As the Government looks to squeeze out even higher contributions from GPs to their pensions, it is time to look at other options for your retirement? Accountant Danny Cox advises.
With ministers planning a hike in contributions and an increase in the retirement age for GPs, there is much talk of GPs opting out either to avoid tax charges or when benefits have been maximised. But is this a viable option?
Financial security in retirement is perhaps the biggest motivation behind saving and investing. But, like wealth, financial security is a perceptive measure – people will rarely describe themselves as either wealthy or financially secure – in part because life expectancy is an unknown and they do not know how much money will be needed.
Many years ago I met a couple in their 70s who lived a modest lifestyle within their state pension income. Yet they had substantial savings and investments worth well over a £1 million. Their biggest fear was that their money would run out and this drove their financial decisions. In reality, once they understood their financial position more clearly, they were able to enjoy life more.
The starting point of your plan is to decide what lifestyle you aspire to in retirement and when you would like this to happen. According to Scottish Widows, the average income people aspire to in retirement is £24,300 before tax, based on a retirement age of 61 and eight months.
If you look at where you would like to be then this will provide some parameters on the level of income you will need and also any capital requirements, for example, to fund a house move.
Planning ahead will help understand your financial position now andwhat financial security means to you. It will also help you make decisions on how you structure your finances going forward, regardless of your decisions with the NHS Pension Scheme.
The foundations of a retirement portfolio will be cash to meet short term purchases and provide an emergency fund – six to 12 months’ worth of expenditure is common. Cash deposits also work well if you are nervous of markets or need your money back within five years – conventional thinking tells us stock market investments are for the long term.
You might be able to improve the net returns either by investing in your spouse’s name, if they pay a lower rate of tax than you, or use cash ISA which provides tax-free interest.
Beyond this the best inflation busting cash investments are National Savings Index Linked Certificates, guaranteed to beat the rate of inflation over the year from investment and a ‘must have’ for long term cash holdings in my view. Check for their availability at www.nsandi.com.
Cash or shares?
However, since cash rarely beats inflation, particularly after tax. Therefore it is important to hold cash but not too much. Risk comes into the equation at this point. We all know that investments do go down in value as well as up. Time is another key consideration; over time if inflation outstrips interest rates (and that is the interest received after tax) then you are guaranteed that your money will have less purchasing power. It is therefore important that you make yourself aware of the risks and weigh them up against your needs and objectives.
To maintain and grow the real value of your savings and wealth to complement NHS pensions, I think you should take a look at the stock market. Stocks and Shares ISAs are an obvious choice since they are free from further tax. Each person can shelter £10,680 from tax in ISA this tax year. At retirement, income from ISA is free from tax and is ideal to supplement pension income.
Don’t listen to those who suggest the tax benefits of ISA are only relevant for higher rate taxpayers – they are simply wrong. Basic rate taxpayers and even non-taxpayers can benefit from ISA tax savings.
After ISA, from a tax perspective, investing in funds or shares is the next choice. The gains are subject to capital gains tax, the rates of which are almost always lower than the rate of income tax paid. For this reason it makes sense to shelter income bearing investments in ISA first.
No capital gains tax is paid until profits are realised and only after they exceed the capital gains tax allowance (£10,600 for 2011/12). Between a couple, tax-free profits of over £20,000 a year can supplement pension income nicely. When capital gains tax is paid, the rate is either 18% or 28% depending upon your taxable income.
Finally, offshore investment bonds are worth considering. These act as tax “wrappers” deferring tax on the profits until they are taken. These can work well for longer term savings (10 years and over generally) and have the facility to withdraw 5% of the original capital value per year without immediate tax. These withdrawals can be used to supplement pension income.
There is absolutely no doubt in my experience, those people in retirement who have the best levels of income relative to their spending, particularly stable or guaranteed income,are the ones who feel the most secure, regardless of their capital position.
Please note tax rates and rules are subject to change.
Danny Cox is head of advice at Hargreaves Lansdown, www.hl.co.uk/news/expert-comment