Take control for a financially worry-free retirement

From the “granny tax” to automatic enrolment into workplace pensions, the retirement income plans of millions will be affected by changes over the coming year.

The major move in 2012 was the introduction of auto-enrolment from 1 October, and that will begin to affect workers all over Scotland in 2013.

Other developments will impact on pension savers, too. They include the phasing-out of additional personal allowances for pensioners, an EU ruling that brings parity to the sexes, new pension projection rates that will make savings look like they are worth less as well as further reductions to the level of tax relief on pension savings.

So it is no wonder that for many, planning ahead for a comfortable retirement can be, well, a little bamboozling, especially against a backdrop of increasingly tight household budgets and higher living costs.

Regarded as the biggest change to pensions in a generation, it is estimated that around 11 million employees will eventually be automatically enrolled into a pension scheme and receive employer contributions. These contributions will be invested until retirement when they will usually be converted to an income for life.

So why is auto-enrolment needed? Factors including longer life expectancy, lower savings levels and the decline of final salary schemes mean action was needed to arrest the decline of pension savings in the UK.

For those on low incomes, however, this may have got a little more complex following news from the Department for Work and Pensions (DWP) that the minimum level of earnings required to automatically qualify for this scheme will increase from £8,105 to £9,440 a year.

This is in line with the personal allowance increase announced in the Autumn Statement in December and it is estimated that around 420,000 workers will be no longer be automatically enrolled as a result.

However, not all is lost. Those affected are allowed to “opt in” to receive employer contributions and this is perhaps something worth seriously considering – not doing so means missing out on valuable employer contributions as well as tax relief from the government.

The question is: will auto-enrolment be enough to support today’s workers in their pensioner years?

Our analysis indicates that if today’s workers want to receive anywhere near the same level of pension as generations before them, additional contributions, above the auto-enrolment minimum are needed.

NOT-SO-GREAT EXPECTATIONS

Other changes in the pipeline may help underline how much you have to save for retirement. Members of defined contribution schemes – now the norm in the private sector – could get a rude awakening in the coming months as their annual benefit statements drop through the letter box. That’s because the City regulator is reducing the standard projection rates used to show possible future returns. As a result, savers may find that their projected savings at retirement are worth less than they expected.

Pension providers and advisers currently make assumptions as to how much an individual’s pension savings will earn in interest in the period before retirement in order to help savers estimate what their pension pot will be.

At the moment, this is based on three scenarios – 5, 7 and 9 per cent a year – but as a  result of an independent review, this will now be reduced to give pension savers a more realistic idea of how much investments might be worth when they come to retire.

This means that for someone aged 45 years today, for example, the new rates – 2, 5 and 8 per cent a year) will reduce pension projections by between 10 and 20 per cent. Ultimately the level of pension will depend on the returns actually received but those targeting a particular level of income in retirement may find they need to save more.

New gender equality rules, which mean insurers can no longer use gender as a consideration in pricing, will also have an impact on what they might expect to receive from their pension. Up to now, the “cost” of buying a pension at retirement was more expensive for females than males – they are expected to live longer and therefore be receive an income for longer. As of 21 December it is illegal to price pensions differently for males and females. While the ultimate impact is still unclear, some estimates suggest the cost of pensions for males could increase by as much as 10 per cent.

GRANNY TAX

From April 2013, the “age-related allowance” which enabled pensioners to start paying tax at a higher income level will be frozen – this was previously worth around £285 a year. Workers retiring in the future will only benefit from the same tax-free allowance as everyone else.

Take control of your retirement planning. The days of employees being able to rely on their employer for a pension are no more – they need to take control of the situation or face a potentially poorer retirement than earlier generations. There is a wealth of free information available from government-sponsored providers (eg The Pensions Advisory Service) as well as from employers and pension providers, but very few workers make use of this.

The key things that drive pension amounts for defined contribution scheme savers, and the things to focus on are:

Level of contributions paid: there’s no way around it – higher contributions typically mean better pensions in retirement.

Starting early: the longer savings are paid for, the more they will ultimately be worth.

Investment returns before retirement: make sure you understand the relationship between how much your investments earn and how much you will get in retirement.

How much is taken out in fees: don’t underestimate the impact of investment charges – an extra 0.5 per cent a year might not sound like much but it could reduce savings over a 20-year period by 5 per cent.

Buying a pension at retirement: The cost of buying a pension annuity can vary by as much as 30 per cent, so it’s important to review the whole market and wide range of options available rather than go with an initial quotation from a current provider.

Finally, don’t despair! Saving for a pension is still worthwhile when you consider the tax reliefs available as well as the prospect of additional funding from employers – opting out of this is like turning down “free” money.

• Alison Fleming is head of pensions at PwC Scotland