e. the amount you may earn before tax. Currently £6,475, government budget proposals promise an increase to £10,000. However, there is no indication of the timing on this, it could be phased in over several years.

National Insurance: clashes over Labour proposals to hike NI contributions by 1% became one of the bloodiest battlefields for the previous administration. The Tories were extremely opposed to the 1% increase for workers, but may still impose a 1% increase for employers instead, using the increase of the tax-free allowance to £10,000 as a sweetener.

Capital Gains Tax: government budget cuts could raise capital gains tax from the current 18% to 40%, or even more on June 22nd. The annual capital gains tax exemption, meanwhile, could be cut from £10,100 to £2,000. While government is not expected to backdate these changes, it is not expected to delay them either.

Capital Gains Tax applies, not to the overall value of an asset, but to the increase in value of an asset since you acquired it. It applies to the profit you make from selling a second property, whether a buy-to-let or a holiday home, to gains from art or antiques, or to gains made from stocks and shares investments. It even applies to gifts – if you gift your home to your daughter, without a penny changing hands, there is still no escape from CGT, which will be calculated on a valuation of the property.  If you bought  a second home 10 years ago for £50,000 and can sell it now for £150,000, you will be taxed on the difference, i.e. on the profit or gain you have made – in this case £100,000. Last year you would have owed £18,000 in CGT; government budget proposals may now raise Capital Gains Tax from the current 18% to bring it closer to 40%, in which case you could soon face a tax bill of £40,000 on that house sale. This is why so many landlords have been rushing to sell their properties lately, before any such budget changes kick in.

These increases in Capital Gains Tax are primarily intended as government budget cuts to tax the better-off, but could affect many average earners too. Employees who receive shares as part of their company benefits package would be taxed at the new levels, on the gains they make from selling their shares. Government has promised to prevent the capital gains tax increase from hitting the elderly. This may protect those who have purchased a second property as one strand of their retirement planning. It may also protect residents who have been in nursing homes for longer than 3 years, who would otherwise have found that their family home was deemed to be a secondary residence, and subject to Capital Gains Tax, when they came to sell it.

One solution to CGT increases are Enterprise Investment Schemes. EIS schemes allow you to defer CGT by investing your gains for three years or more tax-free. As such, they are a ‘shelter’ from CGT for as long as you are invested in the EIS scheme.

Inheritance Tax: the original budget proposals to raise the IHT threshold to £1m are now gone, it will now remain at £325,000 for a single or £650,000 for a couple. As part of the round of government budget cuts, this may be frozen, to allow inflation to push more people over the threshold.

Venture Capital Trusts (VCTs): VCTs offer tax-incentivised investments in smaller British companies. They currently give a 30% up-front tax relief on investments of £3,000 – £200,000, although shares must be held for 5 years to retain the relief. Government budget changes may increase tax reliefs on VCTs to encourage investment in small industry, and in particular in the green technology sector, which was singled out for support through budget proposals in the coalition manifesto.

Are you interested in more information on how the budget proposals will affect you on 22nd June? Contact us now with a financial advice enquiry or ring 0800 678 5929

Government think tank the Centre for Policy Studies has published proposals for a radical rethink of pension savings and tax-incentivised saving in Individual Savings Accounts (ISAs).

The five-point plan contains the following key suggestions for simplifying current frameworks for pensions savings:

1. There should be an annual cap on all tax-incentivised savings of £45,000, including a cap of £35,000 for pension savings. Tax relief should be at the saver’s marginal (i.e. upper) tax rate, offering some 50% tax relief to those earning over £150,000.

2. Savers should be able to access at least some of their pensions savings before retirement. This could be made workable by bringing the pensions and ISAs areas closer together. For instance, pensions saving using ISAs could be encouraged by offering retrospective tax relief at retirement on ISAs savings by re-nominating them as pension savings. Also, existing savers should be allowed to take 25% of their pension savings before they retire.

3. Partners should be allowed to use each other’s pension pots for pensions saving while at the same time receiving tax relief, irrespective of their own earnings circumstances.

4. Unused pension savings could be bequeathed to other family members’ or third parties’ pension schemes, free of Inheritance Tax (IHT). This would encourage pension saving by allowing wealth to cascade down the generations, and strengthening the sense of personal ownership of pension savings.

5. Auto-enrolment under the government’s plans for pensions in the National Employment Savings Trust (NEST) scheme should be extended to include pensions saving in ISAs. This should appeal in particular to younger savers, who could feel that their longer-term or pension savings were working hard for them, without being ’locked away’.

