Unlimited Pension Contributions?

[Denny]

I think that the big problem here is that the new rules on pension contributions have changed due to the new Pensions Act, but there is relatively little case law for practitioners to use in deciding what's legal and what isn't. All that this HMRC guidance amounts to is an attempt by them to take the initiative in deciding what's lawful and what is not. Until we have a few challenges in court, we can't really tell whether HMRC have got it right or wrong (I suspect, as usual, that they've got it completely wrong).

The problem is that their Wholly and Exclusively line is a completely meaningless test: it assumes that there is a difference between
- compensation paid to the employee for the purposes of trade, and
- compensation paid to the employee for their own benefit.

Employee compensation, by it's very nature, is for the benefit of the employee (the taxpayer). Therefore, the distinction is meaningless. It's for the business to decide what an appropriate compensation package, and the employee to decide whether or not to take it. Having decided to take it, the employee has every right to organise his/her affairs to minimise the tax liability, so they can have it either as salary or pension contributions, exactly as they wish (provided that the employer agrees).

The guidance HMRC have set out effectively leaves the decision on pension contributions in the hands of the local tax inspector. I suspect that, once challenged in court by a suitably high powered merchant banker (who will be paid £1 but getting a £1M one-off pension contribution, making our numbers seem somehow trivial); we'll find that you can put what you like into your pension as long as you don't exceed the long-term cap.

Until then, it's just a question of what you personally feel you can justify - I do 10k salary, 10k pension contributions, and am happy to argue the toss with the tax inspector when he comes.

Without even reading it, I would suggest that 'benefit of trade' is about putting large sums into a pension fund to help finance non-owner employee pensions (for which we don't have) to keep a going concern operating with staff employee benefits, not to finance Director's own personal old age. Don't forget these rules are primarily set up and geared toward Limited Companies that operate as growing companies with a marketplace reputation, not EB imposed freelance operations like we are. Otherwise, it may be legit to pay large sums to yourself in old age if you are the Director of a company that intends to keep a hand in the running of the company as a non-exec Director when the business is presumably executed by a family member to run or sold on elsewhere. Again, this is unlikely with a one-man band operation.

I doubt that in our situation such huge contributions well over above salary would be viewed as anything but a tax avoidance measure.

Still, it's worth getting checked out.

[IR35 Avoider]

Yes of course I can find an annuity that invests in shares. The point is to find one that invests in a way that I am happy with

I agree that you will be available to invest in shares more cheaply and precisely (in terms of the exact shares you want) outside of an annuity.

If I remember correctly, the first site I linked to above contains an essay or two where he lambastes planners for the assumptions they build into their Monte Carlo simulations - I actually found the site while Googling for applications of Monte Carlo simulations to retirement planning. It might be worth checking whether his criticisms apply to you. If they do and you disagree with what he says, I'd be interested to hear what you have to say.

His own take is quite interesting: as I remember it he suggests that you must recalculate each year, basing the new calculation on updated life expectancy, i.e. given the extra year of survival, not even bother incorporating expected returns into calculations (since variability renders these meaningless) but take [updated capital]/[updated life expectancy] as your new baseline, though he also adds an element of smoothing to this to prevent sudden fluctuations to annual income. (His planning paradigm is based on a plane auto-pilot, he used to be Finance director for Boeing.)

For conservatively-invested value-oriented shares I believe that is much higher than 2.7%.

I'd be interested to know what sort of figure you have in mind. The 2.7% figure I gave is what I would feel safe taking over my current 40 odd years of remaining life expectancy, without risking depleting my capital. I could see up to 3.3% as being safe, but I don't see how you could go much higher than that, for a general portfolio of shares. Once I have only 10-15 years to go, I'd be willing to start running down capital, and I might contemplate taking a little bit more.

Obviously my 40-year scenario is not quite the same as the typical 15 year scenario in which an annuity is bought, so (my fault) we are talking slightly at cross-purposes.

