Personal pensions get a lot of bad press, particularly in the current economic climate. OK, so they aren't perfect but they do have plenty of plus sides too. For example:
1. You get tax relief on the contributions you pay in. That's a 20% or 40% return straight away depending upon your usual tax level. There are very very few investments that can offer you that "growth" on day one.
2. Any employer payments that go in are also tax free to the employee
3. If you get a Stakeholder pension they must by law have low charges
There are restictions / downsides too such as:
1. Set rules on when and how you can take benefits although in recent years the flexibility has increased
2. Unless you know about investment a fund managed by your provider is usually the best bet so you do have to rely on them to manage the fund well to get growth.
3. Once in the money is in there until you reach at least age 55
As with anything financial it's best not to put all your eggs in one basket so in an ideal world you'll have a pension along with other savings, paying off your debts and mortgage.
Don't let bad press put you off pensions. They are not perfect but they aren't bad and without one or a sensible and well thought out alternative financial plan that you properly action you are going to feel it in retirement.
It is safe to say that the vast majority of people and in particular those in the under thirty five bracket will fail to set aside enough money for their retirement, as our life expectancy levels get ever greater and the number of retired people grows in relation to the ppulation who are in work then we are faced with an increasing state pension bill and for many this will mean they will have to work longer.
There are lots of choices when it comes to planning for your retirement however many of these schems are managed by the same bankers and insurance people who have got the economy into such a mess already so why trust them with your retirement money.
Generally the best option is to join your company scheme if they have one as this provides generally good benefits and the company may contribute on your behalf, the only real risk is if the company goes bust and even then most schemes are protected these days.
A personal pension is like a long term investment plan however you do have to be aware of the risk factors in the funds you invest in and also what the charges are for the scheme, the benefit is you get tax relief on your contributions, I used to have one that I paid into but it has performed badly and I have refused to add any money into it anymore.
Finally you can do your own provision and that is what my boyfriend and I are doing, we are looking to accelerate the repayment of our mortgage and then purchase an investment property and also build up a savings pot as well, that way we have control of the money and understand the risks of what we are doing.
There is a vast and unjustified hype over pensions with every professional recommending the same product to everybody despite falling annuity rates.
Of course rates fluctuate and there will be excellent times to redeem pensions in the future but it is impossible to predict this 60 years in advance and there is little flexibility in terms of when it is practical for most people to buy, I will not be betting my retirement on it.
It is often claimed that pensions get tax relief; this is true on a technicality but the annuity is taxed so all you get is the performance on the deferred tax pounds (unless you are a high rate tax payer before retirement and a standard rate payer afterwards).
The performance of the pension is largely irrelevant as you can neither withdraw more than 25% of the money nor secure debt against it (normally).
A big risk is government policy which is hugely restrictive and can easily change. Means tested pension credit makes investing for income potentially counter productive.
My plan is to build an unwrapped equities portfolio and to change weightings towards zero dividend preference shares and some dividend free ordinary value shares which I will sell in chunks.
Pensions are very boring and tend to be neglected until it is too late, so I thought I would write down my thoughts on the subject.
I have read quite a few articles in Sunday newspapers that would have you believe that middle-class life has a few simple rules: you should pay X% of your earnings into a pension, from an early age, whether it is a personal one or a company one; most of your salary goes towards your mortgage and the rest goes into a cash ISA. This should continue until you are 65, then you can live off the pension. Finance is simple and compartmentalised. I disagree with some of what these standard articles say, with the exception of one thing, which is that you do need to invest quite a lot for retirement and the earlier the better, but you do not have to exclusively put this in to a pension, unless you don't have any will-power and will end up spending it otherwise.
If your employer already pays into a pension or if you pay into a work scheme then you would only need to have a personal pension as well if you thought that scheme was inadequate for your needs.
What is a Personal Pension?
