Home comforts with a catch
THE simplification of private pensions being introduced by Gordon Brown on April 6, 2006, has won general approval from the industry. But it has also brought warnings that the new-found freedoms for would-be pensioners carry their own dangers.
Mr Brown's big idea is that the current multiplicity of private schemes, ranging from personal pensions to company-provided options, will be replaced by a simple annual allowance and lifetime limits on individual contributions. Within those, you will have greater licence as to what you use to create your pension.
The aspect of the changes that seems to have caught the imagination of savers and headline writers alike is the possibility of converting houses into pension plans, something which has been banned up to now. Some have even been hypnotised by the possibility that their own home could become part of this tax-privileged vehicle.
Self-invested personal pensions (Sipps) would be the vehicles for this apparently enticing prospect. Given that an investment in a Sipp attracts tax relief at the highest rate, currently 40 per cent, savers would, in effect, be gaining a subsidy from the Chancellor to buy their own homes.
Colin Batchelor, of Legal & General¹s pensions department, says this might be of interest to people in their forties. If they had £200,000 in their pension scheme, augmented by borrowings of up to 50 per cent on top, they might easily have the firepower to buy their own home, he says.
Yet no one should think that Mr Brown will sit back and let you rob the Treasury of several tens of thousands of pounds. For a start, the rules state that people turning their house into their pension will have to pay a full market rent to live in their own home.
Then, of course, the pension must produce an income for your old age at some stage. Unless you have other means, you will have to sell your home or move to a cheaper one to raise the cash. That is anathema to many old people.
As last year's first report of Adair Turner's government-sponsored Pensions Commission put it: "The scale of funds releasable by trading down is limited by people¹s desire to live in local and familiar areas and in equally attractive areas, even if in a smaller house."
Yet not all financial advisers and their clients appreciate that what makes perfect sense to 35-year-olds, can become nonsense when they get to 75.
Stuart Bayliss, of Annuity Direct, is critical of some advice given by independent financial advisers (IFAs) on this subject. "Few IFAs have advised old people. People change when they get older. Their attitudes change. They want to make things simpler."
This is one of the reasons that the currently very popular buy-to-let properties may also be unsuitable investments for the new, more laissez faire pension regime. Running what is in effect a small property rental business may be fine when you are fit and alert in middle age. It may be less attractive when you are in your eighties.
In any case, for most people the cost of setting up your own scheme is likely to be prohibitive. Mr Bayliss says: "In a normal scheme, providers will want you to keep costs reasonable by using their own established advisers. That is likely to rule out schemes tailored to your own property assets."
There is also the role of the trustees. In a Sipp or other pension, these are the people who nominally hold the assets on your behalf. But Tom McPhail, a pensions expert at Hargreaves Lansdown, the IFA, says their ideas and yours may not coincide. He says if you lose a tenant and cannot keep up the payments on a loan, the trustee may then decide to sell the property against your wishes to keep the bank happy.
More generally, Stephen Yeo, of Watson Wyatt, the actuary, says experience shows how cyclical investment property can be. "You can imagine in 20 years' time everyone will be selling their properties and will wonder why anyone thought it was a good idea to buy them in the first place."
The Turner report put the current value of private property assets at £2.25 billion, even after taking account of the accompanying mortgages. It calculated that people with incomes of about £21,000 a year had housing assets worth about £96,000 just before retirement age. That would be enough to buy an index-linked pension of £4,800 a year, at current rates. But the authors believe it would be wrong to assume that it would be. They argue that house prices are likely to fall as postwar baby-boomers retire because there will be a smaller working-age population to sell to.
Another area of the pension changes to excite interest is the apparent removal of the current requirement that you buy an annuity with your accumulated private pension pot. This puts many people off saving within one of the existing private pension schemes.
They see an annuity, which is a way of converting a lump sum into a stream of income, as a gamble with the Grim Reaper. A few sums show that it takes 14 years for an annuity just to pay back the capital cost at current rates. You may die long before that, leaving the insurance company providing the annuity to scoop up your hard-earned savings.
The new rules will bring in the idea of the "alternative secured pension". This effectively allows people opting for pension drawdown, where they get an income from their pension assets instead of buying an annuity, to continue the arrangement until they die. After that, the remaining fund may be available tax-free to pass on to future generations.