Cross-Examine your finances
Proprietors of most businesses large or small are notoriously bad at sorting out their own personal finances. Barristers are no different than individuals in other trades and professions. There is a simple four question acid test that everyone in business should ask themselves. The questions are quite simply:-
• Have you got a pension arrangement?
• If you have, do you know how much it is worth?
• Do you know how it is invested?
• Have you any idea what income it will produce on retirement?
If the answer is no to one or more of the above questions I believe there is an arrangement which should fill the gaps and has proved a revelation for many business proprietors. It is called a SIPP (a Self Invested Personal Pension). Members of most professions eyes glaze over when anyone starts to talk pensions whether they have a pension or not. We suspect it is because most purveyors of pensions try to make themselves indispensible and clever by overcomplicating what is essentially a simple, tax efficient saving arrangement. Depending on your rate of tax a pension can turn £5,000 into £10,000 at a stroke; the exact amount will depend on your circumstances and the tax rules can change. Another reason why many are reluctant to start a pension arrangement is uncertainty. There are years when practices prosper and other years which are more difficult. There is normally a penalty with most pension arrangements for failing to maintain contributions and even when this is not a total deterrent it results in many people commencing a funding level lower than they might otherwise pay especially in years of plenty.
One of the biggest problems we find regarding most propriety pension arrangements is that they foster “an out of sight out of mind” mentality. In other words many people make either annual or monthly payments into their pension arrangements and only take a cursory glance of what is happening to the investments. Indeed even the annual statements that are sent out are opaque at best and in many cases downright confusing. This has a dual effect on people saving for retirement. They lose interest and this almost certainly means the level of funding will be too low. This is a shame because the tax relief on pensions single them out as the best and most tax efficient way of saving for retirement. Whilst most people will explain the tax benefits on the individual payments into the scheme two other tax benefits also accrue. There is no capital gains tax on the investment and no further tax to pay on any income received into the plan. It is however the capital gains exemption that is most valuable. It means that you can manage your investments without the fear that any capital gains tax will be incurred.
A regular complaint from people who have contracted a pension is the lack of information. Invariably the money is not well invested which means a smaller capital sum at retirement and consequently an inferior income. A SIPP allows choice of the best investment funds from the best investment managers in the UK. Funds should be considered as a long term investment because even the best funds will go down as well as up in value so you could get back less than you invest.
An added bonus of contracting a SIPP is the record of stimulating interest in investment. We have found many businessmen who knew nothing about investment enjoy the experience of knowing about how their investments are doing and found it extremely educational. Many with a SIPP move on to be successful investors in other forms of savings.
Upon reaching the end of the working life a pension, including a SIPP, proves its final worth. First of all on retirement up to 25% of the sum accumulated can be taken straight out of the SIPP as a tax free lump sum. The remaining money accumulated in the historic pension arrangement normally buys an annuity which provides a taxable income for the rest of the saver’s life. There is a further option known as a drawdown pension for those investors who want to keep their pension invested and stay in control.
Drawdown is becoming an increasingly popular route for many professionals in retirement. It allows you to draw income from your own pension fund and allows you to raise or lower this at will according to your circumstances. In other words if someone retires early they can take a higher income until they receive the state retirement pension whereby they can choose to reduce the income from their drawdown pension. The combinations are endless. With a drawdown pension the level of income is not guaranteed and the value of your pension will still go up and down with the stock market. Drawdown is therefore a more risky approach.
We believe anyone who is likely to want a drawdown pension should considering being in a SIPP prior to retirement. With most conventional pension arrangements the pension matures at the date of retirement and you get a lump based on how the investments have been placed. With a SIPP you can slowly start changing your investments prior to retirement. For example; buying income producing assets during the 5 years approaching retirement.
Finally if you answered yes to the first question at the top of this article do not despair. If you are now wondering whether you should have taken out a SIPP all is not lost. Many investors who in the past have taken out regular savings pension contracts and been disappointed with the performance and information have transferred all their existing pension contracts into a SIPP and enjoyed the transparency and the ability to find the best fund manager to give them every chance of producing an income in retirement commensurate with a lifestyle to which years of toil in their own businesses should be available.
Peter Hargreaves, Hargreaves Lansdown , For more information visit www.hl.co.uk/barrister