Emma Wall: Hello and welcome to the Morningstar series Future Proof. I am Emma Wall and here with me today is Alan Higham, Retirement Director for Fidelity. Hello, Alan.
Alan Higham: Hello Emma.
Wall: So we're today to talk about maximising your retirement income. Everybody would like to do it. But I'm not sure they know how to go about it. I thought we'd start with the thing that is guaranteed for everybody, the State Pension. What can you do with that?
Higham: Well, the State Pension is the bedrock for most people's income in retirement. On average, it makes up over a third of what people receive. So you can actually optimise the amount you get from the State. It's a little known fact that you do not have to take it at State Pension age and if you are reaching your State Pension age before April 2016 actually, there are very generous terms for putting off taking it.
So you could put off taking your State Pension. It will grow by 10.4% each year on top of inflation guaranteed. Then you'd have a much higher pension when you come to retire. That plays very well into my second tip, which is always make sure that you've covered your essential expenses in life with secure income that will last you for a life time. For secure income that will last your life time, the State Pension is hard to beat.
Wall: Also with that secure income factor, that’s where annuities can come into play, isn’t it?
Higham: Yes. Absolutely, annuities also can do that, but at a price. You know buying an inflation-linked secure income will only pay you around 3% a year on your capital. Getting it from the State Pension actually is much better. There is a quick example. If you had, say, a State Pension of £8,000. If you deferred taking it for five years, it would be £12,000 in today's terms, that’s a £1,000 month covering basic secure expenses leaving you much more freedom to express yourself with your money, whether it's investing it or spending it or paying off debt. You can be comfortable that you'll always have enough to pay those bills.
Wall: I think it's quite interesting as well because as well as being a savvy investment tip, it suits the way the retirement age is going, because people are working longer. You might actually be working part-time when you come to official State Pension age and it will suit you to put that off.
Higham: Yes, it will. For exactly those reasons and many people are bit worried though, what puts people off taking it is the thought, “Oh, if I put off taking it, I might not live long enough to claim enough on it”. And that is true. There is that risk. But then there is a converse risk. You might live till you're well past a 100 and you don’t want to run out of money. So you can't have it both ways.
However, if you do differ taking your State Pension at the point you come to take it, you do have the option as to whether to take a lump sum or an enhanced pension. People reaching State Pension age before April 2016 have this lump sum option. You'll get all the past payments you've could have had paid interest plus 2%. So you have that valuable option too.
Wall: Let's talk about tax then, because that does play a valuable part in pension planning.
Higham: Yes. One of the tips to maximising your income is to minimise your tax bill and people need to know that pensions are largely taxable. A typical pension fund will pay a quarter of its proceeds out tax free, but the rest is taxed as income in the normal way, added to any part time earnings, property rental, et cetera.
You need to be careful that you don’t take yourself above the next tax band inadvertently by drawing two bigger sum out too quickly. You almost become a 40% taxpayer unnecessarily. And also if you are just part of a couple, one partner may not be using their full tax allowance. So it might pay to withdraw money from your pension, pay basic rate tax on it and use that to fund a partner's pension.
Even if that partner isn’t working, they can contribute £2,880 into a pension, have the government top it up to £3,600, effectively claiming back the tax that you've paid, giving that partner some income in their own name and using their Personal Allowance.
Wall: Let's talk now about investment strategy, whether it'd be in a workplace pension or indeed in a private pension. We've covered off what the state is going to be give you including what HMRC may help you with. What's next?
Higham: Well, what's next? If you've taken all the steps I've suggested and you've got this bedrock of secure income covering your essential expenses, you can't afford to invest more freely. And the real enemy here is inflation. Over the long-term inflation will eat into your money and many people might be tempted to put it in cash, but it's only earning 1% or 2%. Inflation today is low, near zero, but all the forecast suggests that it's going to return to above 3% at some point in the next 10 to 15 years.
So don’t ignore inflation. Therefore, I recommend that people consider a basket of investments stocks and shares, property, other income generating assets such as infrastructure investments as well as bonds. Have a mixture, have it all diversified, don’t put anything too much into one and keep an eye on things.
Don’t take too much out; withdrawal rate of around 4% to 6% ought to be reasonably sustainable. The more you ought towards the 6%, the more likely you are to eat into your capital.
So if you have a good year on the markets, you can afford to take a bit more out and you can afford to have the odd bad year because you've got this secure income that we've talked about earlier that we have already covered off.
Wall: And for those people in the accumulation stage, taking advantage of a generous workplace pension is essential, isn’t it, because your employer will match your contributions?
Higham: Yeah. In many schemes they will. They may more than match it. So you know you may be looking to be in a generous scheme or it’s a two for one match. So not putting as much in as you can is turning down a pay rise from your boss and also the tax position could change. People earning more than £150,000, both the Conservatives and Labour have said, they are going to tax pension contributions when elected. So between now and the Budget after the General Election, there is an opportunity for that person and that category to make more pension contributions and benefit from the current tax reliefs.
Wall: Alan, thank you very much.
Higham: It's pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
