Today I’m going to be answering some listener questions. There’s been a bit of a flurry of activity on the voicemail, so I thought I’d take an entire show to answer those questions for you today.

OK, we have a bunch of questions from listeners this week, six in total on a few different subjects. This means we’ll have to depart form the usual format where we look a what you need to know first and then what you need to do. Instead, we’ll look at each questions in turn and then I’ll answer them, including any practical steps you might need to take.

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But first…

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Question 1 from Sheila in Valencia, Spain: Pensions Changes

Let’s recap the changes that were announced in the budget a few weeks ago. There are things happening next year in April, and then there are some interim measures which are in place now, from the 27^th March.

The major changes are that anyone can take anything out for their pension from April next year. A pension plan, this side of retirement is just a fund of money, unless you’re in a final salary workplace pension – we’re talking about defined contribution, or money purchase pensions here. So you have a fund of money, and you get to retirement – what are your options from April next year.

Firstly I want you to have a picture in your mind of a line in the sand. Maybe you’re actually not he beach and there is a line drawn in the sand. That line is retirement. Now retirement means different things to different people. In this case it’s nothing to do with stopping working, it is simply the transition point where you stop paying into a pension and start drawing from it.

Pension funds change form when they cross the line in the sand. Right now there are two main ways that you can cross that line. One s to buy an annuity which is a one-off, irreversible transaction where you hand over you fund to an annuity company in return for an income for life. The other option is called Unsecured Pension, but everyone calls it income drawdown. Here, you fund stays invested and you draw from it, a bit like yogin to your own pension cash machine each month.

Much has been made in the press after the budget, of the fact that you no longer have to buy an annuity. That’s been the case for years, but practically, unless you had a pension fund over £100,000, that main alternative to an annuity, income drawdown, was prohibitively expensive. But the new rules say that you can take what you want from your pension as of next April. Again, the first 25% is tax free, but the rest is taxed at your marginal rate.

What does marginal rate mean? Well, whatever money you take from your pension is added to your other income for that year. So you’ll pay whatever income tax rate your income falls into once the pension payment is added. For an explanation of Income Tax and how it works, look back to video episode 199 and episode 200 – sometimes it’s easier to explain something using graphics than just by the sound of my voice! Just bear in mind that those videos are two years old so the allowances and bands are out of date now, but the principle stands.

Now those changes to pensions come into force next April so in the meantime the government has brought in some interim measures:

– If your individual pension pots are small, less than £10k, you can take the whole lot out under the small pension pots rules. You can do this if you have up to three small pension pots totalling less than 30 grand.

– If your total pension fund is less than £30,000 you can take the whole lot out under something called the triviality rules.

– In both cases, the first 25% of the fund will be tax free and the rest tax at your marginal rate of income tax for that year.

Many people don’t know that it is possible to take what you want out of your pension fund now. This is called flexible drawdown. The caveat is that you must also have secured income of £20,000 before you can do this. Secured means state pension, annuities or scheme pension from an employer. The interim measure here is that until April next year, they have reduced the requirement for that secured income to be £12,000. So as long as you have £12,000 per year secured income, you can take what you want from the rest of your pension pot.

But from next year it’s a free for all. You can take what you want when you want. Bring it on – Lamborghinis all round.

So, Sheila – returning to your question. Right now we’re in the interim period; from next year your husband will be able to take all his pension fund. So, whether or not the answer your husband got about his £10k pension pot was the right one depends on his other pension provision. If he has other pensions in payment as well as this small £10,000 pot with one provider, then he may not qualify for the small pots rule or the triviality rules. If this is the case, then the answer was correct. He should wait until next year and then he can have the lot under the new rules.

If he has a drawdown plan already, he could transfer the pension fund into that, but he should definitely seek advice on that.

Question 2 – Jon from London: Phased Retirement

Been watching video 58 – Phased Retirement

Good questions Jon. Phased Retirement is fairly complex concept, but is much easier to do than it is to explain. Again, the video explains things, I think, pretty well.

