Saving for a rainy day
From Tax & Technical Jan 23 2012 BY: Luanne Ahearne
, Technical Support Consultant
, Royal London 360
Over the past century, the concept of retirement changed from being perceived as a luxury to an expected right. During the same period, however, life expectancy significantly increased.
According to a research paper prepared for the House of Commons, in 1901, males were expected to live for 45 years and females for 49. Current UK estimates from the Office for National Statistics for male life expectancy at birth are 78.1 years, and 82.1 for women.
Unfortunately, as people have come to expect longer lives, our pension systems have not been adjusted accordingly. While rising life expectancies are good news, they place increasing emphasis on individuals to fund their own retirement.
A survey conducted by Allianz asked the question: “Which do you fear the most: outliving your money in retirement or death?” Surprisingly, 61% said they were more scared of outliving their assets than they were of dying.
The Bismarck sinks
Modern pension systems can trace their roots back to the late 19th century, when Chancellor Otto von Bismarck introduced one of the first nationwide social security systems in Germany. Since then, pensions have spread and become established globally.
State pensions use the tax taken from the income of younger working generations to fund older generations. As global birth rates continue to drop, people live for longer and fewer workers are left to support an increasing number of retirees, pressures on global state pension systems will increase.
Fears for US investors
Inevitably we will see continuing major reforms in most countries over the coming years. For example, in the UK, the state pension age will be raised to 66 from October 2020, and pension experts warn that the latest life expectancy calculations could pave the way for it to hit 68 as early as 2027.
Emerging markets
Looking further afield, the large emerging economies of India and China are in particularly poor shape. China faces a demographic time-bomb more severe than any developed country, caused by its one-child policy. India has a much younger population, so its demographic problems will inevitably be deferred.
In the United Arab Emirates, only nationals are eligible for state benefits and these do not stretch to expatriate employees. In Hong Kong, the normal retirement age is 65. The social security system provides benefits to the elderly, but these are means-tested.
Employer schemes
At the same time as state pensions come under increasing pressure to fund retirement provision, occupational schemes face similar difficulties. These schemes can be either defined contribution (DC) or defined benefit (DB) arrangements.
With a DC scheme, the risk for providing an adequate pension rests on the accumulated savings built up at retirement. With a DB scheme, the investment risk is taken by the employer and the member is guaranteed a retirement income based on pay and length of service.
Over the years there has been a marked shift from DB to DC schemes. Many UK DB schemes are heavily in deficit, and companies are coming under pressure to address the funding gap. It was recently reported that British businesses face a corporate pensions deficit of £295bn ($463bn).
Regular premiums
It is becoming obvious that we must all look beyond state and occupational pension schemes, to ensure we have sufficient retirement income in our old age.
One of the ways this can be done is to invest in a regular premium savings policy issued by an offshore provider. These plans are generally available for UK expatriates or foreign nationals, and are designed to generate capital growth over the medium to long term.
Because the policies are issued offshore, there is no liability to tax on the income or capital gains of the various funds. Therefore, apart from any withholding tax that may be deducted at source on income arising from certain investments, the underlying fund grows without any further deductions of tax.
Regular savings contracts also encourage the discipline of commitment. Premiums can start off small and be increased over time, making the plans accessible and flexible.
UK life expectancies since 1900
For example, it is sometimes possible to change the frequency of the payments and to take a break from paying premiums should circumstances change. Lump sum top-ups can normally be accepted, perfect for boosting the retirement pot should an individual receive an unexpected windfall.
Risk profiles
In an industry that is becoming increasingly competitive, there may also be incentives in return for larger monthly premiums or extended payment periods.
It is important that any funds selected match the investor’s chosen risk profile. Most offshore regular premium policies allow for a broad choice of asset classes, risk profiles, currency denominations and geographical sectors, from a wide selection of fund houses.
They may even allow investment in Shariah-compliant and socially conscious funds.
Furthermore, when an individual is unsure about where they should be investing, or does not have the time to continually monitor investment markets, it is usually possible to invest in a range of managed funds run by professional fund managers.
A real advantage to saving monthly is that individuals do not have to concern themselves with market timing or identifying the best moment to commit. If money is saved on a regular basis, when the share price is down, the individual’s policy buys more units.
An individual accumulates more within the plan when markets are low and then, as a sustained recovery takes place, all of the investment units that have accrued go up in value. This is called ‘pound cost averaging’.
Expatriate benefits
An important benefit, which will relate to UK expatriates only, is that upon relocation to the UK, it is possible to benefit from ‘time apportionment relief’. This is a relief which reduces the proportion of the gain subject to income tax by the amount of time spent outside of the UK.
So, for example, if a client had owned the policy for ten years but lived abroad for five of those years, then only half of the gain would be taxable.
The international financial crisis of 2008 and 2009 highlighted the need for a compensation fund for policyholders. Many offshore jurisdictions now offer the best investor protection schemes in the world, providing all policyholders with compensation of up to 90% of their investment value, in the unlikely event that the offshore provider becomes insolvent.
The wake-up call
Unfortunately, over the past couple of decades, western civilisation has not been adept at saving. While many workers may have planned to retire between the ages of 60 and 65, the truth is that they will either have to work for longer or save much harder during their working lives.
More than at any other time in history, there is an urgent need for all of us to accept more responsibility for the provision of our own financial security. As the well-known author on time management, Alan Lakein, once said: “Failing to plan is planning to fail’’.
The cost of inaction and procrastination is simply too high to ignore.