I believe that the risk-sharing benefit that comes from an annuity out-weighs other factors (such as charges and investment returns) when it comes to calculating a safe withdrawal rate for running down capital over a 15-year life expectancy. Maybe you and I should set up a non-profit insurance company that let's everyone invest where they like but still benefit from pooling the risk associated with uncertain life expectancy? My point is that there is a huge "cost-free" benefit to an annuity that you cannot reproduce for yourself outside of one. I suppose that whether this benefit really does outweigh all the cost and control considerations of annuities is something that has to be calculated, rather than debated as if it were a matter of principal.

In summary, what I'm arguing is that in principle annuities are absolutely wonderful, and what you're arguing is that in practice the implementations are unacceptable.

[IR35 Avoider]

OK, here's my proposal for a mutual insurance company to sell competitively priced annuities to the likes of us.

Everyone who joins has their lump sum transferred into their own account with an on-line stock-broker, where they can manage their money however they like.

Each month-end they are allowed to withdraw at most [account balance]/[current statistical life expectancy in months] from their account. (The transfer out of their stock-broker account goes to the insurance company who deduct tax and forward the balance.) The figure produced by the calculation is called their "withdrawal limit."

Whenever a customer falls off his perch, the insurance company closes out his account at the stock-broker and distributes the cash among the other customers. Each customers share is weighted according to their "withdrawal limit". Since this figure already incorporates how much capital they are potentially contributing to the global pot and their current risk of contributing (current risk of death measured by current life expectancy) I think (without having pondered for very long to work out if I'm right) that weighting by "withdrawal limit" gives a fair result.

The admin costs of the insurance company are funded by a levy on withdrawals.

What do you think?

[rootsnall]

I agree that you will be available to invest in shares more cheaply and precisely (in terms of the exact shares you want) outside of an annuity.

If I remember correctly, the first site I linked to above contains an essay or two where he lambastes planners for the assumptions they build into their Monte Carlo simulations - I actually found the site while Googling for applications of Monte Carlo simulations to retirement planning. It might be worth checking whether his criticisms apply to you. If they do and you disagree with what he says, I'd be interested to hear what you have to say.

His own take is quite interesting: as I remember it he suggests that you must recalculate each year, basing the new calculation on updated life expectancy, i.e. given the extra year of survival, not even bother incorporating expected returns into calculations (since variability renders these meaningless) but take [updated capital]/[updated life expectancy] as your new baseline, though he also adds an element of smoothing to this to prevent sudden fluctuations to annual income. (His planning paradigm is based on a plane auto-pilot, he used to be Finance director for Boeing.)



I'd be interested to know what sort of figure you have in mind. The 2.7% figure I gave is what I would feel safe taking over my current 40 odd years of remaining life expectancy, without risking depleting my capital. I could see up to 3.3% as being safe, but I don't see how you could go much higher than that, for a general portfolio of shares. Once I have only 10-15 years to go, I'd be willing to start running down capital, and I might contemplate taking a little bit more.

Obviously my 40-year scenario is not quite the same as the typical 15 year scenario in which an annuity is bought, so (my fault) we are talking slightly at cross-purposes.

I believe that the risk-sharing benefit that comes from an annuity out-weighs other factors (such as charges and investment returns) when it comes to calculating a safe withdrawal rate for running down capital over a 15-year life expectancy. Maybe you and I should set up a non-profit insurance company that let's everyone invest where they like but still benefit from pooling the risk associated with uncertain life expectancy? My point is that there is a huge "cost-free" benefit to an annuity that you cannot reproduce for yourself outside of one. I suppose that whether this benefit really does outweigh all the cost and control considerations of annuities is something that has to be calculated, rather than debated as if it were a matter of principal.

In summary, what I'm arguing is that in principle annuities are absolutely wonderful, and what you're arguing is that in practice the implementations are unacceptable.

I was just looking into annuities for my father in law and I refuse to believe they are good value and infact I would be tempted to call them a rip off. His wasn't a huge pot and was basically a top up for his state pension and serps ( and other bits and bobs ). The rate he could get for a non index linked annuity was less than he could get in any number of freely available bank accounts. To force someone into taking an annuity on those terms and giving up their pension pot at the same seems crazy to me. I understand interest rates could drop but if you would still have your original capital, I admit possibly decreased in real terms. I refuse to believe we can't have a system in place to allow a better return than that offered by the insurance companies particularly when we aren't talking of hundreds of thousands in the pension pot.

