If you’re anything like me, with the best will in the world, it can be easy to accumulate things. Like a fish in a pond, most of us tend to fill the space we occupy and often find ourselves wondering how we ever coped before we had that space. With this in mind, it’s understandable why people seem to collect pensions like it’s some sort of a hobby. With a new job here and a bit of advice there, I’ve met many clients over the years that have dug out old pensions from all sorts of places.
Let’s face it, for most of us, pensions can be a dull subject. The British love to talk about property prices over a glass of Sauvignon, but seldom utter the word ‘pension’. I’m actually impressed that you’re among the minority who are still reading this article!
So why should we pay closer attention to our pensions? Well, alongside your home, the combined value of your pensions is likely to become one of the greatest assets you will possess in the lead up to your retirement. What’s more, this asset has the capacity to make or break your retirement goals. Get it right, and you could retire on a larger income and enjoy a comfortable lifestyle in retirement, with financial security. Get it wrong, and you may have to continue working for longer and perhaps even downsize.
We’re living longer than ever before, so if you were to retire at the age of 65 and live to be 95, you would need your pension to replace your income for 30 years.
Over the years, there have been occasions when pensions have had a bad wrap from the media. There have been many reasons for this, often associated with an employer’s bad-handling of a company pension scheme. The thing to remember here is that there are two components to consider with pensions.
First, is the pension itself. We sometimes refer to ISAs and pensions as Tax-Wrappers, because the title, ‘pension’, simply dictates how the money is treated for tax and other things like your allowances, investment options and accessibility. This is the part that is written into legislation about how pensions work, what they can and can’t be used for and how they can be accessed in retirement.
The second component is the underlying investment strategy and how the investments perform over time. With pensions, you can invest in almost anything you can think of, and, with such a broad range of investment options, there is always going to be the good, the bad and the ugly. Sometimes, when a poor investment strategy has been adopted and performance has been negative, blame is attributed to the pension, rather than the underlying investment strategy. However, it’s very important to differentiate the two.
Choosing a pension and deciding how much to pay into it is only the first step. Deciding upon a suitable and robust investment strategy for the long-term will have far greater an impact than most of us could imagine.
We live in an information-abundant society, but insight is rare and priceless. Like most things in the world of finance, the pensions landscape can be very complex.
We live in an information-abundant society, but insight is rare and priceless. Like most things in the world of finance, the pensions landscape can be very complex. Believe it or not, in 2006, pensions legislation went through so-called ‘Pensions Simplification’, but ever since then, successive Governments and regimes have introduced more and more layers of complexity. Nevertheless, where there is complexity, there is also opportunity and understanding the complexity is the first step to navigating your way through.
Let’s start by taking a step back. What exactly is a pension? Well, a pension is simply a tax-efficient savings plan for retirement; but it does have some limitations. One of the limitations is that you can’t access your pension until the age of 55. This age is due to increase to 57 by 2028 at which point it is likely that it will become fixed to 10-years less than the State Pension Age.
Pensions benefit from Tax-Relief on contributions, which simply means, that you get your income tax back on the money you pay into a pension. For Higher-Rate and Additional-Rate Taxpayers in particular, this is a significant benefit.
For example, a Basic Rate taxpayer could contribute £8,000 (net) into a pension and get £2,000 of Tax-Relief, so the actual investment would be £10,000 (gross). A Higher Rate taxpayer could claim a further £2,000 on their Tax Return, so the net contribution would only be £6,000 for a £10,000 (gross) investment.
In addition, any growth within a pension is free from Capital Gains Tax. This may not sound like much, but as the value of your pensions grows, this becomes more and more beneficial. In addition, from age 55+, you are able to withdraw up to 25% of your pension completely tax-free.
Deciding upon how much to save into your pension is dependent on a number of factors. Often, affordability is the limitation, but it also depends on when you want to retire, how much income you’re likely to need in retirement, how you’d like to invest and various other considerations.
We’re living longer than ever before, so if you were to retire at the age of 65 and live to be 95, you would need your pension to replace your income for 30 years. Multiply your anticipated annual expenses by 30 and you’ll probably have a sizeable number. Now factor in inflation at 3% pa for 30 years, because in 2047, a pint of milk is likely to cost £1.09. Also, we need to be mindful of the cost of nursing care fees in later life.
Sometimes clients want us simply to consolidate all their pensions into one big pot to help keep things simple. In some cases, this is achievable and can be good advice. In other cases, even if it were achievable, it may be detrimental, so care needs to be taken with each and every pension in isolation, no matter how small, to assess whether it’s worth retaining or switching.
If you find yourself drowning in pension paperwork or simply want to review what you’ve got and what it means to your future, please get in touch.
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This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections.