“[The report] also describes steps towards sweeping away the two-track pension/ISA tax relief regime and replacing it with a single, unified tax framework, on that is easy to understand and attractive to long-term savers. Such a radical simplification is a prerequisite to encouraging more people to save more, and it would, for example, enable the industry to offer customers a simple savings continuum, perhaps under a ‘lifetime savings’ banner,” said the Centre for Policy Studies.

This makes it possible for those drawing pension income in an increasing healthy and long-lived society – the so-called ‘welderly’ - to retain ownership of pension savings, rather than hand our pension income to an insurance company in return for an annuity which will pay us a regular retirement income for life.

However, purchasing a lifetime annuity is likely to remain the most popular means of pensions planning, despite these recent changes in the law, according to a new poll of insurers and industry experts unveiled this month*.

With male life expectancy in the UK now standing at 86 and female life expectancy higher still at 89, the ‘welderly’ will be a growing force in the decades to come.

The advantage of not taking an annuity is that pensions savers can pass their pension savings on to their children and grandchildren, by making the corresponding arrangements in their will.

However, experts predict that the vast majority of people will continue to purchase an annuity with their pension income. The driving force behind this belief is that most people have a relatively small amount of pensions savings built up in their ‘pension pot’, reflecting the view of many experts that those with a pot of less than £100,000 may be better served by the reliable income from an annuity, rather than the more risky strategy of leaving their pension savings in the stock market with an ‘income drawdown’ investment.

Fears that new legislation under the EU’s Solvency II programme would increase the cost of annuities, and reduce pension income, by imposing more stringent capital adequacy requirements on insurance companies, are rejected by half of those surveyed.

*Source: Xafinity Paymaster June 2010

More than half the UK adult population have made pension planning a priority, driven by fears that they will outlive their expected pension income, according to new data released today by Prudential*.

Increasing longevity has led 59% of UK adults to conclude that their current pension plan will be inadequate to sustain them in old age. Today, the life expectancy for a 30-year-old man is 86 years, and for a woman 89, leaving many with the challenge of factoring a 20-year retirement into their pension planning.

Prudential reveals that 55% of British adults are now enhancing their pensions planning with second pensions or other savings and investments designed to boost their pension income.

Over a third (36%) stated they either are or intend supplementing their pension plans with additional cash savings, 17% said they are looking to stocks and shares investments, and 15% are seeking to downsize their homes as part of their pension planning.

In addition to general pensions planning, 19% of adults say they also intend to continue working beyond retirement age.

Over a third (36%) of British adults will still be taking a lump sum upon retirement as part of their pension planning, despite the fact that this will reduce their longer term pension income once they give up work. Of those who will take a lump sum in this way, the average amount to be taken will be 17% of their total pensions savings, Prudential said.

“Increasing longevity means workers are having to accept that pensions will be stretched over a longer period, and will therefore deliver a lower income,” said Richard Harrison, Prudential’s Corporate Pensions Director.

“”This is a scary proposition for people considering how to fund their retirement, but there are plenty of options for boosting savings,” he said.

“We believe everyone should see an independent financial adviser to ensure they are saving enough to fund their life in retirement.”

If you would like to calculate your probable pension income now, use our online pension planner, make a pensions enquiry for our ringback service, or speak to one of our friendly independent pensions advisers on 0800 678 5929

*Survey of 2010 UK adults by Research Plus

A person saving £500 a month for 25 years can generate a pension pot of £407,000, according to insurer MetLife. However, if the value of that fund falls 20% just 5 years before the saver reaches retirement, they would have to increase their pension contributions by an extra £1,031 to meet the same savings target.

Timing and good financial planning advice is the key. If, for instance, the same 20% drop had occurred during the first 5 year of their pension saving, their monthly contributions would need to rise by only an extra £55.51, according to MetLife.

MetLife recommends unit-linked guarantees as a precaution against drops in the value of pension savings. Unit-linked guarantees provide a guaranteed pension income which cannot fall below a certain level. However,  unit-linked guarantees are products suited only to the cautious investor, and not to those seeking the maximum guaranteed income from their pension savings, or those who have a high tolerance for investment risk.

“We believe there is always a case for unit-linked guarantees for more cautious clients, as without guarantees customers are exposed directly to downturns in the stock market,” said Dominic Grinstead, managing director of MetLife UK.

“If markets continue to recover it makes sense to lock in gains along the way, particularly for clients who are close to retiring and in the vulnerable time zone as they approach retirement.”