The Stages of Retirement

This is a more general post on what I see as the financial stages of retirement and what  I need to look out for during each stage.  However, I wanted to make one folksy point before I get into the financial side.

I've been an accountant for 27 years (I started very young) and after all that time accountancy colonizes parts of the brain.  So when I think of retirement I tend to think of it as a financial issue.  But  the big issues around retirement are:

• What do I want to do and;
• Will I be healthy for long enough to do all the things I want to do. 

Obviously financial considerations are important but they trail in a poor third behind "wants" and health.

I'm not going to talk much in this blog about life and health issues, as what constitutes the good life varies so much between individuals, and the internet isn't exactly short of information on a healthy lifestyle. But I thought it was such an important point, that I should make it at least once.

OK back to the money.  For me the stages of retirement are as follows:

1.  Accumulation: say 45 - 55. Prior to 45 its probably not worth thinking too much about retirement.  Putting some money in a pension might be a decent idea but at 30 you don't want to have too much money  that can't be accessed until you are 55.  I have always left extra cash in my company for investment or future dividends. But now I'm 48, if I save into a pension then I can access that money in 7 years, so the tax incentives of pension savings become attractive. The questions that I need to answer are how much can I save? (which I suspect is the real biggy of all pension planning) and how to best navigate the rules around pensions to make the best use of the tax relief available.

2.  Part retirement say 55 - 62 I'd still envisage working at this age but fitting in work around other things.  A reduced level of income means that some years I might be saving, other years I might draw on the savings I already have.  The question of how much can I save is still there but not as crucial. Now I'm engaged in a fiendishly complicated optimization problem where I want to access income, and save, in the way that maximizes the pot (i.e. minimizes the tax) I have available for stage 3.

3.  Active Retirement say 62 - as old as possible.  I've packed in work now so the how much can I save issue is largely redundant. Now I need to ensure that I have enough income to allow me to have the lifestyle I want. Minimizing tax is still important but hopefully a bit more straightforward.   I have two new problems to deal with though.  Longevity (i.e. the possibility that my retirement stays active longer than I stay solvent) and inflation (i.e. my income becomes eroded by rising prices).  It's also a time to start to think about what I want to happen to my money when I dead, you can't take it with you they say (although Tutankhamun surely proved them wrong).

4.   Death and decay.  I'm hoping not to die or decay but just in case.   The question arises of will I be one of the 1 in 4 people who needs to go into long term care? and what is the best way to provide for this? Also how to bequeath any surplus cash on death.  Trying to answer these questions in my 80s / 90s is going to be difficult, so depressing though it is, I'm probably going to need to have these end of life questions in mind throughout stages 1-3 and, hopefully, get them sorted out in stage 3.

My plan for the blog in the next few months is to work through some thoughts for stage 1 and 2 interspersed with  updates as the government fills in some of the detail on the many areas of proposed pensions reform. 

Government Pension Reforms and drawdown

For my second post I wanted to cover the government's proposed pension reforms announced in the 2014 budget.

These proposals will give people more freedom to access their defined contribution pension pot when they come to retirement.  The changes come in two stages; stage 1 applies to the financial year commencing 6th April 2014 (i.e. the current financial year) and the more radical stage 2 is scheduled to be implemented for the financial year commencing 6th April 2015.

Under the current system I have the following options.

1.  If I'm over 60 and I have a small amount of pension savings then I can draw down all of my pension with 25% being tax free and the remainder taxable at marginal rates.

2.  Or at any stage from 55 onwards I could buy an annuity, at the point of taking an annuity I have an option to also take a, tax free, lump sum of up to 25% of the value of the pension pot.

3.  Or at any stage from 55 I can can choose to draw down an income from my pension pot.  There is a limit to how much I can draw down each year, and, as with the annuity option, at the point of draw down I can take 25% of the value of the pension pot as a tax free lump sum.

4.  There is a fourth option that applies only if I have a guaranteed pension income of above a certain amount and additional amounts in a defined contribution pot.  In these circumstances I can draw down all of the additional pension pot with 25% being tax free and the remainder taxed at the marginal rate.

