Article: The Pension Question – Consolidating your pension plans? Make sure you do your homework | Publication: Sunday Herald | Date: 11 July 2010 | Author: Helen Pridham & Simon Bain | Quoted: David Trenner
One of the changes proposed by the new coalition Government in Westminster is the phasing out of employers’ ability to compulsorily retire employees at the age of 65.
Many people will welcome this opportunity to go on working, though they may prefer to cut down and work part-time and supplement their income by taking their pensions in stages. But if their pensions are modest, this could mean they get caught out by a rule which prevents them turning their benefits to cash if they do not complete the whole process within a year. This could make their small amount of pension provision even smaller.
Meanwhile, for those with bigger pots who want more control over their retirement prospects, deciding whether or not to opt for a self-invested personal pension (Sipp) could be a critical decision.
SMALL POTS
Many people nowadays have accumulated a variety of pensions by the time they reach retirement; Pensions that have come with jobs, or personal pensions they have set up for themselves. Sometimes these pension pots are very small due to low contributions or poor investment performance, or both.
When pension funds are small, it usually makes sense to take all the money as a lump sum. With larger pensions, only 25% of the capital value of the pension can be taken as a tax-free lump sum, while the remainder must be used to provide a regular income, either in the form of an annuity or as an unsecured pension. However, if the total pension pot is £18,000 or less, the whole lot can be taken as cash. This procedure is known as “trivial commutation”.
Taking the pension as a lump sum not only provides savers with greater flexibility but it can mean they qualify for larger state pension credits which they would have otherwise foregone by taking a small pension income.
If you do take all of your pension as a lump sum, 25% will be tax-free but the remainder will be subject to income tax. However, if you have no other income in that year apart from the state pension, your tax bill may be lower than you expect, especially if you are 65 or over and qualify for age allowance.
The real snag is where someone has more than one small pension, which together add up to less than £18,000, and they fail to commute them all within a 12-month period. It means they will lose the commutation option. David Trenner, technical director at Intelligent Pensions in Glasgow, says: “This rule was brought in to stop people abusing the triviality rule by setting up lots of small personal pensions and taking them as cash.”
But it is catching out people who have innocently decided to take their pensions more than a year apart. Trenner points out: “A major problem with small pension pots is that it becomes difficult for people to shop around for a competitive annuity rate, so not only are they getting a small pension but it may only be, say, 80% of what they could have got on the open market.”
It is always important if you have a personal pension, or similar invested scheme, to find out if you can get a better annuity rate when you reach retirement than that offered by your original pension company. Even though it may only make a £50 difference, you will continue receiving the extra money for the rest of your retirement, so it can mount up.
However, several of the larger and more competitive annuity providers, such as Canada Life and Aviva, will not sell them for less than £10,000 and, according to Trenner, if your pension fund is worth less than £5000 you won’t be able to shop around at all and will be stuck with your current pension company, no matter how bad its annuity rate is.
But ignorance may be bliss. Trenner points out that if small savers don’t take advice and are unaware of the 12-month rule – consequently taking trivial communications more than a year apart – the authorities may turn a blind eye.
BIGGER POTS
For those who have built up a number of pension pots in different employments it seems to make sense to consolidate them into one wrapper, the self-invested personal pension or Sipp, and adopt a co-ordinated investment approach.
A survey of 70 Sipp managers by Pensions Management magazine last month found the number of plans in force has risen by 25% in the past year to reach 650,000.
But the Financial Services Authority has for some time been warning that Sipps may be a danger area for mis-selling. In April, it admitted that despite its concerns there were still “high levels” of unsuitable advice, where people are being sold a Sipp when they do not need one, and where they may even lose pension benefits by switching into one.
The magazine survey found four distinct types of Sipp product. Two of them, full-range and mid-range Sipps, offer the investor the choice of a wide range of investments, including more esoteric and exotic assets, and will charge accordingly. The hybrid Sipp is cheaper, but it requires the investor to put a chunk of cash in the provider’s own fund – which may suit the provider more than the investor.
Richard Harwood, an adviser at Brewin Dolphin, warns that insurance companies in particular have been “quite aggressive” in trying to get new Sipp business through financial advisers – some paying attractive commissions. Charges tended to be higher, on the basis that the choice of investments was broader. Yet the managers could easily end up investing the money “in funds that weren’t significantly different to before”.
The fourth kind is the platform Sipp, which offers an account where quoted investments and cash can be managed online, at low cost and probably in a “free” pension wrapper. Hargreaves Lansdown’s Vantage Sipp has 1000 investments to choose from, while Bestinvest offers free Sipps on portfolios of at least £50,000. It also warns that some “free’”Sipps will levy other charges such as exit fees.
One pitfall here may be cash. A survey last year found major providers paying next to nothing on cash held in their Sipps, making a tidy profit from investors’ rush to cash.
But for those comfortable with a DIY pension, Sipps can deliver rewards.
Contact David to discuss any of his comments from this article