Investing in a de minimis pension means future generations will be well provided for
How often have we promised ourselves that we will get away this summer, but when we finally get round to booking the holiday, the bargain does not come up to expectation, and the best deal is long gone?
Is this what actually happens to many clients planning for retirement? Is their reality blurred? Perhaps it is. The image of a stroll along a sandy-coloured beach in the sunset, with a cool gin and tonic in one hand and a copy of the Financial Times to watch the value of their retirement fund in the other!
The UK government's latest attempt to make us all self-sufficient when looking at our retirement planning has not yet set the world alight.
However, among the endless legislation lie some key opportunities for you to create your own packaged product, and shape the future of the silver surfers of tomorrow.
You can use the new de minimis personal pension maximum of £3,600 each year to great effect. Your clients can ensure that future generations start pension planning from day one and that 50 is an achievable retirement target.
As there are no earnings needed, your client could contribute on behalf of a child from the time the child is born. A whole host of individuals could contribute. The most likely contributors are the child's parents or grandparents, but these are not the only ones allowed to do so.
In this two-part article, I will initially focus on the child who may be fortunate enough to benefit from such planning. I will leave the various tax-planning opportunities for the grandparent until my next article and focus for now on the benefits to the child.
Is this planning opportunity for the rich only? It is certainly not. For a contribution of £7.69 a day, your client can turn their grandchild into a millionaire by the time the grandchild reaches age 50!
Each contribution will receive basic rate tax relief. £3,600 a year now becomes £2,808 at 22% relief. If directed into a suitable personal pension scheme the funds could grow to more than £1.5m. This could represent a staggering 30% of the national average earnings at this point.
However, your client will also need to consider other issues. They will need to consider school fees and university planning needs, as well as a possible boost to help buy the grandchild's first property.
Now is your opportunity. Packaging the product around other investment vehicles makes this highly attractive, not only to your client but also to you. You can create a one-stop solution.
How do you do this then? Consider the position where a grandmother invests £2,808 into a personal pension for her grandson, George. She also invests £56,160 into a single premium investment bond. She then sets up an annual withdrawal from the bond of £2,808 (5% of the bond value) to fund future contributions to the personal pension.
Over the next 20 years, the £56,160 has supported an extra 20 payments. In total, she would have invested £58,968 into the personal pension. The value of the personal pension fund after 20 years could be more than £175,000. Further, the value of the bond after the same time could be more than £90,000.
Personal pension contributions from the investment bond will probably stop at this point (or earlier had George entered employment, for example). This brings us on to phase two.
Let us assume that George is now at university. He could do with some added support to pay the fees introduced by the Government, and ensure that loans, if needed, are kept to a minimum now that the Government has also abolished grants.
It is at this point that we need to consider the structure of the bond bought 20 years before. It is essential the insurer had issued it with a suitable number of segments. In this way, George will be able to use any or all of his (otherwise) unused personal income tax allowance, to mitigate any liability arising from cashing in all or part of the bond.
If the grandmother received no tax advice, then she would probably continue to draw funds from the bond without considering the best way to do so. However, she would be liable to income tax on any cashing in ' which is not very tax efficient. If, however, the insurer issued the bond with individual segments, the grandmother can assign a segment to George who can then cash it in himself. Consider the following alternatives:
l First, the grandmother draws funds from the offshore bond. If the gains were £7,500 and the grandmother were a higher rate taxpayer, then she would incur a tax liability of £3,000. Thus, the net payment to George would be £4,500.
l Second, an individual segment is assigned to and cashed in by George. Assuming the same circumstances except that George is a non-tax payer, then he would incur a tax liability of £427. Thus the net payment to George would be £7,073.
This represents an extra £2,573 or an increase of nearly 60% to George.
At this point, we can review the object of the exercise. Pension planning can never start early enough and the rules previously hindered parents and grandparents from contributing to these tax efficient vehicles. Your client may be concerned that George cannot access the personal pension funds until he is 50. But is that a bad thing?
For a 20-year old to amass a pension fund of £1.5m by the age of 50, they would have to contribute about £1,600pm. How realistic is this in practice, given that national average earnings are currently just over £22,000? I would not want to scare anyone with average house and mortgage costs, but as you can see, the older we get, the greater the demands on our resources.
The personal pension fund is not completely inaccessible until George reaches age 50. The projected tax-free cash, assuming 25% of the fund, gives young George the opportunity to use the fund as a repayment vehicle for long-term borrowing, for example, a mortgage.
The investment bond itself can also provide further funds for George This example can also be carried forward into his working career. George may have exhausted the bond when he finishes his university education. Alternatively, he may not need it at all.
The projected values at age 50 for the bond and pension funds would make George a multi-millionaire, having a retirement pot of more than £2m. All from a £60,000 investment!
This just shows how, with a little lateral thinking, you can turn a Government low maximum contribution pension offering into a packaged product that will enable tomorrow's potential customer to become today's key client.
I will revisit this subject in the next article but will focus on the tax planning benefits and choices for the grandmother rather than the recipient, George.
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