Pensions! We all have one and know it’s important, but how many of us can truly say we understand how they work?
If that’s you then you’re definitely not alone.
Recent research by personal finance website Nerd Wallet found that fewer than one in five of us would feel confident they know what contributions they need to be making to fund a comfortable retirement.
Well over half did not even know who their pension provider was!
And yet, after a house, a pension is likely to be one of, if not, THE biggest assets you will ever own. If your New Year’s resolution is to finally get on top of your finances, then it could be a good place to start.
Dust off those annual statements and set about working out how well your retirement fund is working for you and you may find that you would be better off managing your pension yourself.
- Workplace pensions
- What about managing your pension yourself?
- Freelance pensions
- How to open a SiPP
- Managing your investments
- Beware of scams
The majority of us (or at least those of us not fortunate enough to have a final salary pension) will have been enrolled in a ‘defined contribution’ workplace pension.
The law now requires employers to automatically enrol their employees (or, at least, those who meet the minimum income requirements) into a scheme. Both the employee and employer makes contributions.
This policy change has created millions of new savers putting away money for retirement. That seems like great news, so, what’s the catch?
Well, the vast majority of us just leave it at that, forget about it and never look under the hood. In fact, research suggests that 95% of savers stay in their pension’s default fund – and this can mean missing out on vital investment returns.
Whatever type of pension you have it will be invested, usually in a mix of the stock market, low-risk bonds and cash. However, default funds are one-size-fits-all and therefore naturally low on risk.
Typically they scale down the risk automatically, by shifting money from the stock market to cash, gradually as you move closer to retirement age.
run your own workplace pension
However, those who choose their investments themselves may be able to get better returns by taking a little more risk.
This is particularly relevant for young people at the start of their career. If you are in your 20s and don’t tend to retire for 40 years (or more!) then you can afford to take a little more risk as you have many, many years to recover from any market downturns.
- Most workplace pensions offer flexibility in terms of different prepackaged funds. It may be worth finding out from your employer or pension provider what your options are and, if you can stomach the greater risk, switching out of the default fund.
- If you know who your pension provider is you can usually assess the different options on its website.
Richard Eagling, senior pensions expert at Nerd Wallet, says: “I would encourage those who have a workplace pension to get in touch with their employer to discuss how it works, and what their contributions are.
“If you know your provider and have the relevant information, you can usually check on their website and see the value of your fund and the plan they have chosen for you.”
For those who are not too confident about investing, a workplace scheme, also called an “occupational” pension, may be the best option.
However, the limited number of prepackaged funds offered by most schemes could feel restrictive to those who want to exercise some freedom over their retirement savings.
For those people – and for people who work for themselves – a “personal” pension is a good option.
This is a pension you open yourself with an insurance company or other pension provider.
One of the most common is a “self-invested personal pension” or SiPP, which gives you the tax perks of a pension but with a far greater choice of investments.
Saving into a pension is a tax-efficient way to put money aside as the Government grants tax relief on contributions in line with your tax rate – so 20% for basic rate taxpayers and 40% for high-rate.
In simple terms, this means that 80p saved into a pension by a basic-rate taxpayer is topped up to £1 by the Government.
The downside is that you will have to pay income tax on any money withdrawn as income in retirement, although you can take a lump-sum of up to 25% tax free.
Another thing to be aware of before deciding to open a SiPP is that not all employers will make contributions to a Sipp. This could be a significant downside as you would be missing out on valuable money paid into your pension. For these people it could make more sense to stay put in the workplace scheme so they aren’t missing out.
Anyone under the age of 75 who lives in the UK can open a SiPP.
Some providers include Close Brothers, Vanguard, Aviva, Interactive Investor, AJ Bell and Fidelity.
You can also open a SiPP on one of the investment platforms like AJBell, Interactive Investor, Charles Stanley or Hargreaves Lansdown. If you do it on one of those platforms it’s quite easy to see what you have in your SiPP and then sell some things and buy others to put into it.
You can open a SiPP even if you already have an existing pension. You can even transfer your old pensions into it to make them easier to manage – although before doing this make sure to check whether you would be giving up any benefits offered by the previous scheme. There could also be exit charges to pay.
Both you and your employer can make contributions, although be aware that not all employers will do so.
There are around five million self-employed people in the UK, but recent research suggested fewer than a quarter of them are regularly saving into a pension.
