Whilst we might imagine our retirement to involve frequent cruise trips to the Caribbean or golf breaks in Marbella, the stark reality is that too often shoddy retirement planning means scrimping in our twilight years.
Even if pension planning isn’t completely put on the back-burner, it is often neglected to such a degree that remedial action is extremely difficult.
Martin Bamford, chartered financial planner at Informed Choice agrees that the earlier you start saving for retirement, the easier it is, but concedes that often other priorities – whether rightly or wrongly - get in the way.
An early start
“Starting early gives your money longer to grow, benefiting from compounded returns, and means you need to contribute less to your retirement pot in total in order to reach the same level of savings.
“In practice, we tend to have competing financial priorities for our money when we’re younger; paying off debts, saving for a first home and childcare are common items of large expenditure.”
He adds: “As we get older, our expenses tend to reduce and our earnings increase, creating the opportunity to maximum retirement savings later in our career. This is beneficial too, although you need to contribute more in your 50s than you would have done in your 20s or 30s to get the same results.”
Whether you are being offered your first workplace pension or looking to boost your pension pot at the eleventh hour, we look at the various options available and consider the pros and cons each.
As Patrick Connolly, certified financial planner and head of communications at IFA Chase de Vere, explains, most company schemes are good value, especially if your employer also contributes on your behalf. All employers will need to do this shortly as auto-enrolment is fully rolled out.
He insists employees should look to maximise contributions if possible. “Find out if your employer will put more money into your pension if you increase the amount you are investing and also if you can use salary sacrifice (salary exchange) where you give up part of your salary in exchange for pension contributions. This can result in tax savings for employees."
For those fortunate enough to have a final salary or defined benefit (DB) pension scheme, then in theory you should be looking at a comfortable retirement based on extended years of service.
Most DB schemes have good benefits. They can often include 50% for a spouse’s pension (upon death, either before or after your retirement date), some offer increases of up to 5% on the deferred pension until the point at which benefits were taken (to help keep the values in line with inflation), and then provide inflation proofing once in payment.
Others also have an element of death benefits in payment if the policy holder passes away within five years of receiving benefits.
Some DB scheme members may also be entitled to ‘scheme protected tax free cash’ higher than the standard 25% lump sum offered on most pensions. This benefit would likely be lost if transferred into a defined contribution (DC) pension arrangement.
If you are thinking of transferring from a DB to a DC scheme, then the best policy is to take independent financial advice.
SIPPs – a flexible friend?
The advantages of joining a company pension scheme should usually outweigh the flexibility of investing in a Self-Invested Personal Pension (SIPP). Most company schemes offer a decent range of investment options and competitive charges.
But for those who do not have a company pension, or are self-employed, the onus is on looking at personal pensions. Typically, a SIPP has more investment options (for instance individual UK and overseas shares, unlisted shares and property) and more flexibility, than a personal pension, but a SIPP will often have higher charges.
This means you need to decide whether it is sensible to pay the higher charges on a SIPP to be able to benefit from the extra flexibility and investment choices.
SIPPs tend to fall into two broad categories. The full SIPP has a very wide range of investment options but is often expensive. A so-called low-cost SIPP is essentially a personal pension with a wider range of fund or share options in which you can invest.
Connolly says: “If you’re investing in a SIPP, it is important to remember that it is simply a pension wrapper, and how your pension performs depends on how much you invest and what investments you hold within it.
“It is therefore important that you adopt a sensible investment strategy, which for many will be a diversified portfolio consisting of equities, fixed interest and commercial property, which meets their financial objectives and attitude to risk.”
If you’re investing in a SIPP and have access to a wide range of specialist investment options, this doesn’t necessarily mean you should use them. If you do then you’re likely to be taking bigger risks that may, or may not, pay off for you.
What investments should sit next to a well-funded pension?
