Many investors pay into or have access to one or more pensions—for example, a workplace pension, a personal pension or a government pension. If you plan to use income from pensions to fund your retirement, it is important to be aware of how your payments are being invested. You should also understand the tax position, whether you have any control in the selection of investments and how the different pension schemes will provide income during your retirement.
The earlier you begin planning how you will fund your retirement, the better. When evaluating your pension income, you should carefully consider if it will be able to cover the full cost of your retirement or if you may need to generate other cash flows. Failing to plan ahead for additional cash flow sources that you may need could increase the chance of a funding shortfall during your retirement.
There are several types of pensions and pension providers available to investors in the UK. Below are some details on different kinds of pensions and considerations to keep in mind when evaluating how your pensions fit into your financial plan.
The State Pension: The State Pension is available for all those who qualify through National Insurance contributions (NICs). It pays a guaranteed income at a set retirement age, and increases every year after commencement. No fund value is accrued which can be drawn in retirement or transferred to another financial product. You can choose to defer your entitlement, which would increase the income payable, but it is funded by the government, and therefore has no underlying investments which benefit from growth. You should discuss with your Pension Adviser how the state pension income fits in with your wider investment portfolio, and how it will fit in with any workplace or private pension and other savings you have as part of your overall retirement income planning.
Workplace Pensions: Workplace or employer-provided pensions can be defined benefit plans (sometimes known as final salary) or defined contribution plans. Defined benefit plans pay out a guaranteed retirement income based on the rate of accrual, the length of membership in the scheme and salary information—often based on the amount you are paid at the time you retire or leave the scheme. On the other hand, defined contribution plan benefits depend on the contributions made and how the investments or assets with the plan have performed. This means that the value can go up or down, and most defined contribution pensions open to new members do not have valuable income guarantees. Your employer is required to automatically enrol you in the employer-provided pension scheme unless you choose to opt out, or fall under an exception.
Personal Pension Plans and Stakeholder Pensions: You can open a personal or stakeholder pension with the provider of your choice. These types of private pension grow as you contribute and benefit from any growth of the underlying investments. As these are defined contribution pensions, the value can go up or down, and most plans open to new members do not have valuable income guarantees. You may have a variety of investment options to choose from, and it is important to carefully assess what will be the most appropriate investment for your situation.
Stakeholder pensions are a specific type of personal pension. Your employer may offer one, or you may set it up yourself. If your employer offers a stakeholder pension, there may be a contribution from your employer and other considerations to keep in mind. Like other personal pensions, stakeholder pensions have flexible options for contributions, but also have to meet some minimum standards set up by the government regarding charges.
Self-Invested Personal Pensions (SIPPs): SIPPs are an increasingly popular pension vehicle. They are personal pensions that allow individual members access to a wider range of investment for their pension fund. You may also have a financial adviser manage the investments for you. More flexibility when making investing decisions may help you better tailor your portfolio to your personal situation and long-term goals.
Regardless of which pensions you may have, you should be aware if there is tax relief available. Personal pension contributions may qualify for automatic tax relief, but check the specifics of your available pension plans and taxes to see how this affects you. In most cases, you may also be able take a portion of your pension savings as a lump sum tax-free.
When evaluating what income you can expect in retirement, you will need to find out how much you can expect to receive from each of your pensions. If you are selecting investments in a pension, you will also need to decide what asset allocation is appropriate for your goals and circumstances.
When reviewing your asset allocation it is important that you understand your investment time horizon—how long you need your money to last. Investment time horizon is not necessarily the same as estimating how long you will live. It may include the life expectancy of your spouse, children or other dependents. Your asset allocation decision should also take account your cash flow and investment growth needs. You will also have to consider how the impact of inflation might affect your purchasing power over time. If you make the mistake of underestimating the effects of inflation or your potential investment time horizon, your income could potentially fall short of your retirement needs.
And, of course, don’t neglect to account for your attitude towards risk. If you aren’t comfortable with market volatility, you may prefer to invest in less-volatile securities. However, understand the risk-return trade off when making this decision. In limiting your exposure to market volatility, you will likely be limiting your potential long-term returns, which may mean making some sacrifices to your cash flow needs and long-term goals. You may benefit from having a conversation with a financial professional to help you weigh these important decisions and find the right approach for you.
If you have control over your pension investments, you may want guidance or assistance on selecting the right asset mix for your needs. Fisher Investments UK may be able to help you review and evaluate your current pension plan and investments.