This framework will persist for the financial year 2014  - 2015 but all of the limits will become more permissive. I have set this out in a table at the foot of the post.  HMRC have recently issued guidance for people who took out pensions at the end of 2013 - 2014 and who would like to unravel the arrangements to benefit from the reforms.

For 2015  - 2016 and subsequent years these old "access" rules will be replaced by a new,more permissive system.  At any age from 55 onwards I will be able to drawn down as much of my pension pot as I like regardless of the size of the pot or the amount of my other guaranteed income.  I will be able to take 25% of the pot as a tax free sum at any age from 55 on, all other draw downs will be taxed at the marginal rate. I've already established that I need to watch out for tax in planning my retirement

One other point of interest in the consultation document is that it makes a commitment to reviewing inheritance tax rates on defined contribution pots.  These are currently at 55%. 

I'd like to make a couple of "editorial" points.  

• Firstly this is not the end of compulsory annuities. No matter what lazy journalists might say compulsory annuities ended years ago.  What it does do, is make what used to be known as capped draw down much more straightforward, I don't need to worry about not taking an income above a certain limit dictated by the government actuaries department and there used to be some weird rules about draw down reviews that I never understood and now will never have to.  But the heart of the defined contribution system remains pretty much untouched, in terms of the contribution limits for pensions, the way that pensions are taxed and the restriction on drawing down pension pots before the age of 55.

• Secondly all of the detail on the proposed reforms remains outstanding.  Normally if the government was planning to reform the taxation of pensions in a year's time it would already have been through a long consultation process involving government agencies and other "stakeholders."  But this has not happened for these proposals.  Actually I think this is fair enough, consultation has a place but works best when government has set out the policy basics, consultation at too early a stage can be used to prevent change.  However, these proposals are supposed to be brought into legislation in Finance Act 2015.  Normally I'd say this is just not going to happen, but given 2015 is an election year I don't think deferral will be an option.  So there's going to be a lot of detail coming up in the months ahead, that I'll try and stay on top of and include in the blog. 

In the mean time I'm planning that next weeks post will take the chance to pull back from some of the detail and try and think about my financial aims for retirement.

		2013 - 2014		2014 - 2015
Small value pot		18,000		30,000
Maximum % that can be drawn down		120%		150%
Guaranteed income level for full drawn of additional pot		20,000		12,000

Should I use my pension pot to buy a Lamborghni?

After George Osborne used his budget spending to announce an overhaul to the UK pensions regime, pensions minister Steve Webb commented: "if people do get a Lamborghini, and end up on the state pension, the state is much less concerned about that, and that is their choice."

It's one of those comments that seems like a political gaffe, but, on reflection, is pretty clever.  What's not to like about the government letting me spend my pension pot in the way that I choose?  But it still leaves the question of how much money it would cost to buy a Lamborghini with a pension pot, taking into account that income tax is payable when money is withdrawn from a pension?

I calculate that it would take a pension pot of £356,419 to buy a Lamborghini for £250,000 (If you just stumbled across this site, and are actually looking to buy a Lamborghini then might I suggest Lamborghini: they say £265,900 but I reckon you could talk them down to £250,000)

Like everything else on this website this is my understanding of the position  - please don't take it as gospel.  I think your pension pot would be disbursed as

			Pension pot		After tax Income
Tax free lump sum			89,104		89,104
Basic rate			31,865		25,492
Higher rate			118,135		77,974
Additional rate			117,315		64,524
Total			356,419		250,000

So as well as paying £250,000 for a car you're paying £106,420 in tax.  That's a rate of nearly 30% on the entire pension pot.  As a rough rule of thumb a medium affluent person could expect to pay tax on their pension pot at 15% (i.e. take out 25% tax free and, assuming some other income to absorb the tax free allowance, pay 20% on the remaining 75%).

Is there a serious point to this?  Well I guess I need to think about income tax when I'm thinking about pensions would be my conclusion.

Next week I'm planning to post on how the government proposes to reform the rules for pensions.  If you would like to receive email notifications for this blog please enter your email address in the box at the top of the home page.