Top tips from Oliver Payne – European Pensions Manager & Actuary, Ford Motor Company
Although I’ve met many people who like to pretend pensions are extremely difficult to understand, the reality is that pensions are not that complicated. If you can understand a mortgage, then you should be able to understand a pension.
I agree it’s possible to go on about the various intricacies of pensions for days but here’s how I would break it down for a pensions novice:
Picture how you want your retirement to look
Everyone should have an image of their ideal retirement, it could be sitting and reading by a pool all day, looking after the grandkids or travelling the world. Once you have this image, there are two details to consider: What age do you want to retire? And how much will this lifestyle cost?
Understand what you’ve got
Next, you need to dig out your pensions paperwork and login details to find out the total value of your pensions.
Figuring what all your pensions are worth may seem daunting (due to all the jargon and caveats) but there are two key figures you are looking for:
- Current pension value (accrued pension, pot value, fund value, account value, plan value etc)
- Value at retirement (projected value, pension at retirement etc)
To keep these values comparable across your different pensions, it’s important to be aware that:
- Statement dates may be different;
- Retirement values may be at different ages; and
- Some illustrations show you the amount of money in your pot, other illustrations show you the regular income you might get at retirement.
When you’re planning your retirement, it’s probably more helpful to think about the income you might get than the money in your pot.
There are many different names for pensions, but they typically fall into 3 main categories:
- Defined Benefit – which provide a regular income payable from your retirement date for the rest of your life. For example, the amount of pension you get could be based on how long you have worked for the employer and how much you earned.
- Defined Contribution – which is more like a bank account and provides a pension based on a pot (or fund) value. But instead of a bank account where the value is the amount of cash in your account, a pension pot will be made of various investments (assets) such as company shares, government bonds etc.
A Defined Contribution pension increases with contributions (from you and your employer), tax relief from the Government and interest from the investments in the pot. However, a Defined Contribution pot value can go down with annual charges and poor investment returns (just like your house value may decrease).
- State Pensions – Paying National Insurance contributions over your career will have given you a state pension. The weekly amount of your state pension will depend on your national insurance history. This can form a significant part of your retirement income, so I would recommend going to Gov.uk for further information, including personalised projections.
Fill the gap
Now you know what you are likely to have and what you would like to have when you retire, there is likely to be a big gap. Here you have several options you have to fill the gap:
- Reduce your aspirations – for example cut back on the planned holidays
- Increase savings and maximise ‘free money’ – there are three main opportunities for this:
- Increasing contributions – many pensions have a contribution matching structure where the employer pays in more if you pay more, for example a £500 extra contribution from you may lead to another £500 of ‘free money’ from a company contribution
- Tax relief – in general, pension contributions are not subject to tax so a £100 contribution could cost you only £60 if you are a 40% tax payer (£40 of ‘free money’). Please note: 75% of your pension will typically be taxed as income in retirement and contributions above the Annual Allowance and Life Time Allowance will not be as tax efficient
- Investment returns – the interest (or investment return) on your pension savings will be additional free money and you will benefit from interest on the interest (compounding) which is extremely powerful. My favourite example of the power of compounding interest is that if you could fold a piece of paper in half (doubling the thickness each time) then it would only take 42 folds until the folded paper is tall enough to reach the moon
- Check the fees – review whether you are getting value for money from the annual fees on your pensions and be aware that a small percentage change in the annual fee can make a very large difference in the long term
- Combine pensions – consider combining your old pensions to potentially benefit from: lower annual fees, increased returns, better user experience, less paperwork etc
- Change your investments – Defined Contribution pensions will typically have several investment options to choose from. Ranging from low risk investments such as cash or Government bonds (which will have a low interest rate) to higher risk investments such as company shares (which may have a higher return – in exchange for higher risk ie more uncertainty and more chance of investment losses)
- Do nothing – you could be happy with your projections or bury your head and ignore the problem.
Bringing it all together
Although it’s possible to keep talking about the various details of pensions for days, hopefully I have illustrated how pensions aren’t as complicated as you might think.
As your retirement is effectively the longest holiday of your life it’s worth putting some time and effort in to understand your personal situation and decide the best course of action to maximise your financial wellbeing in retirement.
Other things to consider
- Financial advice – this article should not be considered financial advice. A good Independent Financial Advisor can be very valuable (unbiased.co.uk may be a good starting point)
- Life Time Allowance– if your total pension savings exceed the Life Time Allowance (currently £1,055,000) you will likely need to pay additional tax.
- Annual Allowance – you may have additional tax to pay if your total annual pension contributions (including your employer’s) exceed the Annual Allowance (currently £40,000 for most people). Note, if you are a high earner (with earnings above £110k pa) and/or you have started to withdraw money from a pension pot, your Annual Allowance could be significantly lower.
- Fees and value for money – in practice, calculating fees and value for money from your pension savings can be very complicated and you may need to understand more than the headline annual charges/returns.
- Other savings/debts – your pensions should not be considered in isolation, debt such as mortgage and credit cards as well as other savings such as ISAs should be considered to complete the picture.
- Pension flexibilities – there are several ways to access your pension in retirement (from taking it all as cash to buying a guaranteed income from an insurer). Careful consideration should be given to these options.
For more information
- Ben’s pension planner – plan your pension at any age: click here
- Quietroom videos: – simple illustrative videos on pensions:
- Money and Pensions Service – independent guidance and information bringing together PensionsWise, The Pension Advice Service and the Monty Advice Service https://moneyandpensionsservice.org.uk/
- Independent Financial Advice – https://www.unbiased.co.uk/
- State pension information – gov.uk