Personal Pension Security
Personal pension schemes (see Personal Pensions), stakeholder pension schemes (see Stakeholder Pensions), defined contribution schemes, money purchase schemes and occupational defined contribution schemes (see Defined Contribution Schemes) all operate in essentially the same way. You make contributions to a pension savings fund; this fund is invested and any investment returns are added to the pension fund. The fund is continuously re-invested until you come to retire, whereupon the total value of your pension fund is calculated and can be used to purchase an annual pension from an insurance company, which is usually payable until death (see Annuities).
The nature of money purchase schemes puts them at risk of the volatility of the investment market. If your pension fund is invested well and you make good returns, your total pension fund will continue to grow at a steady rate until you come to retire. On the other hand, poor investments will result in minimal returns or even losses, and your pension fund will grow erratically until retirement. When you wish to convert your pension fund into an annual pension, the deal that you are offered by the insurance company combined with economic conditions at the time will influence how much annual pension your fund buys you. If you purchase an annuity at a favourable time, you may be able to sell your pension fund for a generous retirement income. If you happen to sell when the economy is unstable or annuity rates are low, your pension fund will only purchase you a small retirement income. Unfortunately you are unlikely to have any influence on the state of the investment market whilst your pension is growing, nor on the state of the economy when you come to retire. It is possible however to protect your pension fund from certain risks and increase your chances of a higher retirement income.
Charges
When you choose a personal pension scheme provider, consider carefully the charges you are being asked to pay. Many pension schemes demand an annual charge for operating your account, additional charges for the administration and expertise involved in investing your savings and monitoring the markets and a percentage of the returns your investment makes as a commission charge. Comparing pension schemes from a variety of banks and insurance companies will enable you to pick the scheme that suits your needs but does not involve extortionate charges. When you have an informed view of the usual charges and the usual rates, you will be in a better position to negotiate a good deal for your savings. It may be possible to negotiate lower charges if you promise to make regular contributions, if you are joining the pension scheme through your employer, or if you intend to invest a large amount of money. If you believe that you have not been offered a fair deal, you might consider employing an independent financial advisor to find you a better deal or negotiate better terms on your behalf.
It is often possible to avoid paying unnecessary charges by reading the terms and conditions of your pension scheme contract thoroughly; you may be charged for failing to make a regular contribution, or charged for making a contribution that is too small or too large. You may be charged for choosing early or late retirement (see Early/Late Retirement). If you know the small print of your contract, there is a much lower chance of your being surprised by unexpected charges; similarly, knowing the charges involved may help you to reach a decision regarding your financial future, for example, choosing not to delay retirement to avoid additional pension fund fees. A secure knowledge of your pension scheme contract will ensure that you make informed financial decisions.
Investment
The way in which your pension fund is invested will influence the amount of money you stand to make in returns. However, an investment portfolio that offers great potential returns usually involves a lot of risk; the greater the chance to make big returns, the greater the risk of losing your money. Any investment involves an element of risk; it is impossible to bet on the investment market without danger. Some portfolios will include high risk investments in the hope of making high returns. If you are happy to risk your money, perhaps because you have other sources of future retirement income or because retirement is a long way off, you stand a chance of making good money with a risky portfolio. If on the other hand you are reliant on your pension fund to provide your retirement income and are not willing to take any risks with your savings, a risky portfolio would be a bad choice. It is vital to ensure that your investment manager is well-informed of your individual financial situation, and of how much risk you are prepared to take. If you are concerned about losing money, request a safe investment portfolio which will offer steady returns in exchange for increased security.
It is especially important to ascertain how your pension scheme adapts the investment portfolios it chooses over time. Many schemes will automatically ensure that your pension fund is invested at low-risk for the years immediately preceding your retirement. Other schemes will continue to invest your pension fund at a higher risk, thus running a greater risk of you losing a significant amount of money shortly before retirement. Be clear about the way in which you want your money to be invested and ensure that you are not faced with big losses if there is a sudden investment market slump the year before you wish to retire.
For more details on investment, see Other Investment Opportunities.
Annuities
When you come to retire you will be able to sell your pension fund to an insurance company in exchange for an annual pension known as an annuity. It is important to request annuity estimates from a range of insurance companies, to ensure that you are being offered the best deal. Different companies will use different formulae to work out your annuity entitlement, so it is normal for estimates to differ. However, be aware that it is not as simple as choosing the highest offer; one company may offer you a lower annuity but agree to make a payment to your surviving partner in the event of your death. Others will agree to make large payments if you are diagnosed with a terminal illness. Remember that a high annuity may camouflage inferior terms and conditions; always check the small print of any contract you sign to ensure you are spared potential stress or disappointment later on. Similarly, annuity estimates will depend on your age and the state of the economy when you come to retire. It is worth requesting annuity estimates that indicate the rate you would be offered now and in two or five years if you were to delay purchasing an annual pension. Many companies will be prepared to offer you higher annuities if you are prepared to wait: the annuity will not be paid for as many years, and if the economic market has improved, insurance companies will be more optimistic and your pension fund will be able to buy you more. Make sure that delaying your annuity is worth the wait, and you will make up the money that you did not receive whilst you were delaying the annuity purchase.
For further information on this topic, see Annuities.
Every pension scheme carries risks and requires serious thought and informed decision making to ensure that you get the best financial deal. Money purchase schemes carry more risk than defined benefit schemes, because the amount of annual pension you receive is only determined when you come to retire. However, there are measures to limit the risk and protect your savings and your interests. Take the time to consider your options and monitor the success of your pension fund; if you are unsatisfied at any time, contact your pension scheme advisor and discuss your concerns. If you feel the need for more detailed or more objective advice, contact the Pensions Advisory Service on 0845 601 2923 or consider paying an independent financial advisor to give you assistance. Ensuring financial security during retirement may seem a low priority at times, but will prove invaluable when you come to draw your pension.
