Ten reasons why pensions are fun

Pensions? Dull, dull, dull. You may think so, especially in the early part of your personal financial journey.

And that’s understandable. You probably don’t get paid a lot in the early days of your career and when being asked to save for something so distant such as retirement, there are other things that always seem to be a bit more lively and that are actually more fun; like a house, a car, a wedding…children. Anything in fact, other than retirement.

But here’s betting a few more of you are now having fun in retirement, or nearly there, because you saved. And here’s betting quite a few didn’t, and aren’t.

Many people are lucky enough to have a pension from state service and it is usually not a great idea to transfer out of them (consult a specialist adviser if you are tempted), but for the majority of us without one, it really is a great idea to take a grip on your provider and know what advantages you can grab.

So perhaps in a world where we have increasing amounts of educational material relating to personal finances, perhaps we should go a few rounds with the anomalous question of why saving for pensions can be fun.


Cigarettes and alcohol

Otherwise known as an annuity. Once you've retired, it's time to start playing up every bad habit you have.

This is because when you retire you can convert your pension savings into an annuity that pays you an income for life.

Obviously, the annuity company doesn't want to pay you more in income than you give it in pension savings, so the longer it thinks you'll live, the less income you will receive. So what you want to aim at is an "enhanced annuity".

These annuities pay out a higher level of income as they are intended for people with health problems that mean they may not live as long as a strapping, healthy 65 year old.

"Even people who consider themselves to be healthy may be eligible for an enhanced annuity if they are a smoker or drink significant amounts of alcohol," says Jim Boyd, spokesperson for annuity specialist Partnership.

There you have it. Who says fags and booze aren’t good for you?


Final salary

By far the best type of pension is a nice defined-benefit scheme, which will pay between 1/40th and 1/60th of your salary for every year of service.

It’s funded by employers who can’t afford it anymore, so unless you worked for a public service up until the early 1990s, or any of its forbears such as ex-nationalised industries (BT, say, or the GPO) you won’t get one. So forget about it.


Employers’ contributions

Eventually all companies with more than six employees will be required by law to provide a pension scheme into which they must pay at least 4 per cent of your salary, as long as you make a contribution of at least 3 per cent.

Sounds chunky, but essentially it means this is your boss giving you free money.

In practice most employers, especially larger ones who in theory can afford it, pay much higher contributions than that – 6 per cent is currently the average.

So by the time you get to draw on it you’ve got 12 per cent of every month’s salary in your pension pot.

Plus, you’ll get tax relief on your contribution, higher and basic, so that makes even more sense. In fact it’s complete nonsense not to do it.

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Tax relief

It’s rare for the Government to offer you a way to reduce your tax bill, so this is almost the best bit yet.

You pay no tax on any contributions into your pension. The catch is that you will pay income tax when you eventually draw down the pension, but in the meantime all that tax is working for you.

Plus, if you are a higher-rate taxpayer now you are unlikely to be when you draw your pension.

This means that you have effectively halved the tax you pay on your contributions. Which is not bad at all.

Plus, for all investors there is no tax to pay on the lump sum you can withdraw when you are 55.


Lump sums

In or out. If you get a lump sum, like an inheritance or a bonus, you can pay it into your scheme and watch it grow without being hammered by taxes or deductions.

When you begin the process of retirement you can begin to cash in from your schemes at the age of 55. This means you can cash in tax-efficiently by taking out up to 25 per cent of your pension pot as a lump sum.

So that yacht, that house in France, that classic sports car can all be yours. Pensions fun yet?


Age

It’s never too late, basically. Don’t feel bad about it, just get on with it before the knees start to go. It is generally considered good advice to try and increase what you pay in each year by 3 to 5 per cent. Regardless of when you start.


Equities

Shares for want of a better word. Many shares out there, particularly the ones listed on the FTSE 100, the American S&P 500, the EuroStoxx, French CAC40 and so on, you probably never knew you were invested in, did you?

Pension funds look for steady growth in massive chunks of money, known in the business as institutional – this means they buy large funds that contain, among other things, big-value shares.


Funds

The very best ones are the ones that grow the most. However, the institutional funds are covered by a lot more rules so the managers can’t swing their active cats as much as they would like.

They are in the same equities and other assets as you have been buying for years, just in a different share class.

Keep them on it and keep them honest by mirroring in your ISA the strategies of your pension fund manager. Do you know who it is who runs your pension? If the answer is no, you need one or more of the following:


ISA

Individual Savings Account. Without a doubt the most vital tool for any self-directed investor.

You can put up to £11,540 in this financial year in equities and funds, and bonds for that matter, and the Government says this amount will increase with inflation each year.

You can trade within them tax-free as the growth is not taxable. That means if one manager has increased your pot from £11,200 to say, £13,000 in a year, you can move it without penalty.

Again, track the behaviour of your own manager. Obviously an ISA does not have many of the advantageous tax efficiencies of a pension pot, but the canny investor under the age of 55 may want to use all or part of an ISA to acquire capital growth without the restrictive rules in drawing down funds – just in case that rainy day comes into town.

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SIPP

Self-Invested Personal Pension. The rules have been changed a lot over the last few years but a SIPP is essentially like a giant ISA with much looser investment rules.

You can only draw on it at the same time as any other private pension but in the meantime you can protect the capital growth of any asset from the taxman if you put it in your SIPP.

Other than the usual asset classes you would expect to be allowed, such as funds, equities, bonds and so on, the instruments you can hold without tax penalty in a SIPP are very wide indeed.

Futures, unlisted shares, commercial property including hotel rooms, derivatives, and gold bullion. Even ground rents from commercial property.

There are others, too. It’s a bit more complicated with chattels and may be subject to unsavoury tax penalties but these include a second home, commercial property, a painting, a classic car, collectable wines, antiques. Some providers won’t allow the so-called exotics, but it is possible.

So, are you having fun yet?