For most people the best approach for long-term savings is a combination of pensions and ISAs. Pensions provide initial tax relief which give your savings an immediate uplift. However, they are still quite inflexible, whereas ISAs can still be tax efficient and you are able to access your money whenever you like.
Make sure you’ve got the right balance between the two to suit your requirements.
So, for instance, if you don’t think you can afford to tie up large amounts of money then it may be prudent to increase the ISA component and maybe boost pension contributions at a later point if circumstances have changed.
How important are reviews?
How important is it to keep an eye on your personal pension portfolio to ensure it remains fit for purpose?
The answer is, it’s crucial as Justin Modray, chartered financial planner at Candid Money explains. “It is important to review your pension at least once a year, both the pension itself and the investments held within. If you have a work pension chances are you should retain it but if a personal pension, check how much its costing you and that its competitive.”
He adds: “As for underlying investments you should ensure they’re well managed, diversified and appropriate. For example, if you’ve 20 years until retirement you can probably afford to take a fair amount of risk, less so if retirement is only a few years away.
Connolly at Chase de Vere takes a similar line. “Put in place plans to review your pensions every six months, or at least annually. This way you can keep on top of how they’re performing and whether you need to make any changes to hit your retirement targets.”
He also stresses the need to monitor ongoing charges. “Find out how much you are paying in charges, because if you’re paying too much then these higher charges will be eating away at the value of your pension fund.
“In particular, many older pension policies have higher charges and if you’re invested via a platform make sure you understand the charges made by both your investment funds and your platform provider.”
The following table looks at the pension fund value at age 65 of people who start investing £100 gross each month at age 25, where their investment funds grew by 7% per annum before charges.
Pension charges per annum
Pension fund value at age 65
Source: Chase de Vere
Retirement planning for the self-employed
Is there anything special the self-employed should consider when retirement planning?
Yes, plenty. For one thing the self-employed are left to their own devices. They don’t have access to a company pension scheme or an employer which provides life assurance, income protection or other benefits.
There are major drawbacks which often prevent self-employed workers investing sufficiently into pensions. Firstly, the need to keep their finances flexible and not lock money away where they are unable to access it.
This is a particular concern for those who have varying levels of income and need to ensure they have enough aside to meet their daily living costs, business expenses and tax bills
This could mean that self-employed people prefer to keep more money in accessible cash savings or ISAs rather than in pensions, where they won’t be able to access any of it until at least age 55.
The downside of this is that having their money accessible also means that they are more likely to spend it, so it won’t be available when they reach retirement
As Modray explains “If you’re self-employed you don’t have the potential luxury of a workplace pension with employer contributions, so you’re on your own. This means you’ll need to save especially hard if you’re to generate a decent pension income in retirement.
“And remember, if you have a particularly good year you might consider bringing forward any unused annual pensions allowances from the previous three years, subject to using this year’s allowance in full first and the total contribution not exceeding your overall annual net earnings.”
An eye to the future
While making the most of annual pension contributions might be evidence of good practice, the reality is that too many of the self-employed aren’t saving enough, or worse still saving anything at all, for their futures.
As Connolly points out, they may feel they don’t have available funds or if they are company owners that their business is their pension.
“They often neglect their own personal finances as they see their business as their pension which is a high-risk strategy as it means they are putting all of their eggs in one basket. This could backfire if their business doesn’t perform well or if nobody wants to take it over when they retire.”
Bamford agrees that the self-employed are often far more vulnerable than they think when it comes to retirement provision.
“There’s a common attitude among the self-employed that they will either keep working forever, and therefore not need to save for retirement, or the value of their business will provide them with sufficient financial resources in later life.
“In our experience, this rarely happens; poor health or an absence of work means retirement is often forced upon the self-employment at some point in their 60s.
“Businesses are difficult to sell for an expected value when needed. As a result, it’s important to create retirement savings separate from your business which act as a ‘plan B’ in case you need to stop working or cannot sell your business for a sufficiently high value.”
The clear message from the experts is to start planning for your retirement as early as you can.