Foreign Perspectives

Archive for the ‘Retirement’ Category

Up until last year, the clear answer was with an increasing proportion of bonds as you approached retirement. However, that advice assumed that you would be buying an annuity on retirement therefore the rising proportion of bonds was aimed at stabilising your pension fund as you got closer to the point of purchasing the annuity.

All that changed last March when the chancellor announced that you would no longer be required to buy an annuity and could continue to manage your pension fund as you saw fit.

But, what does that mean in practice? Well, you don’t have the cliff-edge of an annuity purchase therefore you can carry on running the fund as you would have done ten or twenty years earlier. This means, that you can carry on largely in equities and, in principle, should let you have a rising income over the years that you are in retirement. On a related note, since the fund will go to your dependents, there isn’t the push to spend it all as there would otherwise have been and, of course, you wouldn’t want to run out of money either.

What you can do depends a lot on your circumstances and temperament. For example, if you’ve got the average pension fund of around £30,000 then you’re quite limited. That’s not really enough to allow you to take many risks and probably only really enough to act as a top-up to your old age pension which, in practical terms, means that you might well be best with an annuity. Move up to £300,000 (which a surprisingly large number of people will have) and it’s a whole different ball-game. For a start, that’s well above the minimum that a range of investment managers will take you on and it’s enough to allow you to move more into equities i.e. to take on a bit of risk.

What’s key though is to know what your attitude to investment risk is. Could you sleep at night if your pension fund dropped 30% for instance? Could you convince yourself that it wouldn’t matter if it did? (and it doesn’t – it’s the income that matters on a pension fund, not the capital value)

As from April 2015, those in the UK will have the option of taking full control of their own pension fund which is a fantastic freedom from the shackles of the insurance companies that up to now have controlled almost all pensions investments.

Although there are many people who invest their own private pensions just as they do with their ISAs, there is also the option of transferring one’s company scheme and investing that too. That’s a much bigger deal as one’s company pension is often much more substantial than one’s ISA although, up to now, that was not terribly relevant as you couldn’t take full control of it.

How much more substantial? Well, I recently calculated roughly how much it might be for a colleague and the numbers were quite staggering. Taking a simple example of someone who’d worked 40 years for this employer, earning £40,000 per year, the total value was aroud £450,000. More interesting, the pension that the employer was paying on that equated to around 4.75% (say £22,000).

So, in principle, if he were to take the £450,000 and could get 4.75% or more from the investments, he would do better than his company scheme. However, that’s not the full story. When he died the £22,000 would be reduced to £11,000 for his widow and when she died, the payments would stop. If he took the £450,000 and invested it himself, the pension income wouldn’t reduce when he died and in due course his kids would get to keep the £450,000 (or whatever it was then worth).

It looks like a better deal, and the only question is: would many people actually do that? Although it may seem crazy not to, the amounts of money involved are quite scary, after all you’re getting to manage an investment fund more than 10 times your salary and that’s probably a good deal more than most people are used to dealing with.

One way to get the confidence that you’d need to take the money is to run a dummy portfolio over the 5 or 10 years preceeding your retirement which should give you an idea of how well (or badly) you would be running the investments. That way, when the day comes, you’ll know whether or not you could do it. Whether you’d have the confidence to take the money and run it is, of course, quite another matter.

The changes in pensions announced in the recent UK budget were quite staggering in their scope and I suspect that it will be several years before the full implications of them dawn on most people.

Ignoring the minor, but quite significant, changes the biggie was that as from April 2015 your pensions savings effectively becomes a proper savings plan ie one where you can take the money out. Up to now, pensions often seemed to be an insurance company scam whereby you paid them money over your working life and when you retired they kept that money and paid you out an allowance from it. As of April 2015, so long as you are over pension age (usually 55), you can withdraw those savings.

That to me changes significantly how I consider my pension. Money put into it is no longer lost to some insurance company but is available to me just as my other savings are. One of the effects of that is that I’m much more willing to save money in the pension which can only be a good thing.

Another effect is that it somewhat muddies the waters as regards the difference in a pension and an ISA. In effect both are now fairly equivalent places to invest your money. With the pension, you get tax relief on the way in (ie put in £100 and it becomes £120 in the pension but income paid out is taxable) whereas with the ISA there’s no upfront tax relief but you don’t pay tax on any income paid out. This means that, for most people, a pension is a better savings vehicle as they are likely to be paying higher tax when working than when retired. Also, the limits are different with the pension being, largely, limited to your total income whereas the ISA is limited to £15,000 ie there’s, for most people, no practical limit on pension savings.

Combined with the new freedom, it would seem that it’s best to put your investments in a pension and your cash in an ISA.

A final point to note is that with pensions effectively becoming jumbo ISAs, there are likely to be a lot more investment companies offering them which, hopefully, will reduce the charges in due course.

What I suspect will throw many people is that all of a sudden their pension has become a, hopefully, large savings account. What you need to remember is the reason behind pensions which was always to create a large savings account which paid you an income for the rest of your days ie lifting the lot and spending it as soon as you retire could cause you considerable financial difficulty later on.