Personal pensions are provided by a huge number financial organisations and I won't recommend any one in particular, but they can be a very wide range of types of investment account, depending on your requirement. They can range from an active share trading account to effectively just a very safe, deposit account (or money market fund) but typically it might consist of a pension fund or a selection of pension funds, which are similar to unit trusts investing in a balanced safe portfolio or shares and bonds. The difference is, with a pension, in exchange for signing away your right to access the money at will, you will receive an income tax rebate on all of the money going into the account at your marginal rate of tax and the option to take 25% of the money as a tax-free lump sum at retirement. So that sounds pretty good? If you pay tax at 40% a £60 net investment results in you having £100 in your pension almost straight away. Obviously if you pay 20% tax you would need to pay in £80 for the same £100 (and if you include National Insurance you are not really getting all of your "income" tax back from the government) So personal pensions appear to be very good for higher-rate taxpayers and pretty good for basic rate tax payers.
I am not saying that these assumptions are incorrect. With the exception of the fact they obviously are far more generous to the rich than the poor in terms of tax rebate, there does appear to be a very positive reason for putting all of your retirement fund into a personal pension, but there are a few negative things to consider.
Pensions are not tax free.
Pensions and ISAs when launched were claimed to be tax-free. In the case of the ISA, this was true in that no tax was taken from capital gains nor dividends or interest and all of the money could be taken out tax free at any time. The personal pension was similar, except for the tax rebate described above, but only 25% of the fund could be taken out tax free and only on retirement and the rest had to be used for a pension which would be taxed. This is a simplification, because you can actually wait until the age of 75 before buying an annuity, but even so you don't have full access to all of you money. The tax-free status has also been changed by Gordon Brown, since their launch, in a complicated way involving tax-credits designed to be obscure enough for most not to understand or notice, but the result is that ISAs and personal pensions are effectively taxed at 10% on equity dividends, which means they are not much better for a basic rate tax payer than just holding the investments outside of the pension "wrapper". This only applies to the dividends on shares in an equity ISA and not to income from bond funds in an Equity ISA, nor to interest on cash in a Cash ISA which are both still tax free.
Capital Gains Tax
The government is being very generous by not charging capital gains tax on your investment inside the pension, but you are allowed £9,600 of tax free capital gains per year anyway, which most people don't use, so holding investments outside a pension only becomes an issue when you are are regularly disposing of gains of more than this. Capital gains are taxed at just 18% above £9,600 per year. You can also invest up to £7,200 a year into an equity ISA in very similar range of funds available through pensions, also completely capital gains tax free.
Income tax on Pension
One big argument for personal pensions is that you will probably earn less in retirement than while working, so you will pay tax at a lower rate, either because a bigger percentage of your salary is now in the income tax free personal allowance band (which is also larger for pensioners) or you are paying far less, or no tax at the 40% level. The best candidate, for whom pensions almost certainly beat ISAs, is someone paying 40% tax, but who is not extremely well paid, who on retirement will be just below the 40% tax limit. Tax rebates received while working will be in a higher band than tax paid while retired, but what will happen to the taxation system between now and then. The rules can change and it might not be in your favour. ISA's are not taxed when you take an income from them, nor when you take the money out, which you can do whenever you want e.g. if the ISA rules change, or if you retire early or need the money for something important.
There are several possible investments that could be used for retirement instead of a pension and I'm not referring to buy-to-let property, which has gone out of fashion for some reason. I am referring to other balanced investment portfolios that have different restrictions and tax treatment. Equity ISAs are my favourite and give very good tax incentives as described before, with extra flexibility, but in addition to these, and Cash ISAs there are National Savings and Investments Index Linked Savings Certificates, which are tax free and protect you against inflation and of course the best tax free investment of the lot: your mortgage. If you can pay chunks of your mortgage off without penalty the result is similar to have a really good rate of tax free interest on your savings.
Cheating the system
Recently the rules have changed so you can pay in up to £235,000 in one year, so you can save your money somewhere else until just before retirement, pay it into a pension collect your tax rebate, then shortly afterwards take your 25% tax-free lump sum. This way there is little chance of the government changing the rules and you have the flexibility of being able to do whatever you want with your money.
