AS PRIVATE sector employers give up on final-salary schemes, more workers are now relying on defined contribution pensions for their workplace savings. But with your eventual retirement income from these pensions dependent on how much you invest, the returns and future annuity rates, it pays to take a close interest.
Bill Saunders, a certified financial planner and head of financial planning at Acumen Financial Planning, shares his top ten tips on getting the most from defined contribution schemes.
Top Ten Tips
1HAVE A PLAN
Understand how much you need to contribute towards a pension in order to produce the income you need or desire in retirement. The calculations need to take into account any other assets you have earmarked for the long term, inflation, potential future fund growth and any State pension you are entitled to.
Engage the help of a well-qualified independent financial adviser or a financial planner to undertake these calculations. As the old cliché goes “failing to plan, is planning to fail.”
Pensions remain especially attractive to higher-rate taxpayers. Although recent Budgets have been preceded by talk of ending higher rate relief, it’s still the case that up to 50 per cent of the cost of pension contributions can be picked up by HM Revenue & Customs. There’s still talk that this could change in the 21 March budget, however.
Many employers operate a scheme that promises to match your contributions on a one-for-one basis. In other words, if you commit to paying, say, 5 per cent into your pension, your employer will do likewise. If you only pay 3 per cent, your employer may only pay 3 per cent.
Such incentives provided by the employer are extremely attractive, especially when combined with tax relief. For example, for an employee earning £30,000 a year, a 5 per cent contribution would cost the individual a net £100 per month, but a total of £250 per month would be invested each month if the employer matched the contribution.
Many employers allow their employees to exchange or “sacrifice” part of their salary in return for non-cash benefits such as childcare vouchers, a bike for commuting to work or pension contributions.
Both parties save on national insurance contributions, and in many cases the employer is prepared to pass on their savings to the member of the scheme by paying more into their pension.
There will typically be a wide range of investment funds in which to invest your pension contributions. If you are many years from retirement, investing the bulk of the fund in equities will almost certainly produce a bigger pension than a more cautious approach.
Although many investors are nervous of the stock market at the present time, it is important to focus on the long term. In reality, it matters little what your pension fund is worth in a year or two if you know that it will be 20 years or more before you retire.
With today’s mobile workforce, most people accumulate several pension plans. Understand what these are worth, whether they are performing well and what you are being charged. In some cases, making the most of these assets can bring the financial choice of retirement closer by several years. It could make sense to consolidate your various plans by transfering old money-purchase pensions to your current employer’s scheme if the charges are lower.
Ensure you complete a “nomination of beneficiaries” form, so that if you were to die prior to retirement, the entire pension fund is paid tax-free and quickly to those whom you wish to benefit.
8DE-RISK AS THE DATE NEARS
As retirement approaches, gradually reduce your exposure to shares by switching to lower-risk funds during the six or seven years before retirement. Many defined contribution schemes offer “lifestyle” funds which do this automatically, thereby largely mitigating the effect of any last-minute stock market reversals.
9KNOW THE RULES
Pension legislation is forever changing. For example, since April 2011 people with pension income of £20,000 or more have been able to draw unrestricted amounts from their remaining pension pot. This is very attractive to many, as it allows access to the lion’s share of your pension while you’re still relatively young.
It is vital to understand your options at retirement. You will have the choice of taking the pension offered by your own scheme, or shopping around for a better annuity rate.
If you are not in perfect health, you might qualify for an enhanced annuity from one of a number of specialist providers. Irrespective of your state of health, if you have a larger pension fund, consider income drawdown.
This allows you to draw an income, while staying in control by maintaining the pension pot in your own name.