Pensions – to invest or not to invest – that is the question?
I am on record as saying that I only publish when I have something important to say. I am passionate about quality financial advice for dentists, that’s why I will only ever work with dentists, and making sure they have enough money to retire comfortably and on time is in my mind as important as it gets.
Less than 3% of UK dentists are likely to be overfunding in relation to the lifetime limit
I noticed an article published recently inferring that many dentists are over funding their pensions, it went on to suggest that other forms of investment i.e. ISA’s, Investment Trusts, etc, are perfectly good alternatives to provide for your retirement. Let’s stop for a moment and think about that. Excuses to stop funding pensions are useful to some people because they think they are unable to afford them or don’t believe in them, but those of us who don’t want to take unnecessary risks with our retirement income should beware.
Firstly, in my view, pension plans if properly structured can be an excellent investment. As for the overfunding, from our own statistics and all the available research we can confirm that less than 3% of UK dentists are likely to be overfunding in relation to the lifetime limit and with Mr Darling’s recent announcement it is in fact vital that dental surgeons do not reduce their existing funding of pensions. Space doesn’t allow me to reproduce the details of Mr Darling’s reduction in allowable pension funding with tax relief, but ask yourself why is he bothering. The answer is a substantial number of high earners utilise pension plans. You should almost certainly follow suit.
Not all retirement funding plans are worthy of the name
A few of our clients have no pension holdings whatsoever, but with our help they are maximising their savings
Now to return to the second point that ISA’s, etc., are suitable for retirement planning. Whilst the statement is broadly accurate, we would urge dentists to exercise extreme caution in this area. Leaving aside the debate about taxed income and tax free income, ISA’s and general investments rarely survive into retirement, the reason for this is fairly obvious, the funds are designed to be readily available and are often used up on more pressing items like education, university funding, the new kitchen or that desperately needed holiday.
Please be aware that unless you are very, very financially organised, focussed and disciplined, funds accumulated outside of pension plans will almost certainly not be there in any quantity when you reach age 60. It has taken me nearly thirty years of financial planning to realise that, but sadly it’s true. You may be aware that other health care workers, doctors etc, are not leaving the superannuation scheme as are most dentists. It’s desperately important that the pension averse among us grasp this message.
In fairness a few of our clients have no pension holdings whatsoever, but with our help they are maximising their savings, boosting the value of their practice and estimating how much property etc., they will need to fund an adequate retirement. This is of course a very different scenario and takes extremely careful and consistent financial planning. If you don’t work with a financial planner or you don’t wish to work consistently with one you are in grave danger if you are not putting a substantial amount of money away that is ring fenced for retirement planning. You may well also be missing out on substantial tax planning opportunities.
Why personal pensions are a great idea
A properly structured commission free personal pension, funded by the practice, NOT the individual, is practically a “no brainer”
Personal pensions are of course just one of a whole range of pension schemes. The vast majority of self employed and employed UK dentists use only PPP’s (read also Stakeholder) so for the purposes of this article I will only be talking about personal pension plans. PPP’s as we recognise them took off in the late 1970’s and especially during the 80’s. Originally devised for those who didn’t have access to a company pension scheme they became extremely popular as an investment vehicle that benefited from tax relief at the highest rate suffered. This aspect is often misunderstood.
A useful way to visualise the process is to imagine that when a higher rate tax payer puts one pound into a PPP the Chancellor of the Exchequer puts his hand into his pocket and pulls out 40p and hands it over. Put another way you are buying investment pounds at 60p each, and yes that is as good as it sounds. This is a direct subsidy from the Inland Revenue designed specifically to increase pension contributions and is massively important. Other European governments decided to keep promising state benefits that frankly they will never be able to afford and failed to promote pensions in the same way as successive governments have in the UK. As a direct consequence if you took all the pensions funds of all of our European partners, and doubled them, you would still not have the amount that has accumulated in the UK. Those funds are for the most part invested on a tax exempt basis meaning they don’t have to pay capital gains tax to the government.
Here comes a controversial statement that I will stand by!!!! A properly structured commission free personal pension, funded by the practice, NOT the individual, is practically a “no brainer”.
Why have personal pensions had such a bad press?
Pension companies were quick to realise that they could ramp up charges dramatically without being noticed, especially in the pre “Financial Services Act 1986”
Most of us have long since forgotten or are too young to remember the phenomenon of high inflation. In January 1976 inflation topped out at 23.4%, it stayed for the most part in double digits until it hit another high of 21.9% in May 1980. It remained relatively high until 1986. Pension funds, especially the newly invented unit linked variety were supercharged at a phenomenal rate. I can remember discussing managed funds with clients at the time that were regularly returning between 15% and 20% per annum, some pure equity funds much more. Against this backdrop pension companies were quick to realise that they could ramp up charges dramatically without being noticed, especially in the pre “Financial Services Act 1986” days when nobody felt it necessary to inform clients about charges.
Some 70% of these schemes were sold by direct salespeople (only selling one company’s products) who were not legally required to compare their products with the open market. Stock market growth of this magnitude might sound great, but it doesn’t take a mathematician to work out that nobody was actually gaining very much as inflation was eating much of the gains. When inflation was eventually brought under control growth slowed, the charges remained the same and schemes that had been performing relatively well began to eat themselves. Companies and individuals had got out of the habit of topping up because they didn’t think it was necessary and then disaster. Not all pensions of course underperformed that badly, but a significant number did, certainly enough for the critics to latch onto.
Why does the mud still stick?
Pension owners reading this beware!!!!, there are still a substantial number of old style high cost schemes out there.
