Personal Pensions

Do not lose track of basic savings principles when struggling in the pensions morass.

"You've got to be Einstein to understand pensions" said Malcolm Mclean, chief executive of the Pensions Advisory Service, in 2003. He was right. But he was referring to the regulations, and it's even worse now.

But there is some relief: the pensions concept is much clearer.....

Let's clear up some terminology

When you talk about a pension you probably mean the income you are going to get when you retire. But as used on this page (and by financial product providers) 'pension' has a more precise meaning. It is a set of savings products parcelled up to take advantage of favourable tax breaks and then sold to you as a package, usually called a 'pension plan'. So a pension plan is a savings plan in a wrapper.

The big difference from conventional savings is that there are extensive rules on what you can do with the assets after retirement. This is only fair: you have received extensive tax reliefs on the way to retirement to help you not become a burden on the state after it.

You will be limited in the extent to which you can withdraw your savings without penalty; and those savings that remain within the wrapper must be used to fund a pension plan - the main types being annuity or drawdown. Best refer to the current government rules.

Choosing a plan

The savings plan (contents of the wrapper) must be assessed (by you) in exactly the same way as you would judge any of your savings for the long-term. There are no unique investments that you can only make for 'pensions' and not for any other purpose. So all the warnings about other savings products apply equally to pension plans.

Stakeholder pensions

These are conventional pension plans that conform to certain government requirements on charges and risk. The original concept of providing low-cost, simple pension plans for the less wealthy got lost when the government caved in to industry pressure to allow management charges of up to 1.5%. This makes them no more than ordinary pension plans with a confusing and meaningless government endorsement. If you are an employee they have effectively been superceded by....

Workplace pensions

ALL employers are now required to offer pension plans, with the following features (s at April 2023):

  • As an employee you are enrolled in your scheme unless you positively contract out - described as 'auto-enrolment'.
  • Your scheme will offer you a choice of investments.
  • Your employer must contribute at least 3% of your salary.
  • Total contributions (you  + your employer) must be at least 8%
  • Subject to limits and restrictions you will receive tax relief on your contributions. The monetary effect will depend on your tax band.

Your employer may offer an additional feature called 'salary-sacrifice'. For example, if you normally invest 8% (e.g.) of your salary in your plan your employer could instead contribute on your behalf and reduce your salary by 8%. The advantage is that both you and your employer save national insurance. The disadvantage is that your headline salary reduces, which may effect your mortgage or other salary related issues.

If you are an employee it is hard to construct a scenario where your workplace pension would not be your first choice of long-term saving, unless the investment choices it offers are high-cost or poorly chosen.

For others, or if you want to supplement your workplace pension.....

Wrapper points

There's a whole new set of things you need to watch for:

  • Charges - what you are charged to get in, to get out, and for annual administration. This will be on top of any fund management charges for investments within the wrapper.
  • Ease of exit - can you get out?
  • What choices do you have in the savings plan? Can the investment policy be changed to something you don't like? Are you given any information on past performance, either of the Plan or of the managers?
  • Can the provider put up charges in the future?
  • Can the provider change any of the other terms in the future?

There can be enormous variation in these things.......

......which makes your choice of plan critical.

Tax

Pension plans will trumpet their tax advantages. This is quite correct: they are considerable (tax relief at your top rate on your contributions and no tax on gains and income within the wrapper). But these advantages apply to all pensions within a wrapper. They should not be interpreted as applying to the particular pension plan whose marketing literature you are eyeing.

Charges

The magic of compound interest ensures that high charges can eat up the tax breaks on personal pension plans. Don't let that happen to you.

Some plans have a method of charging involving "allocation units". It is incomprehensible. Sorry, but obviously you will not be buying such a plan.

Management quality

There are some terrible pension plans out there. Hey, you're a captive customer, probably naive, probably unquestioning. What better place for any financial services group to park their dodgy managers and dodgy funds?

But you can fight back...

...........through Self Invested Personal Pensions (SIPPs). If carefully chosen, a SIPP can give you the flexibility and low costs you need for successful long-term saving.