Beware the spending spin

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Beware the spending spin

No one can accuse the department for work and pensions of being asleep on the job when it comes to pensions and care fees funding. The coalition government has introduced:

• Freedom of access to private money-purchase pensions from April 2015.

• Major reforms to the State pension from 2016

• Reform of care fees funding from 2016.

The problem with these reforms is not the changes proposed in themselves, but the political rhetoric that has surrounded their introduction and the impression given that easy access to pensions will be offset by an increase in the state pension and a cap on care costs of £72,000 a person. The detail is more complex than this, but the danger is that the political noise surrounding these changes could leave many underestimating the need to preserve pension funds and income for their later life needs.

This may not have been the intention of our legislators, but it certainly could be a consequence of the encouragement of early access to pension funds and the headline-grabbing assertions that no one will have to pay more than £72,000 of their own money before they get their care fees funding from the state. This, together with the announcement that everyone will get a basic state pension of £148.40 per week from 2016, which is an inaccurate portrayal of the state provision, could lead many over-55s to have a false expectation of what they will get from state benefits and thereby see them using pension funds as an alternative form of overdraft to meet today’s spending needs.

The impact of ill health and physical dependency on others is hard for most people to contemplate and to plan for. Most of us hope that the need will not arise, and even if we are prepared to admit it could be a possibility, determining to forego discretionary spending in retirement in order to plan for something which may not happen has little appeal. Most individuals are therefore predisposed not to plan ahead for care fees costs but instead to react to the need for care costs funding as and when it arises.

This can often result in poor choices being made from the point of view of accessing state funding, and the tax efficiency and sustainability of a particular funding route may become secondary to realising assets quickly. For example, it is common for children with elderly parents to seek to raise funds at short notice by selling their own investments. This can happen even where the parents are better off than the children, if the parent lacks capacity and no power of attorney is in place. While this provides short-term cash with no immediate tax consequences, the longer-term impact of loss of tax-efficient savings may not be apparent for some time.

These children tend to be in the over-55 age bracket with parents typically in the over-80 age group. One unintended consequence of the flexi access rules may be that we see more 50 and 60 somethings raiding their own pension funds to enable their parents to have access to the care of their choice. If that access to pension funds is undertaken without advice, and both income and cash are withdrawn, their future ability to rebuild pensions with the benefit of tax relief may be severely curtailed by the imposition of a £10,000 per annum limit on future funding with tax relief. What was seen as a short-term “loan” from the pension fund to deal with a family emergency could have a long-term impact on their own ability to fund and pay for their own care.

When an individual needing care undergoes a financial assessment of their means to contribute to the care costs, different sources of income and capital are assessed in different ways. For example, investment bonds, which are technically life policies, are disregarded completely in assessing capital available.

If instead an individual chooses to access their pension income via flexi drawdown with no fixed regular income being paid as would be the case with an annuity or occupational pension, the whole of the drawdown fund will be deemed to be a capital asset, with an income tariff applied to it. This could mean that a greater personal contribution would be required from the care resident and any provision for a dependent spouse would be depleted more quickly than would have been the case had an annuity been purchased.

Those planning retirement now need to be aware that the care cap of £72,000 is a massive underestimate of the funds which an individual needs to put aside to be sure of being able to afford a care package which suits them, rather than simply accepting whatever standard of care their local authority deems to be appropriate.

Care funding is essentially made up of three core elements:

The care cap of £72,000 will not include any money spent on care prior to April 2016.

Money spent after this date will not include any of the accommodation or bed and breakfast costs of residential care. This element, which averages around £12,000 a year, will continue to be the responsibility of the resident.

Each local authority is responsible for the provision of personal care, eg assistance with eating, dressing, mobility and personal hygiene, but each puts a cap on how much of this they will pay for. Any spending required over this cap will also be disregarded from the £72,000. So for example, if the personal care element of your care costs is £600 per week but your local authority caps it at £430, the £170 per week of extra spending does not count towards the £72,000 cap.

One estimate from specialist care fees provider Partnership is that the average spend, prior to the cap being exhausted is likely to be more than double £72,000 a person.

Where an individual lacks income or cash to pay the additional costs of their care but has a home and has not yet exhausted the £72,000 cap, they may qualify for assistance from the universal deferred payments scheme. This is a form of equity release whereby the local authority funds the extra care costs but then places a charge on the property and charges interest on the outstanding debt to be repaid when the property is sold. The interest charge will accrue from the date of advance of the funding and will gradually erode the value of the property to be passed to the estate.

Underestimating the personal cost of care and overestimating the level of state support available is a factor which could lead many to access and spend their own pension funds too soon. Leaving funds in flexi access accounts could mean that more of the pension fund is used to fund care and less provision can be made for a dependent spouse, whose interests might be better protected under a scheme pension or joint life annuity.

Kay Ingram is director, individual savings and investments, LEBC Group

Care costs

Now £800 a week, or £41,600 a year

After care cap of £72,000

Private pay fees £800 a week

Council usual costs for care According to latest draft guidance, £570 fees less £230 ordinary living costs paid by the resident

Resident pays the difference £460 a week in perpetuity

Source: Laing & Buisson

Key points

Many could underestimate the need to preserve pension funds and income for their later life needs.

It is common for children with elderly parents to seek to raise funds at short notice by selling their own investments.

Underestimating the personal cost of care and overestimating the level of state support could lead many to access and spend their own pension funds too soon.