“My pension is not fit for purpose”

I had a meeting with a new client the other day who was disappointed with his pension.

He felt that it was performing poorly and was not going to do the job it was supposed to.

On asking him for a bit more detail on why he felt this was the case he informed me that he established it on advice from another IFA about fifteen years ago in order to use the available 25% tax free lump sum to pay off the mortgage he had just started through the same IFA.

Needless to say he had not heard from the IFA since and was now concerned that pension lump sum would not cover the outstanding mortgage debt.

While using a tax free lump sum from to pay off an outstanding mortgage is a viable strategy, the advice this individual had received had two fundamental flaws.

Firstly, the mortgage term was not consistent with the client’s planned retirement age so he faces making a lifestyle choice regarding his pension a time when he may not wish to, or be able to afford to, retire.

Although he will not be obliged to draw an income at this time the benefits his wife would receive on his death will be reduced by 55% under current rules.

Secondly, having never received an annual review service from the IFA who sold the pension, there was no way he could expect to know whether the pension fund continued to be invested suitably.

As investment markets change it is wise to ensure that his portfolio continues to be invested appropriately. Failure to do this can leave pension funds stagnating.

Equally, products that were purchased many years ago can become uncompetitive compared to newer, lower cost versions that offer greater investment options.

At the outset it would have been more suitable for the client and his adviser to understand his risk profile, investment objectives and timeframe so that they could determine a suitable approach.

Appropriate questioning would have uncovered two alternative strategies; either using a repayment mortgage so that the debt would be guaranteed to be paid off by the end of the term or an investment vehicle which the client could access more readily when the capital sum was needed.

But of course the commission available on these options would have been less!

The primary purpose of a pension is to provide an income in retirement so they should always be considered in this context. A sensible starting point is to consider how much income you will need in retirement and work backwards to calculate what size pension pot is needed to generate this income.

From there the monthly contributions that are required at particular levels of investment growth to accrue the required pension pot can be worked out.

How the tax free lump sum is used is an important question to answer at the point of retirement but it should always be the secondary objective when pension planning.

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  • http://twitter.com/Cunningham_UK Alistair Cunningham

    I have considered personally “using the tax free lump sum from to pay off an outstanding mortgage” but I do not see it as “a very sensible strategy”. It’s actually a high risk strategy for three principal reasons:
    1. The old adage of your investment go down, as you mention in your blog – there’s no guarantee you’ll have enough to clear the mortgage, and your home is ultimately at risk
    2. You take a huge legislation risk! What if the Chancellor decided to remove, or at least tax the pension commencement lump sum (as it is now correctly known, and the cynics amongst us might say for due reason!)
    3. Whilst you receive tax relief on the way in, every £4 of fund currently only repays £1 of mortgage. Even a 50% tax payer would be able to clear a mortgage with an ISA at lower cost

    These three risks make the use of the pension commencement sum to clear a mortgage very niche. My view would be that most individuals would be better placed on a repayment basis, guaranteeing their mortgage is clear at the end of the term (as long as payments are maintained). If appropriate they can then take additional risks with Pension, ISAs and other savings!

  • http://twitter.com/Cunningham_UK Alistair Cunningham

    I have considered personally “using the tax free lump sum from to pay off an outstanding mortgage” but I do not see it as “a very sensible strategy”. It’s actually a high risk strategy for three principal reasons:
    1. The old adage of your investment go down, as you mention in your blog – there’s no guarantee you’ll have enough to clear the mortgage, and your home is ultimately at risk
    2. You take a huge legislation risk! What if the Chancellor decided to remove, or at least tax the pension commencement lump sum (as it is now correctly known, and the cynics amongst us might say for due reason!)
    3. Whilst you receive tax relief on the way in, every £4 of fund currently only repays £1 of mortgage. Even a 50% tax payer would be able to clear a mortgage with an ISA at lower cost

    These three risks make the use of the pension commencement sum to clear a mortgage very niche. My view would be that most individuals would be better placed on a repayment basis, guaranteeing their mortgage is clear at the end of the term (as long as payments are maintained). If appropriate they can then take additional risks with Pension, ISAs and other savings!

  • http://twitter.com/Cunningham_UK Alistair Cunningham

    I have considered personally “using the tax free lump sum from to pay off an outstanding mortgage” but I do not see it as “a very sensible strategy”. It’s actually a high risk strategy for three principal reasons:
    1. The old adage of your investment go down, as you mention in your blog – there’s no guarantee you’ll have enough to clear the mortgage, and your home is ultimately at risk
    2. You take a huge legislation risk! What if the Chancellor decided to remove, or at least tax the pension commencement lump sum (as it is now correctly known, and the cynics amongst us might say for due reason!)
    3. Whilst you receive tax relief on the way in, every £4 of fund currently only repays £1 of mortgage. Even a 50% tax payer would be able to clear a mortgage with an ISA at lower cost

    These three risks make the use of the pension commencement sum to clear a mortgage very niche. My view would be that most individuals would be better placed on a repayment basis, guaranteeing their mortgage is clear at the end of the term (as long as payments are maintained). If appropriate they can then take additional risks with Pension, ISAs and other savings!

  • http://twitter.com/Cunningham_UK Alistair Cunningham

    I have considered personally “using the tax free lump sum from to pay off an outstanding mortgage” but I do not see it as “a very sensible strategy”. It’s actually a high risk strategy for three principal reasons:
    1. The old adage of your investment go down, as you mention in your blog – there’s no guarantee you’ll have enough to clear the mortgage, and your home is ultimately at risk
    2. You take a huge legislation risk! What if the Chancellor decided to remove, or at least tax the pension commencement lump sum (as it is now correctly known, and the cynics amongst us might say for due reason!)
    3. Whilst you receive tax relief on the way in, every £4 of fund currently only repays £1 of mortgage. Even a 50% tax payer would be able to clear a mortgage with an ISA at lower cost

    These three risks make the use of the pension commencement sum to clear a mortgage very niche. My view would be that most individuals would be better placed on a repayment basis, guaranteeing their mortgage is clear at the end of the term (as long as payments are maintained). If appropriate they can then take additional risks with Pension, ISAs and other savings!