Workers being made redundant in their fifties and early sixties face the prospect of unwanted early retirement as Scotland stands on the brink of a new surge in unemployment.
Many of those with several years to retirement but struggling to secure new full-time work will now have to find a way of bridging the income gap as their savings and pension plans are thrown into disarray.
A number of Scotland's biggest firms are in the process of shedding jobs, with financial services hit especially hard. Edinburgh-based firms RBS, Standard Life and Aegon UK are all in the process of reducing headcounts and while Tesco Bank and Virgin Money are doing their best to reverse the trend, more jobs are being lost than made.
That picture may prove positively rosy compared with the public sector outlook for the coming months, as Scottish councils face up to swingeing spending cuts that will see thousands of jobs culled.
For some people redundancy is an opportunity to take early retirement and consider other options, but few can afford the loss of income that comes with ending their full-time working lives earlier than previously hoped.
What's more, many people who use redundancy to take early retirement underestimate the funds they need to make their income last, according to Paul Lothian, chartered financial planner at Verus Financial Planning in Dundee. "The reality is few people can afford the drop in income that early retirement brings about," he said.
The cost
Take the example of a 55-year-old man with earnings of £50,000 a year comprised of a £40,000 salary, which is pensionable, and a £10,000 bonus, which is not.
He was made redundant and pensioned off early after 25 years' service, in a generous final-salary scheme with a normal retirement age of 65 and is entitled to a tax-free redundancy lump sum of at least £10,260. Provided he is allowed to take his pension benefits early, and with no actuarial reduction for early retirement, his pension would amount to £16,667 a year in retirement, compared with the £50,000 a year earned while working.
"That's a 60 per cent drop from a net £3,000 a month to £1,200 a month, ignoring any pension contributions he would have been making from pay," said Lothian. "Unless he was previously saving a large part of his salary, such a drastic change in income would be a huge challenge for anyone."
And that's before you consider the earnings lost due to retiring ten years before the default retirement age.
"Had he worked until 65, and ignoring any pay rises, he would have earned a further £360,000 and boosted his retirement pension to £23,300 a year. So, early retirement can be hugely costly if the income and benefits accrual are not replaced," Lothian said.
This generous example underlines the challenge facing someone who earns more than twice the average wage.
Relatively few people being made redundant in their late fifties and early sixties will have significant pension benefits to cushion the fall, particularly with so many employers closing their final salary schemes to both new and existing members in recent years.
"In reality then, most people in this situation would have to find other employment, perhaps part-time, to augment their income," Lothian said. "This underlines the importance of building significant savings from an early age and living well within one's means."
The plan
So how can you bridge the income gap if you're made redundant ahead of the state pension age yet feel a return to work is unlikely?
Brian Steeples, managing director of the Turris Partnership in Glasgow, advised putting together an income-and-expenditure plan, starting by setting out all the pension income that can be taken straight away. It's also important to consider when exactly state pension benefits will begin and how much they will be. Once that is done, build an annual expenditure plan by setting out all of your monthly and annual costs, including irregular outgoings such as holidays and birthdays. The outcome should identify what shortfall of income there is, if any.
The next step is to identify all capital, savings and investments and a list of all liabilities, including mortgages. That should hopefully leave a balance of assets that can help reduce the income shortfall and be used for investment purposes.
How that money is invested depends on the amount, circumstances and appetite for risk. Independent financial advice is highly recommended when it comes to working out your risk appetite, the required investment return, investment timescales and what you should invest in.
Investments should always start with tax-efficient options such as individual savings accounts. "This will help to maximise tax free income depending upon the size of investment," Steeples said. "Capital gains tax is another important and useful tax allowance that can help to supplement income in retirement."
Bridging the gap
But building a robust retirement fund for the long term is not the top priority for many early retirees who simply need to shore up their income over the short term, perhaps until their pension benefits kick in. This temporary shortfall can be addressed by putting aside a specific capital sum - a "capital bridge". One option is to use a redundancy payment - which is tax-free up to £30,000 - as a lump sum in lieu of lost future earnings.
"There is nothing wrong with spending a known amount of capital in a planned and controlled manner in order to plug a short-term gap in income," said Steeples. "It is perfectly in order to use the lump sum as a means of bridging the gap between the point of redundancy and the date when other pension income may start, as long as it is done in a planned, controlled manner."
It may well be that this allows you to defer taking your state pension.
By doing this you can boost your weekly pension payment by 1 per cent for every five weeks that you defer, or get a lump sum plus interest of the base rate plus 2 per cent if you delay taking it for at least a year.
You can get a forecast of your state pension entitlement from the Pension Service (0845 300 0168 or www.thepensionservice.gov.uk).
Article from The Scotsman