I have a personal pension into which my employer paid a large chunk of my salary for many years (rather than set up their own company pension) When this started personal pensions really were tax free (no 10% tax on dividends) I really was getting all of my income tax back on the money put in and I was allowed to choose and manage the investments, or get a fund manager to do it for me. In addition to that I could take the tax-free lump sum and pension at the age of fifty and sail off into the sunset. Fifty sounded like a good target in my industry which is full of youngsters. Unfortunately Gordon changed the rules and now I can't have the money until I am 55 and I actually semi-retired this year at 41 and I have to wait for 14 years for my money and what's to stop Darling from extending the pension age to 60 before I get to 55? Good job I put money in other investments too.
Income tax rebate (especially for higher rate tax payers)
Capital Gains Tax free
Good range of investment possibilities
25% tax free lump-sum at retirement
You will probably effectively be in a lower tax band in retirement
Can't take the money out until retirement age
Dividends taxed at 10%
Governement can change the rules and the minimum pension age
Pension will be taxed and the rate could be much higher
ISA tax rules are nearly as good, and they are far more flexible than pensions
Paying off credit card debt and loans is a better bet than either ISAs or Pensions and paying off the mortgage is a good alternative to a pension too.
In Conclusion there is a very good compelling argument for putting money into a personal pension, if you don't already have adequate cover from a company pension, and especially if you are a higher-rate tax payer, but you will have your money tied up until pension age, which, along with other pensions rules, might change to your disadvantage. If you want life to be simple and predictable, or if you don't have the discipline not to spend your money put lots of money into a pension, otherwise spread it around a bit just in case, and use your equity ISA allowance as well and pay off all expensive debt before any investment.
"Pensions. Hmm, how dull. I don't really want to think about them. I mean, after all, it will be years and years before I retire, right? I've got plenty of time to save up money before then, right?" Wrong. It is never, ever too early to start paying into a pension scheme. This is something I was fortunate enough to learn whilst working as an actuarial clerk for a large insurance company. One of my jobs was to produce statements of "Estimated Benefits", that is, the payments someone was likely to receive on their pension once they retired. Some of these were absolutely pitiful. They ranged from as little as £500 a year, to maybe £2,000. Thats right, that was a year. OK, so you may have your mortgage paid off by then, but even so, do you want to live on that? "Well, maybe I'll need to pay something in then. But still, I can leave it a bit longer and pay in lots when I'm older and I've got more cash". Doubtful. I remember we'd been asked by a chap to quote how much he would need to pay into a personal pension plan to get £20,000 a year. He was about fifty. The answer was, he simply couldn't. Even if he had the money, the government restricts the amount you are allowed to pay into a pension scheme, and at that time it was 15% of your income. It simply wasn't possible for him to pay in enough. I think this limit has increased a little now, but even so, you really don't want to be leaving it too long. I joined my employer's pension scheme as soon as I was able. I was 23. I do not, by any means, think that was too young to join a pension scheme. "What about the state pension?" I hate to be cycical, but I am extremely dubious that the state pension will even be around when I retire (in at least 30 years time). Even if it is, it is a pittance. If you had no other income than the state pens
ion, you would qualify for Income Support. "That's all very well and good, but I'm not sure I trust those pension scheme thingies. After all, aren't they dependent on the stock market? And you keep hearing big scandals of firms going under. Can't I just stick a load of money in the building society?" Indeed you could - you could save it up and live off it in your retirement, or you could save and purchase an annuity (an annual income) later in life. But there are benefits of saving within a "proper" pension scheme. Firstly, payments into pensions are tax exempt, meaning that effectively the government helps contribute to your pension scheme. For every £100 you pay, £22 of that is coming off your tax, so the net cost is only £78. Bonus. Secondly, if you are lucky, you may be able to join an employer's scheme, and they will most likely make an additional contribution on your behalf. That's on top of your salary matey. They're giving you free money, what are you waiting for? As for "trusting" all those nice insurance companies and pension providers, I can understand your concerns, particularly in this world of dodgy stock markets. But don't let this worry you unduly, especially if you are still of a relatively young age. Like all things financial, the stock market will go through peaks and troughs, but over time the value of your investment will increase. The high-profile collapses of some insurance firms, seeing investors lose the pensions they thought were safe, is far more worrying. However, the good news is there is some new legislation currently going through parliament which will force pension providers to contribute to an insurance scheme to cover investors in such eventualities. Although this may push up costs slightly, this will still offer a great deal of reassurance in a currently uncertain market. "OK,
