Updated 23 January 2017
Until recently it’s been financial good practice for spouses to ‘equalise their assets’ – by fairly sharing all that they own. But in the wake of the pensions shake-up, this might not be the best solution in every case. Dave Penny of Invest Southwest explains.
When helping clients who are married or in a civil partnership, most financial advisers are hard-wired to the idea of ‘equalisation of assets’. Essentially, this means splitting a couple’s assets roughly half and half, as far as possible. This helps use up both tax-free individual allowances, and also guards against the 5 Ds: Death, Disability, Dispute, Debt problems and Divorce – which can be a lot more troublesome if one partner holds most of the assets.
To date, this principle has also included pensions. Annuities usually benefit the policy holder more than the partner, so to protect both partners the advice has been to equalise assets and share pension income equally over the long term. But with the recent seismic changes to the structure of pensions, all that has changed.
Pension pot holders can now, on their death, pass on any remaining invested funds to their beneficiaries tax free. So if an individual did not select the annuity route (no longer compulsory) then their spouse or other beneficiaries may receive a fund worth tens or hundreds of thousands of pounds – free of any tax penalty, which previously could have been up to 55 per cent.
What’s this got to do with equalising assets?
No-one should act without seeking individually tailored advice, but there is one scenario in particular in which equalising assets may not be the best course. Take the example of Graham and Lisa. Graham is a 40 per cent taxpayer and Lisa is a 20 per cent taxpayer. Every pound that Lisa puts into her pension becomes £1.25 overnight, thanks to tax relief. But because Graham pays more tax, every pound that he puts into his pension becomes £1.66 overnight. This is a big difference, which this married couple can exploit by sharing the benefits.
If Lisa pays all her pension contributions into a pension in Graham’s name, then the pot of money available to them both at retirement will be significantly larger, because of the higher rate tax relief that Graham is entitled to. (We’ll come to the risks of doing this in a minute!).
What it means in hard figures
If Lisa, a basic rate taxpayer, contributes £100 a month over a 40 year working life net of tax, then in total she would have paid in £48,000 of her own money. Tax relief alone makes this £60,000. If we assume a net growth rate of 5%, the final fund value would be £190,260. Yes, £48,000 becomes £190,260. That alone is an excellent performance. However, if Lisa chooses instead to contribute to Graham’s pension, then (because Graham pays tax at 40 per cent) that fund would end up being worth £251,997 – a further uplift of nearly £62,000 or 32%. Now that figure of £48,000 becomes nearly £252,000. Wow. (These figures don’t take into account any payments that Graham himself makes into the pension, which would add to the effect of compound interest).
It is a quite astonishing gain, made possible by the certainty that the full benefit of this accumulated pension fund can be enjoyed not only by the pension holder but by partner, spouse and beneficiaries too, and furthermore passed on through the generations, tax free. Knowing that the fund will not die with the individual in this case means an additional £62,000 is available to Lisa and Graham and their family – with no additional contributions necessary to achieve it.
But let’s play around a bit more. Suppose you increase the net contribution to £400 a month. Then the final pension fund would be over £1 million – an additional uplift of £248,000 simply for contributing via a higher rate taxpayer. The figures are so dramatic that even the most die-hard proponent of asset equalisation may want to think twice.
So what’s the catch?
The catch, of course, is that real life is not a calculation on paper. The 5 Ds are an ever-present risk for every couple, and different individuals – even within a partnership – may have very different attitudes to investment risk and reward. Also, many people may still feel that an annuity is best for them, if they are unprepared to accept that the value of their pension funds may fluctuate after their retirement. That said, with an annuity the value of the pension funds is lost upon the death of either one or both partners – it cannot be passed on to other beneficiaries.
The scenario of Lisa and Graham, in which all retirement funds are invested in one partner’s name, is not for the fainthearted. What happens, for example, if Graham has an affair and names his new girlfriend as the beneficiary of the pension? A court case might well reinstate Lisa’s fair share, but it’s far from certain; it could also be slow, expensive and stressful.
The new freedoms that George Osborne showered upon pension savers include the freedom to be flexible and creative, but also the freedom to be irresponsible and damaging. More than ever before, all options should be considered with an open mind, alongside a rigorous understanding of the new pensions regime.
What should I do about this?
That depends entirely on your own circumstances, goals and attitude to risk. Every individual either saving for retirement or about to retire should seek professional advice, so that the new freedoms become benefits and not pitfalls. Nevertheless, the example above shows that it is now possible to enhance your pension by as much as one third, for no additional contribution. If this does not demonstrate the value of quality advice, then nothing does.
Take advantage of the FREE pension check being offered via the unbiased.co.uk, simply follow this link to learn more. www.unbiased.co.uk/free-pension-check
About the author
Dave Penny has worked in the financial industry for over twenty years. He regularly features in the media, appearing as a financial commentator on BBC Somerset radio. Dave is currently Managing Director of Invest Southwest.