After dinner conversation to this day is still often dominated by those who bemoan the performance of their pensions and tell their children not to touch them with a bargepole. Newspaper sales are still boosted by gory tales of lost pension benefits due to stock market fluctuation and the greed and inefficiency of the insurance industry.
Even financial advisors who in my view should know better have decided not to swim against the tide and consider it trendy to knock pensions (I wonder if it could possibly have something to do with the low commissions now paid out on pensions). In fairness the insurance industry was painfully slow to react to the problems and it wasn’t really until the advent of the government sponsored Stakeholder pension that they were forced to address the situation and begin to substantially reduce costs. Even that might not have happened without 70% - 80% of schemes by now being sold by independent advisors who are required by law to compare scheme charges etc with the open market. Pension owners reading this beware!!!!, there are still a substantial number of old style high cost schemes out there.
Even if you are unlikely to increase your pension funding it is wise to have existing schemes reviewed. If you have substantial existing funds already, by substantial we mean over £50,000, we would suggest that you consider the viability of having those funds actively managed.
Why dentists should be making more pension contributions and not less.
We advise our clients that as a very rough guide they will need to be investing at least 6% of gross fee income into a retirement plan to ensure anything near adequate income when they retire.
The modern PPP/Stakeholder is a very low cost, flexible and easily managed investment vehicle with a very broad spread of investment possibilities. You do need to work with a fee based financial advisor and ensure that he or she rebates all commission to the policy. Consider this for a basic retirement planning concept. Looking back to the superannuation scheme you will recall that 6% of your gross income less some deductions was taken away from you before you received it, sadly, the money wasn’t invested, but it did buy you a given retirement benefit based on the amount of work you were carrying out under the NHS increased by the number of years you remained a member.
Many, many dental practitioners, unlike as mentioned the majority of your doctor colleagues, have now massively reduced the amount of NHS work they carry out and many more have dropped out of the scheme altogether. We advise our clients that as a very rough guide they will need to be investing at least 6% of gross fee income into a retirement plan to ensure anything near adequate income when they retire. Clearly, your individual circumstances, your age now, your income and the length of time you have effectively been out of the superannuation scheme varies the amount you need to invest and to give you an accurate figure you need a financial planner who uses very sophisticated shortfall analysis.
In my view, this analysis should show actual figures at a given age in today’s money terms and clearly state the amount that needs to be invested to make up the shortfall. We play safe and assume only a 6% annualised return instead of the 7% that has become the norm.
What to do to avoid the problem of reduced Superannuation benefits
we have adopted a system called “Pension Performance Review”
You simply replace one system that worked i.e. the superannuation scheme for another system that will work if you invest the correct amounts over a long enough period of time. If it’s a short period of time it needs to be a lot, lot more. Planning tip for young dentists, don’t wait, get started now even if it’s only a relatively small amount. Obviously, stock market fluctuations will effect the outcome and you don’t have the guarantees built into the superannuation scheme, but if the projections are conservatively based with adequate fund diversification, given enough time all should be well. Clearly financial planning is rather like teeth; work carried out without regular monitoring and maintenance is likely to lead to higher cost and a certain amount of pain.
As previously mentioned, retirement planning is a very important and technical area, your IFA must analyse all your existing pension arrangements including the superannuation scheme, provide you with a shortfall analysis and then provide you with a well thought out portfolio that relates directly to your attitude to risk and the amount of time before your actual retirement. The technology required to do this well has taken a number of years to come of age and after a great deal of analysis and comparison we have adopted a system called “Pension Performance Review” which is designed to cope with all the above criteria and also dovetails well with our existing review systems.
Who picks up the bill for your retirement funding?
Why on earth should you and your family pick up the bill for your retirement costs, clearly your patients should.
Last, but by no means least, and as I appear to be the only one banging this drum, funding of the above is a bona fide practice expense and should be treated exactly the same as your normal operating costs i.e. wages, lab bills and materials. Superannuation scheme contributions are a built in cost, if you start to move away from it why not continue to build the cost in. You and your family do not pick up the bill for your practice wages, your patients do. Why on earth should you and your family pick up the bill for your retirement costs, clearly your patients should.
Unfortunately, generally negative comments and newspaper articles have created a debate in peoples’ minds as to how they should fund for their retirement. That debate and confusion causes delay and many people will put off making a decision until it is too late. Our advice is make sure the practice funds an adequate retirement safety net, then all other assets, property, ISA’s unit trusts, goodwill, etc., becomes a bonus and a backup rather than the last resort when it comes to retirement. Broadly speaking, you could argue that retirement funding should be out of your gross income, everything else comes out of your net income.
The obvious method to achieve the above is to simply increase your fees and although it can be as simple as that we would normally expect to carry out a careful review of the practice operation to see if there are any obvious inefficiencies that when remedied will free up the necessary cash.
The advert
We have recently re-launched our website, we have a blog (I promise I won’t tell you how many cups of tea I drink in the day and when I am going to bed). I absolutely promise I won’t give you too much to read. We expect our clients to focus on dentistry while we focus on the financial planning.
An important planning tip:
Many of our new clients after years of ineffective or no financial planning come to us at age 50 – 60 and ask us to sort things out and ensure a reasonable income in retirement. We are very happy to assist and where clients follow our instructions to the letter we are always successful. That said there are substantial savings for clients who put a plan in place before age 50. Give us a call or email and we will tell you why.
Please visit our website at www.dentalfinancialassociates.co.uk or call us on 01489 890111 if you would like further information.