OK, y ou've convinced me I need a pension, but it's all so darned confusing. Which one should I go for?" That rather depends what is on offer to you. If your employer offers a pension scheme, always find out about that first. They may well make additional contributions, and it will all be dealt with directly from your pay, saving you any hassle. Employers' Schemes can be either "Defined Benefit" Schemes (Sometimes also called "Final Salary Schemes"), or "Defined Contribution" (or "Money Purchase") Schemes. * DEFINED BENEFIT SCHEMES * Defined Benefit schemes are usually the best, but are unfortunately becoming rarer, as they are the most expensive for employers to offer. They are to the best of my knowledge only offered by employers - you cannot purchase one privately. Defined Benefit schemes, as the name suggests, base the final pension payable to you on your salary at retirement. This is usually calculated as a set fraction of your salary for each year you have contributed to the scheme. For example, the scheme may be a 1/60 scheme. This would mean that if you contributed to the scheme for 27 years, you would get 27/60 of your final salary - that is 1/60 for each year you have contributed. Your pension will then receive an inflationary increase each year. Some schemes are less generous, offering perhaps 1/70 or 1/80 for each year you contribute, but even so, you are likely to be better off that in a defined contribution scheme. Defined Benefit schemes often come with additional life insurance and dependants pensions should you die in service (i.e. whilst you are contributing to the scheme). Employee contributions to such schemes can vary from as little as 3% of your salary to as much as 8 or 9%, but it is worth every penny. If you are lucky enough to be offered a final salary scheme by your employer, my strictly non-professional advic
e would be to snap it up while you can. If you work in the public sector you should be in the fortunate position of being offered such a scheme. * DEFINED CONTRIBUTION SCHEMES (Including Stakeholder Pensions) * Again, as the name suggests, defined contribution schemes focus on the amount you pay into the scheme, rather than the amount of benefit you get when you retire. This means there is no guarantee of how much you will receive in retirement - that all depends on how well your investment performs. This is why they are sometimes called "Money Purchase Schemes", because you are purchasing an investment. Once more, if you are lucky enough to have an employer operating a scheme, you will probably find they also pay contributions into the scheme for you. Again, this is free money, so is usually worth doing. However, with the Labour government came a new kind of pension scheme called the "Stakeholder Pension". This is a pension scheme that anyone can set up with contributions from as little as £15-£20 per month. The government is keen to encourage everyone to have some sort of private pension, and for once I agree with them. This has meant a lot of employers who previously didn't offer any kind of pension scheme setting up stakeholder schemes where contributions are deducted at source from your salary. Unfortunately, often they will not make any contribution into the scheme for you, so it is worth shopping around to see if the scheme offered by your employer is really the best. * SO WHICH SHOULD YOU GO FOR? * As a rule of thumb (and this won't necessarily be the case for everyone), if your employer offers a final salary scheme grab it while you can, as many employers are phasing these out. During the 1980s a lot of private pensions were sold to people with the option to join final salary schemes, which proved more expensive and gave less benefits than the final salary sche
me would have. This led to the mis-selling of pensions scandal, where the insurance companies concerned had to make large compensation payments to people who had been mis-sold personal pension plans. This just serves to underline how good final salary schemes are. If your employer operates a defined contribution scheme into which they also pay contributions, this is probably your next best bet, as at least they will be paying in extra money for you. Most employers will only have one set scheme that they pay into - they won't let you shop around and pay their contribution into the scheme you favour, although on rare occasions some employers will. If your employer only offers a stakeholder pension or other defined contribution scheme into which they DO NOT make contributions, it could well be worth your while shopping around to see if the scheme they are offering is the best for you. When shopping around, remember you are only going to be looking at defined contribution schemes - unfortunately it is not possible to buy a final salary