Personal Finance: Financial Makeover - The pension can't wait

NAME JANET MATTINGLEY AGE 57 OCCUPATION TEAM LEADER, LOCAL AUTHORITY SOCIAL SERVICES DEPARTMENT

JANET, WHO is divorced, has brought up four children and still supports her youngest son at university. Not surprisingly, she has had little income left over to save.

She contributes 6 per cent of her pay towards her pension. The scheme is a final salary contracted-out arrangement, with a normal retirement age of 65.

With 22 years' service within the scheme, at 65 she will be entitled to an index-linked scheme pension of approximately 27.5 per cent of her final salary, plus a tax-free lump sum of about 82 .5 per cent of her final pensionable pay. These benefits are in addition to the basic state pension.

Janet has made no additional voluntary contributions to boost her pension, has very little savings, although has recently been left pounds 1,000 which is currently on deposit in a National Savings Investment Account currently paying 5.25 per cent before tax. After meeting all her normal monthly expenses, she has about pounds 300 per month available for savings and clothes.

Her house is worth approximately pounds 130,000 and she has a Bristol & West repayment mortgage with about six years to go, with monthly repayments of pounds 215.

When she retires, she wants to move to Cambridge to be near her daughter and granddaughter. However, properties in Cambridge are more expensive than Essex, where she lives.

The adviser: David Holland, managing director of RK Harrison Financial Planning, with offices in the City of London, Bedford, Salisbury, Exeter, Banbury and Scotland (01234 305555)

The advice: The rate paid by National Savings on Janet's pounds 1,000 can be improved upon. We would suggest the much-publicised Prudential Egg Instant Access Account, a telephone/ postal account currently paying 8 per cent gross (annual interest) on balances of pounds 1 or more. Prudential guarantees to pay 8 per cent gross until the end of 1998 and no less than base rate plus 0.25 per cent until 1 January 2000.

Janet should also save a further pounds 100 per month in her Egg account. This will replenish her holiday monies and will mean that by the time she retires at 65, she will have in excess of pounds 5,000 and still have instant access in the meantime for emergencies.

Ill health benefits under her local government pension scheme are not as generous as some, which immediately give the member the value of the prospective pension had they served to normal pension age.

Janet would receive, in such circumstances, an extra 6.66 years' service over and above her membership accrued to the date of ill health. This means with 14 years' current pensionable service, if she were to be retired on ill health grounds, her immediate pension would represent approximately 25.8 per cent of her current pensionable salary.

As she is divorced, she should check with the DSS (0191 213 5000) to see if she could enhance her entitlement to a state pension at retirement by claiming on the basis of her ex-husband's national insurance contribution record (if this was greater than her own).

This is usually, but not always, checked by the divorce solicitor, however, she should remember than any improvement would be lost should she re-marry, as her entitlement would then be based upon either her own or her new husband's contribution record.

Janet could consider a permanent health insurance (PHI) policy to protect income in the event of ill health enabling her to meet her mortgage and other commitments. As a smoker, but otherwise in good health, a policy providing 50 per cent of her income would cost pounds 45.35 per month where the income commenced after an initial period of continuous prolonged illness of 52 weeks, or pounds 56 per month if the deferred period dropped to six months.

The benefit under such a policy would remain level throughout payment and would cease at age 65; to have the benefit linked to RPI would increase the cost to pounds 51.48 and pounds 66 per month respectively.

We would recommend that the remainder of her surplus monthly income should go towards Additional Voluntary Contributions (AVCs) with the local government pension scheme. Contributions would obtain immediate tax relief. This means that pounds 100 invested with 23 per cent tax relief would, in effect, only cost Janet pounds 77 per month. Assuming she invests pounds 100 a month into AVCs from now on, at 65 her retirement fund might be worth just over pounds 13,000. Using current annuity rates, this sum would deliver pounds 1,100 a year, or if it were linked to RPI, the starting pension would be pounds 795 per annum.

Finally, with regard to Janet's intended move to Cambridge when she retires, on the assumption that there is still a significant differential between property prices in Cambridge compared to Essex, then she could consider a Shared Appreciation Mortgage, whereby the lender will lend money secured against the property.

Instead of making monthly repayments, the lender takes a percentage of the appreciating value in the property. The well-known Bank of Scotland scheme is currently unavailable.

There is, however, Norwich Union's Capital Access Account. This is slightly more complex to understand than the Bank of Scotland arrangement but works on a similar principle.

For example, on a property costing pounds 100,000 with a loan of pounds 25,000 for somebody aged between 65 and 69 years, the rate of interest is calculated as 2.95 per cent of the property value.

Given that Norwich Union are only lending pounds 25,000, this gives an equivalent rate of 11.8 per cent (pounds 100,000 times 2.95 per cent, which comes to pounds 2,950. Divided by pounds 25,000, this gives 11.8 per cent).

Each year, as the additional interest is accumulated, so the rate of interest reduces, so that after 20 years, the effective rate drops to 7.38 per cent. The typical APR for such a loan is 8.5 per cent per annum.

The problem with this arrangement is that in the event of repayment or death in the early years, it can prove quite expensive. For example, if the loan were to be repaid after 10 years, the total interest would amount to pounds 33,740 plus the loan of pounds 25,000 making a total repayment of pounds 58,740. In this example, if we assume a property currently worth pounds 100,000 with property price inflation at 5 per cent over the next 10 years, the property would then have a value of pounds 162,890, leaving a net value after discharging the loan plus interest of just over pounds 104,000.

Finally, my advice to Janet would be to stop smoking and save another pounds 86 per month. Between now and retirement, assuming the cost of cigarettes rise at 5 per cent a year, this would save her a further pounds 12,800.