Phased Retirement shouldn’t be that affected by the proposed changes in the Budget because Phased Retirement isn’t a ‘thing’. It isn’t a product or even a solution, it’s just a way of vesting, or retiring, your pension bit by bit over time.

Back to that line in the sand. You can either move your entire pension over the line in one go, or you can do it in bits. Why would you do this? Two main reasons: death benefits and income tax

Death benefits first: Money held in a pension fund before retirement is passed to your beneficiaries free of tax in the vast majority of situations. That’s a valuable benefit, particularly if you have a large fund. Once you have vested your pension and taken it over that line in the sand into retirement, any fund passed to the next generation is going to be taxed at 55% – pretty steep. So the longer you delay shifting your pension fund over the line the better, from the point of view of death benefits.

The other reason to adopt a phased approach to retirement is income tax. Every bit of fund you take over the line has 25% tax free lump sum latent within it, and an income from the rest (current rules). So let’s say you have a big pension fund and you want to get an income of £30,000 from it. Well, you could vest £100,000 of the pension pot, take £25,000 as a tax free lump sum, and a £5,000 annuity. In that first year, you’ve had your 30k income but it’s mostly tax free.

This can’t carry on indefinitely of course; eventually you will have vested all your pension fund and all the tax free cash will be used up, but it’s an efficient of providing an income in the first few years of retirement.

None of the changes announced in the budget affect the efficacy of this approach as far as I can see. Annuities and drawdown plans will still exist. The 25% maximum tax free cash will still exist and the rest will be taxed as income at your marginal rate. If I had a quid fro every time I’ve uttered the phrase marginal rate in the last few weeks…

The one change will be that if using drawdown to execute a phased retirement approach, you currently have to bring enough of the fund over the line to provide the income part, within the current limits. This won’t be the case after next April as you’ll be able to take 100% of whatever your fund is.

Again that’s complex stuff, and I totally understand why Jon, you’re slightly confused by the interplay between the phased retirement approach and the new pensions rules. I’d put good money on the possibility of 50% or more of financial advisers not fully understanding phased retirement, which is perhaps worrying. It’s a great system though, in the right circumstances, just get advice from a financial planner who is experienced in such things.

Question 3 – Guy: Workplace Pensions

Good question Guy. You're asking about the relative merits of having your company pay into the pension for you or taking the money out of the company in some other way and paying into the pension yourself.

The answer to this is mathematical, so let’s look at the two options. For context, remember that the maximum you can put in is 100% of earnings, which means salary and other earned income – not dividends or interest. The overall maximum annual contribution where you still get tax relief is £40,000. You can contribute more than that, but you won’t get any tax relief.

So, let’s say the limited company pays £5,000 into a pension for you. That’s £5,000 of costs the company is paying so it won’t pay corporation tax on that amount. Assuming it’s a small company, that’s a 20% tax saving, of £1,000.

Let’s say instead that you take that £5,000 as salary and then pay it into a pension yourself. Well the company will save corporation tax of course, but may pay employer’s national insurance on that money. You will pay income tax, assuming you have other income and possibly some NI too. You will get income tax relief when you pay it into the pension, but you won’t get NI relief. Here are a lot more tax and NI angles on this method.

If, like many small business owners you pay yourself a smallish salary and the bulk of your earnings is in the form of dividends, then remember you maximum contribution is based on earned income, and dividends are not include in that. Dividends are profits which are paid out, having already had 20% corporation tax paid on them.

So, it depends on the amounts involved, kinda, but it’ll probably make life easier for you to have the company pay in on your behalf.

The second part of your question asks about the new auto-enrolment pensions rules coming into force as we speak. You’re right to say that most small employers are not yet involved, but they will be. Basically, if you have an employee, even if that employee is you, then you must have a pension scheme in place if the employee:

• is aged between 22 and the State Pension age
• earns at least £10,000 a year
• works in the UK

So the salary level here might be a factor. If you pay yourself, say £5,000 per year salary, then you wouldn’t have to have a scheme in place as that’s under the £10,000 threshold.

