Provided we?re of sound health and mind, most of us would relish the prospect of a nice long life. The longer we live the more time we?ll have to enjoy the company of our loved ones, share in t
Provided we?re of sound health and mind, most of us would relish the prospect of a nice long life. The longer we live the more time we?ll have to enjoy the company of our loved ones, share in their lives, to see our family grow as our grandchildren have children of their own etc. Those who moved away from the UK to warmer climes on retirement will wish to have as much time as possible to enjoy their new life.
Thanks to advances in science and medicine, the possibility of us having 30 years or so in retirement increases. A 65 year old healthy man has a 50% chance of living until age 87, and a 25% chance of reaching 92 years. A 65 year old healthy woman has a 50% chance of living until age 90 and a 25% chance of reaching 96.
As medical research progresses these life spans will increase. In time it may become more common for people to live a further 35-40 years once they have retired.
From a financial point of view, we all need to be aware that as life expectancy increases, so does the length of time we need our savings and investments to last and provide an income. The longer you live, the further your money will need to stretch and the higher the possibility of it running out early.
This risk should not be underestimated. The last thing anyone wants is to be worried about money and have to reduce comforts and items like private healthcare, or even run out of savings completely, in their later years, when they are least able to deal with it.
Your financial planning therefore needs to take into account the possibility of you living longer than you may have previously expected. And of course it also needs to take inflation into account, inflation being perhaps the biggest financial threat to retired people. If, for example, you typically spend around ?5,000 a month nowadays, in 10 years time you could need around ?7,000 a month to maintain the same spending and in 20 years over ?10,000.
The traditional investment approach for people approaching retirement was to move capital out of equities and into less volatile assets like cash and gilts. However, when you take the possibility of living 30 years in retirement into account, this is no longer sound judgement. Your capital needs to earn enough capital growth to keep pace with inflation, and cash in the bank does not provide this. Your portfolio will need to include a mix of ?real assets? (equities, bonds, property) as well as cash. Your financial adviser should recommend a bespoke strategy based on your personal objectives and circumstances.
Moving away, for the moment, from the personal implications and onto those for governments, longevity will only add to the already high burden on the State.
For a start, the elderly tend to need more health care than younger people, so the more older people there are, the higher the national health bill for the Treasury, not to mention other social services for pensioners.
The second issue revolves round the change in demographics. Governments rely on taxes to fund their costs. In the past, when people did not live as long, there were more people in work than in retirement. Taxes were largely collected from the working population, who pay both income tax and national insurance.
Today, with less people in work and more people in retirement, there much less tax coming in to support social services for retired people.
So, what are governments to do? One solution would be to increase taxation. There are already steps towards this:-
– The UK?s autumn Pre-Budget Report announced that (1) from 2010/2011 there will be a progressive reduction in the basic personal allowance to one half for those earning over ?100,000 and to zero for those earning over ?140,000; (2) from 2011/12 a new 45% income tax rate will be introduced on income over ?150,000; (3) national insurance rates are to be increased over 2009-2012; (4) the pensions Annual Allowance and Lifetime Allowance have been frozen between 2011 to 2016, which will push more retirees into a tax charge.
– In the EU, the withholding tax applied under the terms of the Savings Tax Directive launched at 15% in 2005. It was increased to 20% last summer and will jump to 35% in July 2011. That?s 133% higher than the starting rate and much higher than many countries? savings tax rates. The Directive is currently under review, to be tightened to bring more people into its remit.
However, governments are unlikely to increase income tax to 50% or 60% or 70% as needed to cover their costs, even once the economy improves. Three other options available to them are to:
1. Further increase efforts to prevent tax evasion and collect previously unpaid taxes.
2. Change the health care system so that people have to contribute a larger amount to their costs.
3. Change the taxation system so that retired people have to contribute more to the national coffers than they currently do.
While we will have to wait and see how things pan out, it is possible that we will see all three introduced eventually in one way or another.
Of course, options 2 and 3 would impact significantly on retired people, further reducing their capital (on top of the inflation effects mentioned earlier).
It therefore makes sense for retired people to set up their financial planning to shelter as much of their income from taxation as possible. In the process, it is very important that they ensure that all methods used are fully legitimate.
There are arrangements available to expatriates living in the EU which will provide tax mitigation within a legitimate framework. Reducing the amount of tax you have to pay will make your money go further and help combat the effects of inflation.
The investment opportunities available within these ?tax wrappers? will help you structure your finances with the aim of keeping pace with inflation ? thereby allowing you to combine the various aspects of your financial planning in one exercise.
As always, it is essential that you ensure that any financial decisions you make are fully in line with your personal situation and objectives. Advice from an authorised and professional firm like Blevins Franks will help you get your affairs in order and ensure that you get your tax planning right from the outset.
by Bill Blevins, Managing Director, Blevins Franks