Policeman's lot a very happy one

Steve is a police inspector, promoted late in service, who retires next May at 50. He writes:

'My wife, Val, is a non-taxpayer and hasn't worked for the past two years. We intend using her tax allowance as part of our retirement plan.

She will be 49 when I retire and, having worked shifts for 35 years, I do not want to work much then, just enough to keep my mind active and get a little fitter. I have an honours degree in law which I took at night school, while working shifts. I am now qualified to train police officers, which pays £500 a week and, because of my qualifications and background, I can easily pick up consultancy work. I also wish to retrain in a manual skill such as bricklaying to keep myself active. I was an electrician before becoming a police officer.

I will retire on a pension of £20,433 a year gross and a £103,000 lump sum.

My wife would like us to pay off the mortgage of £53,000 out of the lump sum. We also intend giving our son £8,000 as a wedding present, putting £5,000 away to use to refit our house and paying off the £8,000 we owe on the caravan and credit cards.

This will leave us near enough £30,000 in cash which I propose putting in fixed-rate bonds in my wife's name, currently at 5.85 per cent gross, as part of her tax allowance.

We will receive payments from a number of endowment policies after retirement, totalling £45,500 at the lowest estimates. We propose putting these into fixed-rate bonds in my wife's name as they mature.

We do not want to risk any of our money. My residual pension is not index-linked until I am 55 in September 2009. We have no other debts or savings.

I have worked without any break in my National Insurance contributions since I left school at 15. My wife has been the home-maker, and worked sporadically, making no National Insurance contributions. I am considering registering as self-employed as this would allow me to pay the minimum stamp towards our state pension.

If I stopped working altogether and paid off the mortgage and bills, I estimate that, given my outgoings (gas, water, rates, car, insurance, household bills and pocket money), after the endowments mature and the interest starts to flow from the bonds, we would have a minimum of £8,000 a year for our holidays and luxuries.

We do not have expensive tastes. We just intend staying in this country, taking holidays abroad in the sun and helping our family.'

Your pension's terrific - so take some risk

Your retirement plans are well organised and you
have worked hard to be in this comfortable position.
But, after 35 years in the job, you will not have a full
National Insurance record for the basic state pension.
You can check exactly where you stand by getting a
pension forecast from the website www.thepensionservice.gov.uk, tel 0845 3000 168.

The Inland Revenue website has downloadable leaflets about National
Insurance contributions. When you become
self-employed, you must write to your nearest Inland
Revenue (National Insurance Contributions) office and
will have to pay Class 1 contributions if your freelance
earnings exceed ?91 in any week.

Anna Bowes, savings and investment manager at
Bath-based Chase de Vere, comments: 'Steve has a
terrific pension that should comfortably be enough to
live on, especially when it becomes index-linked in five
years' time. As their everyday income is covered and
they have emphasised that they are low-risk investors,
they are right to maintain a large proportion of their
investment capital in cash.'

Normally, people need to take some risk with their
investments in the hope of making the amount they
need: 'But because Steve and Val's investment income
will be used mainly for holidays and luxuries, they can
afford not to take much risk. All the more so because
Val is a non-taxpayer and can therefore receive gross
interest.' In other words, it is not catastrophic if your
money loses some value to inflation because you have
a good indexed-linked pension.

That said, you should try to minimise the effects of
inflation as your money might need to stretch 40 or
even 50 years. Because the value of money in deposit
accounts remains the same, the income from it is
based on the same capital amount, even though prices
continue going up, which means your income, and
capital, reduces in real terms.

In addition, interest rates move up and down, warns
Bowes: 'While they know how much income they will
receive throughout the term of any fixed-rate bond,
when this comes to an end and they have to reinvest,
interest rates could have dropped so their income will
be less.'

She explains: 'At the moment, for example, the best
fixed-rate bond available is paying only 5.4 per cent on
?75,500, which would provide ?400 less a year than
the rate of 5.85 per cent which Steve mentioned.'

So Bowes recommends taking a little risk: 'They
should consider diversifying a little and investing into
some corporate bond and commercial property funds,
as well as cash. They could each invest up to ?7,000
into a corporate bond Isa which would then provide
tax-free income. This would not be fixed but it should
be fairly stable, as should the capital value over the
medium to long term.

'Commercial property is similar. It is considered a
lower-risk asset class but they would be unwise to put
all their eggs in one basket.' These investments provide
no guarantee that your money will keep up with
inflation but income and capital may increase over
time.

It is certainly sensible to pay off the mortgage and your
other debts immediately you receive the pension lump
sum, as the interest you avoid paying will outweigh any
interest you could earn from keeping the money on
deposit.

The wedding gift to your son will immediately reduce
your estate for inheritance tax purposes. Each parent
can give a child ?5,000 when he or she marries, on top
of the ?3,000 that anyone can give each year outside
the inheritance tax band. Gifts outside the limits are
calculated as part of your estate for inheritance tax if
you died within seven years. Download Inland Revenue
leaflet IHT3. Any money you give Val to invest is also
excluded from inheritance tax.

Steve's to-do list

1. Use the pension lump sum to pay off mortgage
and debts.

2. Keep making National Insurance contributions
and check the self-employed rules.

3. Use Val's non-taxpaying status to reduce tax.

4. Diversify your investments to compensate for
inflation.

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