scheme off the shelf - if it was everyone would have one! If you are employed you can look at both stakeholder and other personal pension schemes. There are no definite ways of guaranteeing a good scheme, but here's a couple of pointers to help you out: * Look at the past performance of the scheme. Have the investments been growing at a reasonable rate? * Try and choose a well established company with proven results. This will offer some protection against the firm going under. I emphasise though that this is not guaranteed - as we have seen even the big names can go under. If you are unemployed or not working for any reason, until recently you would not have been able to pay into a pension scheme. However, the introduction of stakeholder pensions now offers you this flexibility, as absolutely anyone can have one - even children. Indeed, some parents, conscious of
the changing world of pensions and the potential lack of financial security in the future are even paying into schemes for their kids. The same rules of thumb for choosing a scheme apply. "Unfortunately, my employer doesn't offer a scheme so I've had to get a private pension. How much should I pay in?" As much as you can afford! The more you can pay in - especially in the early years - the more your investments will grow and the better the pension you will get in the end. It's as simple as that. "OK, OK, you've convinced me! I'm off to get myself a pension sorted a.s.a.p!" Very good, pupil. You have learned well. May the force be with you ;)
The traditional match-play knee-jerk response to the concept of the private pension was until fairly recently that it was 'a good thing'. The tide is changing somewhat now. I am one of the increasing band who think that they are a bad thing, a poor deal. I have made no significant provision whatsoever for my old age in the way of a pension, except for a few stakeholder carpet-bags, although, as I discuss below, I do not intend to spend my retirement too badly. I may as well declare that I don't share this view of pensions with regard to the final-salary pensions schemes, which guarantee you e.g. two-thirds of your final salary when leaving. If you have one of these - good - if you're offered one - dive in (unless you happen to work for someone called Maxwell). Trouble is, they are a rare beast now, particularly for new employees - their expectation that the pensioner will have served for several decades for an employer doesn't reflect our non-jobs-for-life culture, and they are also very expensive for employers, with pensioners enjoying increasingly long retirements. But your standard private pension scheme - an odd concept. (1) Entrust a significant stash of your earnings to commission/bonus-led macks who will invest it fairly sensibly for the first few years to add to their bonuses, then allow it to underperform once/if it becomes a 'closed fund' (no new pensions being added, therefore no need to have any level of performance from that time). Did someone mention 'Equitable Life'? Lovely. (2) On the 'commission' bit above - note it may well be 90% for the first couple of years. Invest £10,000, becomes £14,000 with tax-back, becomes £1,400. Sweetness - for the pensions industry. Stakeholder pensions are much better - you should be looking at commissions of 1% or less - but you're restricted in the sums you can pay in each year to £3,600, which simply isn't enough to get
a decent whack with today's annuity rates. I have in fact bought a few stakeholders as carpetbags and tax-dodges, and I have also set out at the end of this piece a get-rich-quick scheme involving the stakeholders (to be avoided like a mouse should avoid peanut butter and tuna on a metal spike) for those of you lucky enough to have passed the 'half-mile stone', i.e. of golden years. (3) Yes the tax-back. Superficially a good thing; Mr Brown will reimburse your tax on your pensions contributions at your highest rate. Well that's fine - until you take your pension. Mr Brown's granddaughter will simply tax it then. Much more transparent is to use the ISA as your vehicle - no tax-back now, but no tax in the future. This allows you to plan much better, because for the present you won't know what the granddaughter's tax rates will be. (4) Anyway, getting back to the pensions investment. You will hand over a significant portion of your salary - do you know where and how it's being invested? Of course not. The most detail you'll be lucky to get is the spread of shares/bonds/property/cash. Why? Nominally, because it's a trade secret. Actually? Because they are making pretty bog-standard investments, and wouldn't want Joe Public to know they're taking 90% of your money to research such unknown potential companies as Unilever, Tesco, and Coca-Cola. The bulk of pensions money goes into such blue chip investments. Its odd that the government trusts you to provide for your old age but won't, unless you're in the mega-rich bracket, allow you to administer your own pensions scheme. Pure nannying. If they're worried about the tax-back somehow being extracted prior to retirement, schemes or accounts could easily be set up, like the ISA's, to ensure that early withdrawals are not permitted - or, if they are, to make sure that the tax-back element is also withdrawn. (5) Then th
