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Thursday 11 February 2010

QROPS and Pensions: Retiring Abroad

Deposits, bonds, shares and investment returns - all these will boost your pension plan during your retirement as a British expat.

Rising numbers of people now spend a quarter or even more than a third of their lives in retirement, enjoying what is – quite literally – the holiday of a lifetime.

However, just like any other holiday, you need adequate funds to make the most of it. As the novelist Somerset Maugham observed: “Money is like a sixth sense; without it, you cannot make full use of the other five.”

Planning ahead and seeking specialist advice sooner rather than later will make it much easier for you to achieve your retirement objectives.

For example, the sooner you start to save and invest for retirement, the better the chances are that you will accumulate the large sums of capital needed to provide an adequate income in today’s economic environment of low interest rates.

What’s inside the wrapper?

There is no particular magic to the word pensions - whether they are QROPS, SIPPs or any other sort of retirement savings – they are only a tax-efficient wrapper to hold assets which can deliver income, capital growth or a mixture of both. So, it is vital to consider carefully, in conjunction with your financial adviser, the different risk and reward characteristics of various assets or means of storing wealth.

No single answer will be right for everybody because individual and family circumstances vary so widely, but it is worth considering investment returns from the main asset classes in the past when deciding which components should play some part in your pension portfolio.

For most people, the appropriate advice will be to hold a mixture of different assets, with the proportions varying on the individual or family requirement for security, income or growth and how long they can afford to remain invested.

Deposits: low-risk, low-income

There is no need to take any short-term risk to enjoy the tax advantages of pensions; you can hold all of your contributions in cash deposits. However, while that might be a reasonable, cautious strategy in the final year or two before you intend to retire and draw benefits – because it will protect you from stock market setbacks - it would be wrong to imagine that this option is risk-free.

The explanation is that inflation tends to erode the real value or purchasing power of money over time. Even with today’s low levels of inflation, this is worth considering because, when planning retirement, you may want to protect the purchasing power of your pension decades into the future.

Banks and building societies promise to return your capital in nominal or face value terms; they do not promise to preserve its real value or purchasing power.

Perhaps unsurprisingly, low-risk deposits have tended to provide lower returns than the other two main types of asset which can be held in British pensions.

Bonds: higher-risk, higher income

Large companies issue IOUs to investors called corporate bonds, which usually promise to pay a fixed rate of interest for a fixed period of time before repaying the original sum invested. Countries also issue bonds and those issued by the British Government are called gilt-edged stock or gilts.

Both types of bond usually pay higher interest than deposits but entail a higher degree of risk; for example, bonds are not covered by the £50,000 per person statutory safety net that protects deposits with banks and building societies registered with the Financial Services Compensation Scheme.

By contrast, no bond is any better than its guarantor or the company that issued the bond. As a general rule, the higher the yield – that is, the income paid by a bond expressed as a percentage of the price for which it can be bought – the higher the risk of the bond.

This could be a specific risk – for example, the risk that the bond issuer might default or fail to pay income and/or capital; or it could be market risk – for example, that inflation is expected to rise and erode the real returns from all fixed interest bonds.

Quantitative easing - an economic policy intended to prevent the recession turning into a slump in Britain and elsewhere - increases the risk of inflation, as that is what has happened on previous occasions when governments printed more money to solve current problems.

Shares: high risk in pursuit of high returns

Shares – also known as equities – are higher risk than deposits or bonds, because they make no promises about repaying investors’ capital or income and enjoy no statutory safety net. However, despite recent setbacks, shares have tended to provide higher returns than other asset classes over most periods of five years or more in the past.

That historical fact is set out in the table, Shares versus Bonds and Deposits. Barclays Capital – a subsidiary of the high street bank – measures returns from these different stores of wealth going back to 1899 and updates its analysis annually. Before going on to consider those statistics in detail, it is important to understand that the past is not a guide to the future. Share prices can go down and you may get back less than you invest.

Investment returns: how long have you got?

According to the Barclays Capital Equity Gilt Study 2009, shares broadly reflecting the composition of the London stock market delivered greater returns than bonds or deposits in about three quarters of all the periods of five consecutive years in that sample of more than a century. To be precise, shares beat deposits on 74 per cent of those five-year periods and beat bonds 75 per cent of the time.

However, it can be seen that if the period of investment was shortened to just two consecutive years, the probability of shares doing best fell to nearer two thirds. In other words, there was a one-in-three chance that bonds or deposits would do better. This demonstrates the risk that short-term setbacks can hit share prices and explains why many advisers say shares are only suitable for money you can afford to remain invested for at least five years.

Over longer periods of time, such as 10 consecutive years, the historical probability of shares doing best increased to 92 per cent relative to deposits and 81 per cent compared to bonds.

Diminishing risk by diversification

Many pension savers remain understandably wary of the risks entailed in bonds and shares, despite the fact that bonds generally pay higher interest than deposits today and that shares have tended to deliver higher total returns than either bonds or deposits over the medium to long term in the past.

One way to square that circle is to consider pooled funds which seek to diminish risk by diversification.

These include unit and investment trusts, open-ended investment companies (OEICs) and other managed funds which bring together individual investors’ money to spread these funds over large numbers of underlying shares, bonds and other assets. This should give investors exposure to income and growth from the underlying assets while setting out to reduce their exposure to setbacks or failure at any one company, country or sector of the stock market.

The value of expert advice

In addition to diminishing risk by diversification, pooled funds also enable individual investors to share the cost of professional fund management. In other words, dedicated staff spend their days trying to keep abreast of today’s fast-moving money markets to make the most of your investments while you get on with making a living or enjoying retirement.

However, with more than 2,000 pooled funds authorised to be marketed in the United Kingdom and many more overseas, it is difficult to know which ones to choose. Just as do-it-yourself investment will not suit everybody, with many people preferring to pay professional fund managers, it may make sense to pay a professional financial adviser to recommend appropriate funds – and to make sure your portfolio of pension investments remains appropriate to your changing needs in the years ahead.

Flexible strategies for the future

For the reasons set out earlier, there is no single portfolio that will suit everybody and no substitute for seeking fully authorised financial advice which will be tailored to your individual – and, if relevant, family – circumstances.

This will entail a fact find procedure, where the adviser will seek information about your attitudes to risk and reward as well as other factors such as your requirements for income, growth or a mixture of both.

This may seem a bit of a chore but should enable the adviser to recommend an appropriate asset allocation or financial strategy to suit you. You should not regard this as a decision to file and forget but as a strategy that should be reviewed regularly.

For the reasons set out in the final chapter, it makes sense to choose your financial adviser carefully and to keep in touch with him or her during your retirement.

There is no single portfolio that will suit everybody and no substitute for seeking fully-authorised financial advice which will be tailored to your individual – and, if relevant, family – circumstances.

By Ian Dowie
http://www.telegraph.co.uk/finance/personalfinance/offshorefinance/7189808/QROPS-and-pensions-retiring-abroad.html

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