Flexible companion to pension planning

PERSONAL EQUITY PLANS

PENSION plans dominate most people's thinking when planning for retirement, writes Grant Ringshaw. Quite naturally too, considering the upfront relief at your highest rate of income tax that is on offer. Although pensions are a big part of the story of longer-term financial planning, PEPs can help fill the gaps.

Contributions to a pensionscheme are tax-free. But there are limits. For personal pension plans you can get tax relief on 17.5 per cent of what is called your net relevant earnings (basically your income, but more complicated if you are self-employed) if you are under 35. The limit rises in steps to 40 per cent for investors aged 61 to 74. On retirement, investors may take a lump sum of up to 25 per cent from their pensions tax-free. The tax sting in the tail is that the remainder has to be converted into regular pension payments that will be taxed.

The main problem for investors is that pensions are pretty inflexible. Money cannot be taken from an accumulated personal pension pot before the age of 50, and company pension schemes set their own minimum retirement date, usually ranging from 60 to 65. In addition, once you have bought the annuity - a pension for life - you are locked into a level of income, although under some circumstances it can be structured to increase.

It is worth noting that the introduction of flexible annuities or income- withdrawal schemes is now allowing people to delay buying an annuity until the age of 70, while still taking some income in the interim. But these are considered a high-risk alternative to the traditional annuity.

For the investor who is fully funding his pension, PEPs can either be used to provide regular income or as a savings vehicle to build long-term capital growth.

Graham Hooper, investment director of financial adviser Chase de Vere Investments, says: "I think the key is to have a foot in both the pensions and the PEP camps. For someone who is stuffed to the gunwales on their pension contributions, PEPs are an obvious choice."

In tax terms, contributions to PEPs are paid out of earned income, so there is no tax relief at the outset. Benefits come later.

But the key to using PEPs in pension planning is their flexibility. Unlike the position with a pension, investors can get easy access to their funds. The whole of a PEP investment may be cashed in at any time, and with no tax penalties. This also means that an investor can not only produce income by investing in an income-producing PEP, but also by cashing in the appropriate number of shares or units whenever necessary.

This is ideal for someone who wants to take early retirement and needs an income until a pension matures. Or a PEP may be used to top up the income from a personal or employee pension available on early retirement until the investor is eligible for state pension benefits.

Investors looking to maximise retirement income may be attracted by the new-style corporate bond PEP. There are more than 30 such plans on offer, producing an average income of about 8 per cent a year.

PEPs versus Pensions

PEPs Pensions

Tax relief on None At highest rate

contributions?

Tax on fund? Rolls up tax-free Rolls up tax-free

Tax on proceeds? Wholly tax-free With personal pensions

a lump sum of up to a

quarter of the fund can

be taken tax-free. With a final salary company

scheme you can take up

to one-and-a-half times

your final salary as

tax-free cash.