Personal Pension Schemes in general
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Personal Pension Schemes in general
Member Name: delawney
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Personal Pension Schemes in general
Date: 02/07/03, updated on 16/11/04 (2585 review reads)
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Disadvantages: Darned confusing, Spending Money Now!
"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 ;)
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 ;)
Summary:
