Ian Muirhead calls on solicitors to make the most of the pension opportunities on offer


One of the major economic conundrums facing governments around the developed world is the question of how to reconcile the financial demands of an increasing retired population with the productive output of a decreasing workforce. The usual conclusion is that individuals need to be encouraged to save more.


Solicitors, by and large, need no such encouragement. Being for the most part self-employed, they are conscious of the need to support themselves by their own efforts. The problem with solicitors is that many have failed to give serious consideration to the question of how best to make the necessary provision.


This dilemma will be the subject of a breakout session at the Law Society annual conference in Birmingham next month. Four pensions and investment specialists will address the following issues.


Are traditional pensions products the best way of achieving the optimum investment returns? Might it be sensible for individuals to consider rationalising existing pensions policies and switching to different types of pension product and/or different providers? What are the merits of self-invested personal pensions? What inheritance tax planning opportunities do pensions offer?


The backcloth to the discussions is the government’s pensions simplification proposals, which will come into effect on 6 April 2006 (the so-called ‘A’ day). These represent the most radical and comprehensive reform of pensions for 30 years. Some of the main changes are as follows:


• The eight current tax regimes will be reduced to a single regime.


• Concurrent contributions will be permitted to occupational and personal schemes.


• Instead of the current scale of age- and earnings-based contribution limits, all individuals will be permitted to contribute up to £3,600 per annum and those who have relevant earnings will be permitted to contribute 100% of annual earnings with tax relief.


• For the purposes of tax relief, every individual pension fund will be subject to a maximum figure known as the lifetime allowance. This will initially be £1.5 million, but will increase each year after 2006/7. Excess funds will be subject to a charge to income tax.


As a transitional measure, individuals with pension funds in excess of the lifetime allowance may register with the Inland Revenue to have their lifetime allowance increased, and thereby to protect the value of their fund.


• As of 2010, the minimum retirement age will rise to age 55.


• Up to 25% of the value of each fund may be drawn in the form of tax-free cash.


• The range of allowable pension investments will be extended, to include, among other things, residential property, works of art and classic cars.


• Members who benefit from scheme assets, for example in the form of rent-free accommodation or the enjoyment of works of art, will be subject to a tax charge on the benefit in kind.


There is, of course, a wider social dimension to these changes. When pensions were conceived a century ago, they were regarded as an insurance against the risk that workers might live beyond retirement age. Now, the expectation is that retirement may be almost as long as an individual’s working life. This prompts the inevitable conclusion that financial well-being in retirement depends on being able to carry forward sufficient earnings to provide an adequate income in retirement.


We need also to review the commonly-held assumption that on a certain day earnings will cease and pension income will commence. Aside from the risks inherent in changing investment policies on an arbitrary date, there are psychological considerations involved in sudden changes in lifestyle. We should therefore, arguably, be planning a phased transition from work to retirement, in the same way as some of our more progressive US counterparts.


The financial transition can be assisted by taking advantage of the ‘lifestyle’ investment options offered by many pension schemes, whereby during the run-up to the retirement date, funds are switched gradually from equities to the relatively greater safety and higher income levels afforded by fixed-interest securities (which conveniently also happen to track annuity rates).


Similar smoothing can be achieved post-retirement by opting to phase the release of accrued personal pension funds and to apply each withdrawal to purchase a separate annuity, which is topped-up with the tax-free cash from the scheme.


One of the benefits of these arrangements is that they reduce the impact of the current requirement that all money purchase pension fund investors must apply their funds to purchase a pension annuity by no later than age 75. Annuities have for some years represented notably poor value, and a fund of roughly £1 million would currently be required to provide a pension of £50,000 per annum.


Importantly, the new simplified pension regime will make an exception to the age 75 rule by permitting pension funds, in certain circumstances, to be transferred on death after the age of 75 to associated schemes owned by the member’s family. Pension arrangements will therefore become an important consideration in estate planning for many clients, though the Capital Taxes Office will need to be satisfied that the main objective of any pension scheme is to provide retirement benefits for the member.


The annuity problem has been the main reason why some financial experts have advocated other savings options in addition – or sometimes in preference – to pensions. Individual savings accounts (ISAs), which permit fixed-income distributions to be made free of tax, will continue to play an important role, as will venture capital trusts, which in addition provide income tax relief on sums invested (though here an eight-year minimum period of investment should be assumed).


Pensions need to be seen for what they are – simply another financial planning tool – though for solicitors and their clients, pensions do offer special attractions in permitting investment in personal and business property, and the potential for inheritance tax savings.


Diversification between both savings vehicles and providers is all-important. In the words of the preacher, ‘cast thy bread upon the waters’. Failure to diversify was the mistake made by many Equitable Life investors, who placed too much confidence in a single institution on the basis of the spurious contention that a mutual company that refused to pay commission to intermediaries would necessarily be benefiting investors. The reality, of course, was that Equitable paid more to its direct sales force than other providers paid in commissions.


The risks of being dependent on a single provider are compounded if that provider is also responsible for the investment management – another possible reason for considering switching existing policies. The recognition that no single fund manager can deliver in all circumstances, or address all relevant markets with equal expertise, is reflected in the recent dramatic growth of multi-manager investment offerings and the increasing use of external funds by life and pensions providers.


This is a symptom of a wider development, namely the separation of the component elements within any pension or other investment plan – the administration, the tax-wrapper and the investment management – in such a way as to achieve cost savings and to increase choice.


It is now several years since the Gazette reported on a survey which remarked on ‘an alarming lack of awareness’ on the part of solicitors about their own pensions. Since then, increases in expectations of longevity, combined with low annuity rates and volatile investment markets, have reinforced the need for pension planning.


However, the problem will no longer be the complexity and opacity of the schemes on offer. Rather, it will be a failure to appreciate the opportunities that recent legislation has created.



Ian Muirhead is chief executive of Solicitors for Independent Financial Advice and a speaker at the forthcoming Solicitors 2004 conference