Further information to support the main articles around pensions.
Company & private pensions Annuities and their replacements Choosing the funds
- Money Purchase Pensions (all stakeholders and private pensions, some company pensions).
Technically known as ‘defined contribution' pensions, here you pay a monthly amount or a lump sum, which builds up a pot of money/investments. The pension pot's final size depends on how much you put in and the growth of your investment.
With private pensions, you contribute all the money. With company schemes, employers can contribute towards your pension often as ‘matched contributions'. In other words it says ‘you put in up to 4% of salary and we'll match it'. If so, bite its hand off! Try and put the maximum in or you're missing out on free cash to build a much bigger pension pot. Also if you have one of these types of pension, when you're applying for a new job, remember to include it as part of your salary.
However, if your company offers a money purchase pension (it'll probably be a stakeholder) and doesn't offer to contribute, find out what its charges are and the fund choice. It's actually likely that by doing it yourself privately you'll pay less and have a wider investment choice, in which case there's no point in going with your company pension.
- Final Salary Pensions (only company pensions).
Technically called ‘defined benefit' schemes, here your company provides a pension plan (you could be asked to contribute too), but what you'll eventually be paid out doesn't rely on the investment performance but solely on how long you worked there and your final salary when you leave.
These used to be the gold standard, and common advice was ‘grab one if you can'. Yet unfortunately due to under funding by companies plus a tax measure by Gordon Brown in 1997 that took nearly £5bn a year out of pension funds, some final salary pensions took a dive and confidence was knocked.
In April 2005, the Government set up a fund to protect the payouts and this looks like it should solve the problem, though there are questions about whether the size of the fund will be sufficient.
The bigger problem for most people is that final salary funds are rarely offered anymore.
The annuity rules raised disquiet for many years. Many people (me included), thought they were unfair. They were designed so those with pension money don't blow it all then rely on the state. However, having to spend 75% of your fund, regardless of its size, seems over the top.
Until April 2006, you had to buy an annuity before reaching your 75th birthday. Now a variety of alternatives which are new, more flexible, and of course, as with much in this type of finance, complicated.
Getting it wrong can be costly; buy a standard annuity and you're stuck with it for the rest of your life even if it was the wrong call. That makes this in many ways the most important single financial decision in anybody's lifetime. Thus whilst I'm usually no fan of paying for advice, in this case most people are better off taking the safe route of seeking an Independent Financial Adviser (IFA).
To find a local IFA go to the www.unbiased.co.uk, alternatively call to one of the three big specialist annuity advisers, Annuity Bureau, Annuity Direct and William Burrows.
Some of the annuity type options:
- Standard annuities. Here you trade in a lump sum of cash and receive a payment (which is taxed) each year for the rest of your life until you die – meaning no money is left from it for your dependants. The payment depends on the lump sum size, current annuity rates (which sadly have been dropping rapidly over the last 10 years) and how long the actuarial risk tables predict you're likely to live.
The longer your predicted lifespan, i.e. for non-smokers, those in better health, women, those cashing in pensions earlier, the less per year you'll get. Thus live longer than the risk tables think you will, and you're doing well, but don't live as long, and you've doubly lost. - Secured income. In April 2006 the ability to use your pension pot to draw down a taxed “secured income” up to the age of 75 was introduced. In other words you can take some money out of your pension pot each year and use it rather than buying an annuity, this leaves your pension intact so if you died it can be passed on to your dependants. The amount you can take out is limited though, so you don't blow it all at once on a Ferrari or helicopter spending spree
After age 75, you can buy an ‘Alternative Secured Income', which is similar except you can take less money out per year. - New types of annuity. There are now two new types of annuity. Limited-Period Annuities last for just five years, after which time you can buy another or a bog-standard lifetime annuity. Value-Protected Annuities will pay out any remaining pot to your heirs when you die, but produce a lower income than normal annuities.
- Just take the cash. Anyone with a ‘trivial pension', where the total fund at retirement is worth less than £15,000, will be able to simply withdraw the cash, though only 25% of it will be tax free.
Those starting early (i.e., 20s or early 30s) should aim for higher-risk funds, as there's time to wait out any bad performance. This typically means a mix of share based funds from a variety of countries and sector specific funds e.g. healthcare.
The closer you get to retirement, the more important it is to lower the risk, so short-term stock-market fluctuations can't hit too heavily, e.g. a market crash the day before you retired would permanently damage your retirement income. Therefore lower risk gilt and cash funds become more desirable.
This site doesn't primarily cover investing, but some good sites that do are Interactive Investor, The Motley Fool, Citywire and ADVFN also those going through discounter Hargreaves Lansdown, will find it provides investment choice information.