There’s much more info back in Session 35 and also the Government pages are pretty good too.

Question 4 – Andy in Leeds: Pensions vs ISA

Thanks for the question Andy, much appreciated. That is yet another fantastic article from the guys at Monevator, which must be one of the very best personal finance websites out there, bar none. Everybody listening to this should read that website regularly – it’s well-written and talks perfect sense. They don’t like advisers very much, but where we agree is that most people just need to do the basics right, and they’ll be fine, financially speaking.

There isn’t much for me to add to that article really, it does a masterful job at explaining the differences between pensions and ISAs and why, generally speaking, pensions are a better bet for those looking to save for retirement.

Andy, your questions specifically talks about those who are higher rate taxpayers. This simply comes down to the tax situation of pensions and ISAs.

You pay into an ISA from money which has already been charged to income tax at 20% for basic rate payers or 40% for higher rate payers, and even 45% for the top rate. You get no tax relief putting money into an ISA. But you do get access at any time and no tax implications.

With Pensions you get tax relief going in. You get basic rate relief at source, so if you put in £800 the government makes it up to £1,000. This either comes from putting the money in before tax if you’re employed, or by the physical addition of money if you pay into your pension from taxed income. Any higher or additional rate tax is reclaimed through your tax return.

When you eventually take money out of a pension you can have 25% of the fund tax free and the rest is taxed as income.

Most of us will be basic rate taxpayers when we retire, which means that if you’re a higher rate taxpayer now you can get 40% added to the money you put into a pension, but only 20% taken off when you take it out later on.

So for long term retirement savings which you can’t access until you’re age 55 or over, pensions are the way to go. For shorter term savings like saving up for a wedding or university fees, ISAs win out.

The ideal is to have both of course, but if it’s an either/or kind of question, for a HR Taxpayer a pension offers the best deal all round.

5. Pay off mortgage versus Invest?

This question has been simmering in my mind for a little while, and has been mentioned by a couple of correspondents and clients in the recent past. I did have it in the pipeline to cover as a topic in its own right, but I think it fits better here, which also means that I don’t have to stretch it out too much!

On paper, this is a mathematical answer again. If you have a mortgage at the current low interest rates, let’s say you’re paying 2.5% interest on your mortgage, then that is very cheap money. Let’s say also that you have a lump sum of £10,000 burning a hole in your pocket. Should you pay that amount off the mortgage or should you invest it.

Well, if you’re paying 2.5% interest on your mortgage, but you pay the £10,000 off, then you are acing 2.5% on that money going forward. No tax to pay on that sign either, so that’s straightforward enough. If you can get 5% return by investing the £10,000 then that would seem like the better deal. Why settle for 2.5% saving when you can get twice that by investing?

Of course, unless you’re talking about a savings account with a bank or building society, then the returns are not guaranteed. There may also be some income tax to pay perhaps, and there will definitely be charges, so the return on the investment may be diluted a bit.

But if you can get a better return by investing, than you can by paying down the mortgage, that’s the logical answer.

But, paying off your mortgage has intangible benefits in my experience. There’s no feeling like being debt free, and maybe that feeling outweighs the financial benefits of investing? Here, everyone is different. If your mortgage is massive and the £10,000 won’t make much of a dent, then that’s a factor. But if your mortgage is £20,000 and you can pay half of it off, that’s quite a nice feeling.

Access to the money is important too. If you can’t borrow the money back once you have paid it off your mortgage, then it has, essentially gone. Whereas in an ISA you’ll be able to use it should you need to. Access can be both an advantage and a disadvantage, depending on your level of discipline!

