Planning for retirement is vital if you wish to enjoy a certain lifestyle and not be over-dependent on the state. With the average retirement expected to last 19 years, most of today’s workers will run out of money after only seven, according to an HSBC survey.
Of 15 countries researched, the UK had the lowest proportion – just 32 per cent – who regarded saving for retirement to be a priority over saving for a holiday. This is half the rate of thrifty India.
As a rough guide, save an annual percentage of your earnings equal to half your age, so a 40-year-old should invest 20 per cent of their salary each year in a pension until they reach retirement.
Whilst acquiring property (buy-to-let) and fully using an Individual Savings Account (ISA) are popular options, the traditional route has been to fund a pension through an insurance provider.
In this financial year, up to £50,000 can be subscribed but any unused allowances from the previous three years may be used. Take action now as the Treasury has announced the limit will be reduced to £40,000 from next April.
The tax carrot is substantial. If £8,000 is contributed, £2,000 in basic tax relief is automatically added. Higher rate and top rate taxpayers can claim further relief through their tax returns. The effective cost to a 40 per cent taxpayer of a £10,000 gross pension contribution could be as little as £6,000 and £5,500 for a 45 per cent taxpayer.
The earlier a plan for retirement is put into place, the longer it has to grow. The Department for Work and Pensions predicts that a boy born now is expected to live to 91 and a girl to 94 years.
Most individuals under the age of 75 years qualify. Children and spouses with no earnings are also able to fund a pension up to £3,600 after basic tax relief. This means only £2,880 needs to be subscribed.
Pensions are therefore attractive tax-efficient vehicles. Yet insurance companies have not proved to be good at investment decisions. The OECD reports that pension fund returns actually fell every year from 2001-2010. Part of the reason is their move out of equities – down to under 10p in every pound on final-salary pensions – into bonds and gilts.
This has proved to be disastrous: equity investment was 81 per cent in 1993, according to UBS Global Asset Management, and cut to 12.2 per cent in 2011 and is now just 9.9 per cent.
An alternative approach would be to make your own savings decisions and use an adviser with a proven track record. This do-it-yourself version is known as a self-invested personal pension (SIPP for short).
Growth in a SIPP can be substantial. Assuming 5.5 per cent net growth, an £8,000 investment outside a SIPP is worth £8,433 after a year but £10,542 inside. In addition, all gains are free of further personal income tax and capital gains tax.
Around 200,000 SIPPs are created annually and since their birth in 1989 number around one million with assets exceeding £110bn.
One myth is that only the self-employed can have a SIPP. Anyone can and, if employed, ask their firm to contribute directly with you making the investment decisions from a far wider range than traditional pension insurers will consider.
When selecting a SIPP supplier, ask about:
n Controls and processes for handling client money
n When was the last audit and outcome
n How comprehensive is the permitted investment range
According to research by Moneyfacts, the average fee for set-up is £227 and annual servicing £386. However, advisory firms will often ‘absorb’ such costs into their overall charge.
One of the advantages of using a SIPP is to merge former pensions into one pot which makes it far easier to handle and ensure a more balanced portfolio. This is particularly vital where a pension is ‘frozen’, managed by an insurance consolidator (like Phoenix or Resolution).
By comparison, traditional pensions are rarely transparent. Those who offer several sectors – like Aviva – do not provide an overall picture to show savers where there are gaps.
Monitoring performance becomes far easier with a SIPP. If you do not have the time or inclination, ask an adviser to keep a regular eye, taking into account your attitude to risk, available additional money and likely time before retiring.
Research by Barclays Stockbrokers, the UK’s largest execution-only retail brokers, reveals that 83 per cent chose to invest in a SIPP so they have complete control of how their savings are invested with 78 per cent reviewing their portfolio at least once a month.
Yet “a SIPP is not the most appropriate pension wrapper for all investors, only for those who wish to use the additional flexibility or investment choice that is not available in a personal or stakeholder pension”, says Samantha Paskin-Bywater, independent financial adviser at AWD Chase de Vere in Leeds.
With charges usually higher than other pension arrangements, there is little point in paying such costs if there is no intention to use the extra functionality.
She warns about inadvertently investing in specialist funds which are higher risk than realised.
Some like a full SIPP so that they can buy a commercial property but others want a funds-only SIPP where the investor requires additional fund options. SIPPs are usually inappropriate for low risk investors, those with small pension pots of less than £50,000 and/or low contribution levels and with little or no investment knowledge.
Good performance is likely to come from a diversified portfolio consisting of equities, fixed interest and property.
To gain such a mix, select assets that behave in different ways, have alternative aims (such as growth or value investing), invest in different sized companies and with a geographical spread.
The longer to retirement, the more market fluctuation that can be accepted but still invest within your risk parameters. If over a decade from retiring, opt mainly for global growth (notably small companies and Asia) and later switch to high income investment trusts and funds.
The Government is considering widening the SIPP allowance for property by permitting commercial to be converted into residential. Dentons, a SIPP specialist, says over 15 per cent of SIPP clients invest directly in commercial property, up from four per cent in 2008.
Take care to only invest in ‘unregulated’ areas where you have knowledge and confidence. The stellar returns suggested for some of these fields – carbon credits, film schemes, forestry estates, jewellery and wine – are laughable.
If cash is held within a SIPP, make sure it does not exceed the protection limit (£85,000) if held with just one bank. Not all providers take the precaution of splitting such money between banks.