For years, investors have been turned off retirement savings plans by poor performance, inflexibility and lack of investment choice. Product innovation and regulatory change have helped ensure that pension planning now looks more like other forms of saving, but some anomalies remain. So how can investors ensure they are the masters of their own retirement destiny?

First, it’s important to say the situation is probably as good as it’s ever been. ‘A’ Day in April 2006 amounted to a small revolution in pension planning, increasing contribution limits, allowing personal and corporate pensions to run alongside each other and boosting investment flexibility. Since then, the pensions industry has brought in more innovative products with a wider choice of underlying investments.

Broadening your horizons
The most obvious of these have been the expansion of the self-invested personal pension (SIPP) market and the introduction of qualifying recognised overseas pension schemes (QROPs) for UK citizens retiring abroad and globe-trotting executives. A trickle-down effect has forced personal pension and corporate defined contribution schemes to increase the investment options available.

Investors need to decide how much flexibility they really need, because it generally comes with higher costs. Although not suitable for all, QROPs come out top for flexibility. The exact range of options will vary depending on the jurisdiction under which the QROP falls, but may include UK residential property and offshore-domiciled alternative investments such as hedge funds.

For the majority of UK investors, however, fully functional SIPPs are their most flexible option for retirement savings. These cost more but allow for the inclusion of assets such as commercial property. Symon Hawken, head of the London wealth management division at Collins Stewart, uses this type of SIPP for all his clients. Clients’ money is usually managed on a discretionary basis, but this set-up allows for inclusion of existing business or investment assets.

Low-cost options
Groups like Hargreaves Lansdown and Fidelity have brought in low-cost SIPPs, which have helped democratise the SIPPs market. Rob Fisher, head of UK retail marketing at Fidelity, says, ‘Investors now have access to free pension wrappers with investment groups they know and top-name fund managers. Previously, pension fund choice tended to be pretty restricted, but now there is a breadth of options.’

These will generally offer sufficient flexibility to build a broad, geographically diversified portfolio of funds. Fisher says most of their SIPP investors use this flexibility, holding an average of 4.5 funds. Group SIPPs, run along similar lines but for employees of specific companies, are also coming into the mainstream.

However, Sheridan Admans, investment adviser at The Share Centre, says, ‘There are a lot of people who buy funds within a SIPP and review them once a year. It is not as easy to produce cost advantages with SIPPs as it is with stakeholder plans.’

Admans says most investors don’t have the time or skill to make the most of the investment flexibility and may, therefore, be better off in a stakeholder product. He believes stakeholder pensions are particularly useful for children, adding, ‘You need to be 18 to open a SIPP. Parents can invest for children in a stakeholder product and the child gets tax relief.’

Still playing by the rules
But while flexibility has improved, investors are still bound by pension regulations on maturity. With the exception of QROPs, this means that they cannot be taken until age 50 (or 55 from 2010). And they still attract the requirement to buy an annuity, with any income taken subject to income tax.

Advisers are increasingly recommending that investors use ISAs to supplement their retirement planning. Tom McPhail, head of pensions research at Hargreaves Lansdown, suggests that planning in this way can make income tax in retirement a voluntary system from which it should be possible to opt out.

Put simply, when investing in a pension, tax relief is available on the contributions and the investment growth, but tax is payable on any income withdrawals. By contrast, an ISA investor makes contributions out of taxed income, receives some tax relief on investment growth and can withdraw their income tax free.

ISAs also offer greater access to capital. They fall beneath the taxman’s radar and do not need to be reported on a tax return, though this can be a mixed blessing. It can be tempting to dip into retirement savings when the fridge breaks or the roof leaks, which is perilous for long-term capital accumulation. But on the whole, many investors appreciate being able to access a portion of their pension savings at any time. This is likely to become particularly pertinent when the age limit for taking pension benefits rises to 55 in 2010.

Planning for early retirement
This age limit will prove crucial for some investors. If someone plans to retire before 55, they will need to generate other sources of income until they can draw on their pension. Elliot Farley, senior funds analyst at specialist funds of funds manager T. Bailey, says that many fund groups now offer a regular withdrawal facility within their ISAs so investors can have an income stream prior to their official retirement or supplement their regular income from pensions.

There is also the question of inheritance. ISAs can be passed on to heirs pre- or post-retirement. Pre-retirement, a personal pension scheme can be passed on as part of the deceased’s estate and will retain its tax relief. After retirement, however, the government goes to great lengths to ensure the pension is not passed on, except to a spouse. The cumulative tax charge can be as high as 82 per cent.

Steve Potter, head of technical services at Tilney, the UK arm of Deutsche Bank Private Wealth Management, suggests another advantage to blending ISAs and pensions: ‘Where someone is a basic rate taxpayer now but is likely to be a higher rate taxpayer in the future, there is an advantage to investing in an ISA now instead of a pension and then transferring the fund as a pension contribution at the point when higher rate tax relief will be available, as this will increase their overall “pot” by an extra 20 per cent at current rates.’

This strategy could be useful for young graduates, starting their careers with an expectation of being higher rate taxpayers later, or professional women temporarily working fewer hours during the early years of their children’s lives.

Getting the strategy right
If investors do choose to use ISAs alongside their main pension, the investment strategy is likely to be similar to that in their main pension scheme. Elliot Farley says the development of multi-asset class funds has made equity ISAs more useful in this regard.

‘With good planning you can buy higher-risk equity ISAs when you are younger – these have more opportunity to deliver higher returns. As you grow older you can move the money to multi-asset class funds, which will invest in a mix of equities, bonds, cash and commercial property to help deliver lower-risk, more stable returns.’