[tim123]

I don't understand why they are doing this as its the insurance Co's who plunder your pension pot rather than the taxman getting 35% of what is left when you snuff it.

The insurance companies don't 'plunder' the pot. They use the money that is surplus from the people who die early, to pay more to those that die late. If you (your estate) got 'your' pot back when you died, the annunity rate that you were offered in the first place would be even lower than it is now.

tim

[IR35 Avoider]

I was just looking into annuities for my father in law and I refuse to believe they are good value and infact I would be tempted to call them a rip off. His wasn't a huge pot and was basically a top up for his state pension and serps ( and other bits and bobs ). The rate he could get for a non index linked annuity was less than he could get in any number of freely available bank accounts. To force someone into taking an annuity on those terms and giving up their pension pot at the same seems crazy to me. I understand interest rates could drop but if you would still have your original capital, I admit possibly decreased in real terms. I refuse to believe we can't have a system in place to allow a better return than that offered by the insurance companies particularly when we aren't talking of hundreds of thousands in the pension pot.

I looked on the FSA web-site at the comparative tables which told me that the best deal for a single-life level annuity for a pot of £100,000 from a non-smoking man aged 74 (the oldest age it would let me put in) with no guarantee period was £869 per month. This was from a company I'd never heard of. The second highest amount was from Friends Provident, who offered £802. These figures equate to roughly 10.4% and 9.6% each year, which was a lot higher than I expected.

Changing the age to 65 gave a second-highest figure from AEGON Scottish Equitable of £588, which equates to about 7%.

Without straining my brain for a few hours doing calculations, I've no idea if these figures are good value in actuarial terms, but they sound reasonably good to me.

What were the figures for your father?

[tim123]

Really? Just a wrapper? Only for what is offered, only at the companies' prices. Can you point me at an annuity that invests in the asset class that I am tempted to base ISA investments on?

The point about an annunity, is that the return is guaranteed. Once you have signed up, how the company invest their assets to get that guaranteed return isn't your concern.

You might like to think that you could get a better deal by investing the money differently, but to do so you would be taking a bigger risk. So the return isn't going to be guaranteed.

And this is the difference. Either you want a guarantee or you want to take more risk.

Where you may have a problem is with the compulsion to take an annunity with a pension pot. But that's the deal you signed up to. HMG gave you tax relief on the contributions in return for you never seeing the capital again.

If you don't like what comes out the end, don't put your money in at the start.

tim

[rootsnall]

I looked on the FSA web-site at the comparative tables which told me that the best deal for a single-life level annuity for a pot of £100,000 from a non-smoking man aged 74 (the oldest age it would let me put in) with no guarantee period was £869 per month. This was from a company I'd never heard of. The second highest amount was from Friends Provident, who offered £802. These figures equate to roughly 10.4% and 9.6% each year, which was a lot higher than I expected.

Changing the age to 65 gave a second-highest figure from AEGON Scottish Equitable of £588, which equates to about 7%.

Without straining my brain for a few hours doing calculations, I've no idea if these figures are good value in actuarial terms, but they sound reasonably good to me.

What were the figures for your father?

I haven't got the figures at hand but he was 61 at the time and it worked out at around 5% I think. He retired for health reasons ( but not bad enough to increase his payout ) and couldn't get his state pension for 4 years so needed the money. I have no doubt he would of been a lot better off if he could of just stuck the money in ING.

[IR35 Avoider]

For a man aged 61 I get a second-highest quote of £535 from AEGON Scottish Equitable, which equates to roughly 6.4%.

[rootsnall]

For a man aged 61 I get a second-highest quote of £535 from AEGON Scottish Equitable, which equates to roughly 6.4%.

Like I say I don't have the figures at hand, it was 6 months ago and done and dusted now, Prudential were the best at the time.

I know who to come to for future penison advice !

Are you personally paying large contributions in a low salary setup ?

Do you know how the umbrella Co's have dealt with this ? I quized Parasol a while ago but didn't find anybody who really understood what I was asking, they just quoted the standard annual limit.