FEATURE: How to plan your retirement

With the UK population continuing to live longer and the last remaining final salary schemes coming to an end, James Redgrave looks at how to plan your retirement.

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Nearly a quarter of the UK population is currently over the state pension age, according to United Nations figures.

The same analysis predicts this will rise to almost 30 per cent by 2030. Even as the government reacts to this demography by raising the age at which people can draw on a state retirement income, this presents serious problems for a population in which many already cannot live comfortably in old age.

As it stands the government has pledged to raise this from 60 for women and 65 for men to 66 for both by April 2020, with an unspecified timetable to raise this to 68 in future.

The highest state pension available to individuals is just £102.15 per week. Last month the DWP announced a consultation on increasing the state pension to £140 per week, while doing away with the means tested element of the supplementary benefits, with draft legislation on the issue expected later this year.

The cost to the taxpayer of this provision – £4 billion by next year according to the Department for Work & Pensions – limits government in its ability to raise provision beyond inflation.

Meanwhile, the ageing population will prove increasingly expensive. Yet the split in total UK retirement income between private savings and public pension benefits is approximately 50/50, according to statistics from think tank the Organisation for Economic Co-operation and Development.

For the 12 million healthy UK adults of economically productive age currently making no contributions to a private pension or long term savings product, maintaining an acceptable living standard to the end of their lives is further compounded by how long that figure is likely to become.

Living longer
Current ONS figures have men living for 78 and women 84 years on average, with these predicted to rise to 85 and 89 years old respectively. Club Vita, which provided specialist life expectancy research to pension schemes, claims 80,000 UK citizens will live to 100 by 2033.

The easiest way for many to access a private pension is through their employers. Most large companies offer a workplace scheme.

Furthermore, the government is set to make this provision compulsory for all firms by 2017, with some automatically enrolling staff from 2012.

This will be complemented by a state managed defined contribution (DC) pension scheme called the National Employment Savings Trust (Nest). In DC arrangements workers pay a percentage of their salary into a fund, to which the employer can pay an additional sum.

This is invested in a range of assets – mostly stock markets – until the saver retires, at which point they cash in the accumulated pot and use it to buy an insurance policy called an annuity, guaranteeing them an annual income for the rest of their lives.

Companies can choose to take on ‘Nest’ as their pension scheme, set up a different scheme with a private provider or maintain their existing schemes if they have one, but all staff have to be enrolled in such a scheme and only withdrawn at their own request, which in turn must be within three months of joining.

Employer contributions
In the latter of those three scenarios, the employer must pay the equivalent of a minimum of 3 per cent of the scheme members’ annual salary along with their paychecks.

Workers under 22 years old and/or earning less than the minimum tax paying wage (currently £7,475 per year) are exempt from this change in the law. Certain workplaces – the vast majority in the public sector – will still offer staff a defined benefit (DB) pension scheme.

As with DC pensions, employers and employees will pay into a pot, but the employer guarantees an annual income, post retirement, based on a percentage of the employee’s salary at retirement (or occasionally, the average salary during their time with that employer).

The cost of guaranteeing these benefits for an ever longer living population has made almost all private sector firms still offering DB drop it for new joiners, and the government has commissioned an ongoing review aimed at reducing the cost of DB schemes in the public sector.

But where they can still be found, they represent the best value for money form of private pension provision. People who move jobs can transfer any savings they have built up in a DC workplace pension to their new employers scheme (assuming they have one), and money can also be transferred between different personal pensions.

Personal or individual pensions are DC schemes in which people pay into pots independent of their employers, managed by insurance companies, and again buy an annuity at retirement.

The difference between personal pension schemes is significant in terms of the fees charged to maintain them, the range of investments available to savers and the control those savers have over the investment of their money.

Tom McPhail, head of pensions research at Hargreaves Lansdown, recommends savers look at their workplace provision as a first resort.

With most companies contributing to their schemes and compulsory employer contributions coming, he says, ‘Not joining a company pension like this is in effect turning down free money ‘

In terms of your choices of individual pensions, a stakeholder plan [a pension where fees the employer charges are capped by law at 1.5 per cent and 1 per cent after ten years of saving] – is a good starting place because it is designed to be simple and to avoid any hidden charges.

‘It will also have a default investment which means you can start saving for retirement without having to think about where to invest your money, if you don’t want to.’

More confident consumers can look at pensions which invest more widely and allow them more discretion over individual investments.

Investment freedom
The greatest freedom to invest comes with a Self Invested Personal Pension (Sipp), which allows the customer or their financial adviser to buy assets [within certain parameters, some set by the provider, some legal – residential properties are forbidden, for example] without reliance on the pension provider at all.

‘The more you are likely to want to take an interest in your savings, the more a Sipp is likely to work for you,’ says McPhail.

But he warns the fees charge for Sipps varies, according to the underlying investments available to the saver, with more difficult to access asset classes – like shares in companies from less developed nations – driving fees above the two per cent mark. Within smaller parameters, the above is true of normal personal pensions too.

An independent financial adviser (IFA) should research these costs, and anyone seeking to buy a pension directly from an insurance company should shop around for the best prices, compared to available investment.

A personal pension where the investments are set by the provider, workplace or personal, should take into account the age and circumstances of the saver.

Risk considerations
Younger people taking on pensions should be invested predominantly or entirely in shares, where the potential for making money is greatest and the long time before retirement makes the risk of losses on those assets less serious.

But as they approach retirement the pot should be phased across to assets less likely to significantly decline in value before it is ultimately converted to cash. This is known as ‘lifestyling’ or ‘a glidepath’ and Sipp customers should bear it in mind when investing.

Again an IFA should help with these decisions. The next part of pension saving which requires shopping around is the annuity. The insurer providing a pension is likely to have an annuity product to offer savers, but is required by law to pass this money to another company, if the customer chooses.

They are further required to make this right clear to customers, although the insurance industry has come under considerable pressure to do more in this regard, on the back of perceived failures to do so. As such it is sensible for consumers to be aware of their rights.

Financial advisers can help with this choice or ‘open market option’ as it’s known. Annuity providers can sell directly to consumers and there are a wide range of products available, some allowing people to continue investing after retirement, rather than trading the whole pot for an income.

James Redgrave is a journalist with the Financial Times Group.

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