So theres not a clear-cut answer to this one I’m afraid, but quite a few variables. Do the maths and then consider the other factors and make a judgement call if you’re in this position. Consider overpaying the mortgage from income if possible, which will reduce the interest payable and the term considerably, leaving any lump sum windfalls you may get to be used for other things.

6: What is the Help to Buy scheme? 

Again, this is another question which has been raised a couple of times by reviewers and email correspondents. So thank you to those who asked this.

First off, for info from the horse’s mouth, the Help to Buy website is actually pretty good.

Help to Buy is a scheme dreamed up by the government to help people get onto the housing ladder. In this country we do seem to link our sense of financial wellbeing with home ownership, a concept which is much less the case in continental Europe for example. Help to Buy works in two main ways:

The first is the Equity Loan. If you can muster up a 5% deposit on a new build property only, then the government will loan you up to a further 20%. You then take a mortgage for the other 75% and bingo, you’re a homeowner. The Equity loan from the government is interest free for the first five years thereafter it is charged at 1.75% (cheap money), with the rate rising each year by inflation as measured by the Retail Price Index plus 1% (currently 3.5%). This scheme is available through new housebuilding firms which are registered with the scheme, and remember only applies to new build houses.

The second method that Help to Buy, rem, helps you to buy a house is Mortgage Guarantee. You don’t see this, as the borrower. This scheme allows certain mortgage lenders to purchase a guarantee from the government which protects them for up to 30% of the mortgage amount they will lend you. This safety net means that the lenders will offer better interest rates, making life easier for borrowers. This element of the scheme can be used for new build or existing properties up to £600,000 in value. You still have to borrow the mortgage for the full amount you will need, but the lender gets some protection.

You can’t combine the two elements of the scheme and there are certain other caveats, a big one being that you can’t use either element of the Help to Buy scheme to buy a rental property to let out. The scheme is to help people buy their first home or to increase the size of their home, so in order to benefit form Help To Buy, you can’t own any other home anywhere in the world.

Do check out the website, it’s very good. The government sites are getting better I reckon, with the notable exception of the Money Advice Service.

Summary

So six questions answered there; hope they were helpful. If you have a question, you can always leave me a voicemail, just like Sheila, Jon, Guy and Andy did this week. I’l either answer the question at the end of a normal show or group them together for a Q&A type session like this one. Go to meaningfulmoney.tv/feedback to leave me a voicemail right from your computer.

This week’s reviews

[This is where I read the reviews]

If you like what you hear on this podcast, please leave a rating or review on iTunes by going to meaningfulmoney.tv/iTunes just like Razo2012 did this last week. This helps others to hear about the show and to subscribe, because it keeps me near the top of the rankings. Or just hit the big red button below:

News

You may remember if you listened last week that I was given a major wake-up call from listener dazandjacs about my stagnant weight loss efforts. He suggested that I set up a JustGiving site so that he could contribute to a cause I care about, and that might be a motivator. Well I have done just that, and my new regime started yesterday. I weighed yesterday and it showed that over my holiday I put on a couple of pounds so my new starting point is 17st 8lb. Listener Andy who was one of our questioners on today’s show has pledged to donate every time I step down into a new stone, so when I’m 16st something, he’ll put in some money. Sound like a plan?

I’ll have some good news for you next week, so watch this space. In the meantime, check out justgiving.com/meaningfulmoney to donate or find out more. My cause is the Merlin MS Centre here in Cornwall, which is our chosen charity at my company Jacksons Wealth Management. It’s the only  place in Cornwall MS sufferers can get assistance and respite so it’s a very worthy cause.

Next Session Announcement

Next time we'll be talking about Funds. There are many different types of fund, and many different sub-types too. This can make life confusing, but as ever, I’m here to sort through the mess for you. If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/feedback

Outro

That's it for this session of the MM podcast, I hope it was helpful. Did I miss anything? Do you have any questions or comments? If so, please leave them in the comments section below.

I hope you enjoyed this session. Thanks for listening – I'll talk to you next time.