e final con - the annuity. More sweetness for the industry. By 75, you're going to have an annuity, with more commissions rolling in for the advisers and assorted hangers-on. In reality, you'll be buying this when you retire, probably at 60 or 65. From today's Times - 'A man aged 65 buying a joint pension with his 60-year-old wife can use their £250,000 savings to buy an annuity of just £18,025 a year.' And their children and friends will have lost any chance of inheriting that hard-earned and hard-saved cash. And Ms Brown is going to snatch a quarter of it every year as well. You could invest the sum in a deposit account and do almost as well, while keeping your capital to cascade through the generations. The advantage of the annuity is of course that if you happen to live to 105, the same sum (index-linked if you choose, for a lower income) will still be coming to you. However, the likelihood is that the pension will be going straight into the LPG-tank of your nursing home owner's Aston Martin by then. So what are the alternatives to pensions? The best is the ISA - gives you tax-exempted savings, which you can deal with and plan and, nearing retirement age, consider how to deal with to fund you to death, or thereabouts. Maximum investment £7,000 per year at present. There's always property. The hey-days are gone - if the old trends continued houses will cost a million even in Railway Terrace, Rugby. Still, the property market is an odd anomaly amongst financial bubbles, sustained by inheritances and a divorcing demographic, cash-rich and clamouring for housing. The most important property is your own manor. This is one of my chief financial schemes. I'm throwing the pension wad into the mortgage to pay it off early, get the true equity, move up the old ladder. Then, in simplest terms, once I've stopped earning, as I need cash, either remortgage or move to a wee-er place. Makes sense t
o me, although little evils such as stamp duty do complicate the issue. Buy-to-let is also a possibility, although so many are trying to get into and have got into this area, I think the bubble is due for a big pop in terms of rental incomes - more beer money for the students though, a good thing for youth and brewers. But, and I hate to say this, my main pension plan will be the state pension. Daft? I don't think so. Guaranteed minimum pension is £100 per week from April 2003. House paid off - add whatever per month currently paid into mortgage. Add spouse's pension/income. Once you're not worrying about paying a mortgage or rent, £200 per week isn't all so bad (my God, I'd earned less than that for long enough and still had a whale of a time), when you have lots of cash/equity/savings to slosh about. Best of all, if I do need my money in the meanwhile, due to sickness or dole-days, I can get my paws on it, or at least borrow on it. One thing I will be doing though - if it's still available at the time. You can draw down 50% of the cash value of your stakeholder pension from age 50 to 75. Maximum contribution £3,600 a year. Pay it in at age 50, get the 40% added (£5,040), then withdraw 50% (£2,520) - pay that in again, topped up to £3,600 the next year, 40% added again. Withdraw again and so on for 25 years. You will make a sweet mint, effectively getting 40% compounded from the Treasury. Here endeth the rant.
I work as a Pensions Administrator, so I hav to know a lot about pensions, boring you may think! No far from it, but what is strange is that so many people think they don't need one, or worse still they can't have one. Everybody needs one and most people can have one. So have you got one? If not why not? Are you too old - no. Are you too young - not now. Or do you just not know enough about them , or maybe you think it's ages yet until I retire. Maybe it is but, its never too early to start and the best time to do it is now. Why put off today what you can do tomorrow. I'll tell you why, the longer you delay, the more you need to pay. Why do you think that so many retired people are struggling. Because they rely on the old age pension. Unfortunately, by the time most of us get to retirement age there won't be an old age pension. So how will we live. We need to start a pension or if we already have one we need to make sure it will be sufficient to live on when we reach retirement. With the introduction of Stakeholder Pensions everyone can have a pension. Even your newborn baby or your grandchild. The earlier you start paying the bigger the pot will grow and the more comfortably off you will be in retirement. Where do I get one, how do I know it's right for me? Wee, if you are sensible you get a healthcheck from time to time. Why not get a pension healthcheck. Either from an Independent Financial Adviser who can advise you on any number of Companies products or from a Bank, Building Society or Insurance Company direct. A monthly pension contribution can be as little as £10 per month (that's about the cost of 3 gallon's of petrol). You also get tax relief on the contribution - therefore, you only pay £7.60, but £10.00 gets invested. A good deal hey. If you don't start one now, when you retire you might not be able to afford that
petrol, don't think about it - do it. I for one don't want to be a penniless pensioner - do you?