The New Year is the perfect time to take stock of our finances. Employees who are retiring and have a defined contribution (DC) pension will have a number of decisions to make given the freedom and flexibilities. Contributor Jonathan Watts-Lay, Director – WEALTH at work.
To help with this, WEALTH at work, a leading provider of financial education, guidance and advice in the workplace, have created a list of top 10 considerations for employees who are thinking about retiring in 2018. Do employees understand all their options?
Flexibility and choice in retirement is great news for employees, but it’s also a frightening prospect because of the potential risks involved such as being scammed, paying more tax than necessary or running out of money during retirement. This is why it’s crucial that they take their time to research and fully understand all of the options available. Drawdown has become increasingly popular but there are concerns that many employees are not taking financial advice, so are buying costly products which may not fit with their needs during retirement.
Employees should list ALL their assets – Before making any decisions about retirement employees should work out exactly which assets they have and list what they are all worth. Many may have final salary pension benefits as well as defined contribution pension benefits and in addition other assets such as ISAs, shares and general savings; all of which need to be considered as part of a sensible retirement income plan.
Do employees know how much they will need in retirement? – They should start by thinking about how much income they are going to need in retirement including essential income to meet their day-to-day living expenses (including household bills), and discretionary income for holidays, hobbies etc. They also need to think about how this income requirement may change over time, for example, income needs are widely believed to follow a ‘u shape’ in retirement with the first ‘active’ phase being the most expensive. Spending seems to fall after a while in what is known as the ‘passive’ phase, as people become a little less active and perhaps cut back on areas such as travelling. But costs then may go up later in retirement in the ‘supported’ phase, if extra care and support is required.
Employees should carefully consider whether they can really afford to retire – They should think about if they have enough put by to be able to afford to retire, or if they need to work a little bit longer, or perhaps part time. Research has found that most people live longer than they expect, so employees should keep this in mind when doing their sums. For example, a 65 year old man now has a 50 percent chance of living to 87 and a 65 year old woman has a 50 percent chance of living to 90.
Have employees thought about how to access their retirement income? – If they’re sure they can afford to retire and if they have a DC pension, employees need to decide how to access their income. They can choose between income drawdown, buying an annuity or taking it as a cash lump sum. It doesn’t have to be just one choice as they could even choose a combination of options. Financial education and/or regulated financial advice can help employees understand exactly what each option means and which approach best suits their needs.
Are employees aware of the tax implications? Only the first 25 percent of a DC pension is tax free; the remaining 75 percent is taxed as earned income, so employees could find themselves paying more tax than they need to if they don’t plan carefully. For example, they may be better off taking a smaller amount each year from their pension, and topping it up with withdrawals from an ISA to use for income, as this is paid tax free.
Are their pension beneficiary details up to date? In 2015, the Chancellor abolished tax on death on DC pensions for anyone who dies before the age of 75. This means that any remaining pension can pass onto their beneficiaries tax free, subject to them not exceeding the current £1 million lifetime allowance (rising to £1,030,000 from April 2018), and providing that the company pays out within two years of the date of death.
Have employees shopped around? Employees should make sure that they shop around before they purchase any retirement products. Research by consumer group Which? Found that there could be a difference of up to £10,000 in charges over a decade between the most expensive drawdown provider versus the cheapest. It is crucial that employees do as much research as possible to ensure that they select a retirement option that best suits their needs. This means finding a solution that enables them to access the right amount of cash as and when they want it, and for as long as they need it.
Employees should consider financial advice as an investment. Many people are concerned about the cost of financial advice without realising that when they buy retirement products such as annuities, through for example online brokers, there are commissions to be paid which can cost just as much, if not more than getting advice. In fact, employees should see financial advice as an investment; research suggests that individuals who take advice save on average £98 more every month and receive an additional income of £3,654 every year of their retirement, based upon a pension pot of £100,000. This is because a financial adviser will look at all of their assets, work out the most tax efficient way for them to fund their retirement and then put a bespoke plan in place for them. This will also give employees the benefit of consumer protection for the advice given, as well as a retirement plan tailored to their individual needs.
Are they switched on to scams?
Scammers often use highly professional looking websites and marketing literature to lure people in, and they tend to sound completely legitimate when cold calling. It’s easy to see why so many individuals are fooled. A staggering 10.9 million consumers have been victims of cold calls about their pension since April 2015, according to Citizens Advice. So, whatever employees are planning to do with their retirement savings, it’s really important they check whether any company that they’re planning to use is registered with the Financial Conduct Authority (FCA) https://register.fca.org.uk/. They can also visit the FCA’s ScamSmart website which includes a warning list of companies operating without authorisation or running scams www.fca.org.uk/scamsmart.
Jonathan Watts-Lay, Director at WEALTH at work, comments; “The freedoms and flexibilities employees now have with their pensions is a good thing, but it can be incredibly daunting. Without the right support employees are at immense risk of making costly mistakes such as running out of money, being scammed, paying too much tax or simply buying an inappropriate product which will all have lifelong consequences.”
He continues; “Many workplaces now offer support to their employees in terms of financial education, guidance and advice. This approach helps both the employer and the employee by ensuring the retirement process and the options available are well understood, therefore leading to better outcomes.”