If you are one of the three-quarters who is not then you could be left with very little to retire on and forced to rely on the state pension. Depending on your circumstances this can be quite meagre.
Self-employed pension savers can opt for a SiPP, just as described above, or they could join Nest, which is the Government-backed pension scheme and offers some of the lowest charges available.
It is also worth considering an option like PensionBee or Penfold, which offer schemes aimed at the self-employed.
The former allows you to consolidate previous pension pots in order to make them easier to manage, while the latter claims to offer minimum jargon and take just five minutes to set up.
It is worth noting again here in stronger terms that SiPPs should only really be considered by people who are relatively confident with investing and happy to spend the time doing the research and managing their retirement savings for themselves.
For those who aren’,t a workplace pension is ideal as most of the hard work is done for you. You can also buy a ready-made personal pension from one of the pension companies that you don’t have to think about – the fund managers do the choosing for you.
But for those who are up to the challenge, then choosing your own investments could be a good way to maximise your returns.
what to put in your pension
Like any other investment account, your pension can be invested in shares, funds, gilts and corporate bonds or held in cash.
stocks and shares
Buying a share means buying stock in a specific company in the hope that its value will grow over time. You can buy shares in any company listed on the stock exchange, for example Royal Dutch Shell or BT. If the company performs well then the value of your investment will grow, but be aware that if it performs poorly then you could lose money too.
A note here on volatile markets: companies can go through a sticky period and come out the other side, recovering their value. Given your pension will remain invested for many years, it is not always the right idea to sell a stock when it falls, as this locks in the loss of value. You will have to make a decision as to whether the drop in value is temporary or permanent.
Funds are a bundle of individual stocks packaged together to create a basket for you to invest in. They will normally focus on a particular type of company, like renewable energy firms or the FTSE 100 for example. They can be attractive as they build in diversification (more on that in a moment). They are either chosen by a fund manager or an algorithm – the former will be more expensive to own than the latter, but theoretically can be more agile to volatile markets.
Bonds and gilts are effectively loans you make to the Government or a company in exchange for scheduled payments and your original capital returned at a fixed point in the future. They are considered lower risk than stocks and funds, but they are by no means a sure thing. Make sure you do your research, particularly if the bond is being offered by a company you have never heard of. If it goes bust, then it won’t be able to give you your money back! Also, at the moment, bonds and gilts give so little returns that most professional investors are ignoring them. You probably should too until the returns are better.
There is another type of bond called a “mini-bond”, which are offered by very small or emerging companies. These should be treated with extreme caution as these companies frequently fail or turn out to be completely fraudulent. They are not meant for ordinary investors and, in fact, advertising them to such customers is now banned. They are best avoided by most people.
Finally, money held in cash will not grow in value but at least cannot be lost to poorly performing companies or volatility. However, inflation means you are unlikely to want to have too high a proportion of your pension in cash, particularly if you are many years away from retirement.
Whatever you choose to invest your money in, a key thing to remember is to diversify. This simply means making sure your eggs aren’t all in one basket. You should NEVER invest your entire pension in one company, for example, as if it goes bankrupt you would lose all of your retirement savings – which would be catastrophic.
Ideally your savings would be split across a range of different stocks, funds, bonds and with some held in cash for good measure.
You may want to consider your level of risk as you get older, and closer to retirement. In practice this means selling out of stocks and funds and transferring to more bonds and cash as you get nearer to the time the money will be needed. This should shield you somewhat from big dips in the market occurring just at the time you need the money.
Finally, there will be charges to pay on your investments. Your Sipp provider will charge you a fee, as will the company that runs any funds. You could also be charged to buy or sell stocks, depending on your pension provider. It is worth shopping around to find which provider offers the lowest fees and what the drawbacks are.
We can’t tell you what to invest in, but now you are armed with the basics, you will be much better equipped to head out and make decisions for yourself.
Your pension will be a huge financial asset and therefore it could well become a target for scammers.
Be aware that cold-calling pension savers to offer investment opportunities is now BANNED. This means that if you receive a call out of the blue about an enticing investment opportunity it is highly likely to be a scam.
Don’t panic if someone does offer you something like this. Take your time to think about it and do your research. And remember the age old saying: if it sounds too good to be true, it probably is.
This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.