FOOL'S EYE VIEW
10 Things You Must Know About Pensions

By Stuart Watson (TMFTiger)
October 22, 2001

Great Titchfield Street, London -- There have been a number of surveys recently that show that many of us are in the dark about pensions. Indeed, with all changes going on in this area of personal finance, it's often difficult for anyone to be completely up to speed. But here are ten things that everyone should know about pensions.

1. The State Pension Is Not Enough

The current basic state pension is under £4,000 per year. It goes without saying that for many people that is highly unlikely to be adequate. We'd all like the State to look after us in our retirement but, for the moment at least, the sums just don't add up. Having more money that you need when you retire is a problem few of us have. Ensuring that you have a decent income in retirement is entirely your responsibility

2. The Earlier You Start, The Better

The difference between starting a pension at 20 instead of 30 is quite astonishing. This example will show you. It really is a case of a stitch in time saving nine. Ask anyone you know over the age of 40 whether they wished they'd started a pension early or are pleased that they did.

3. A Pension Is Just One Way Of Saving For Your Retirement

Pensions are not the be-all and end-all of providing a retirement income. Investing in tax-free schemes like ISAs is a viable alternative. The main disadvantage of a pension is that it is inflexible and you can't get your hands on the money until you are at least 50. Rather perversely the main advantage of a pension is also that it is inflexible and you can't get your hands on the money until you reach 50. The choice of which route to use may be down to how much financial discipline you have.

4. There Are Two Basic Types Of Pension

The first kind is a defined-benefit scheme. This is a stand-alone fund run by trustees on behalf of your employer. They will set the amount you need to contribute each month (usually a percentage of your salary) and they may also contribute some of their money on your behalf. Money is taken out of this fund when you retire to pay you an annual income, the level of which will determined by your final salary and how long you worked for the company.

The second kind is a defined-contribution scheme. They are run by pension companies. You decide how much to put into a fund (and your employer may contribute some money as well). When you retire your annual income will be determined by how much you put in and how well the fund has performed.

5. What You Need To Do With A Defined-Benefit Scheme

With regards to the pension itself, you have no responsibility beyond your monthly pension payment. It is up to your company to ensure the fund has sufficient money in it to fund your retirement. However, what you do need to do is see how much you are likely to get from this pension and decide if that is enough for your purposes. If you think it isn't then you need to make additional investments, which may or may not be done inside the same pension scheme. Even if you think it is enough, you probably should invest a little extra just to be on the safe side.

6. What You Need To Do With A Defined-Contribution Scheme

You decide how much to put in, when to do it and where it should be invested (normally you'll be given a choice of several funds). It is your responsibility to monitor the progress of your fund and decide whether you need to put more money in. Again, it is better to be on the safe side and invest more than you need.

7. Your Pension Fund Is Linked To The Stock Market

All pension funds have a substantial part of their money invested in the stock market. This is a good thing. Over the timeframes that people invest for their retirement the stock market has traditionally been the best way to generate the growth required to ensure you have enough when you retire.

8. The Final Sum Is Used To Buy An Annuity

In the case of a defined contribution scheme your final pot is not yours to spend as you like. You can take up to 25% as a tax-free lump sum. You must use the remainder to buy an annuity which pays you a predetermined income (upon which you will be taxed) until you die. You can get various types of annuity that are linked to inflation or that pay out until both you and your partner die. You can buy an annuity at any time between 50 and 75, even if you are still working. Make sure you shop around, as annuity rates can vary significantly between providers.

9. Scandals Will Happen

Maxwell, pensions mis-selling, Equitable Life – we've seen our fair share of scandals in the last 20 years. There will be scandals in the future. Wherever money is involved it is inevitable. It's important that we learn from history and our experience. The very worst thing we can do is to be paralysed into inaction. In very few cases would anyone involved in these sagas been better off had they just kept their money in a bank account or under a mattress.

10. Watch Out For High Charges

You could be putting money into your pension for more than 40 years. An example is the best way to illustrate the effect of charges. Say your fund grows at 10% a year and you put in £100 a month. If your find charges 1% a year your final sum will be £424,965. If it charges 2% a year your final sum will be £324,180. Unfortunately many pension schemes have high charges basically because they can get away with it. Find out how much your pension charges and don't be afraid to ask for it to be explained in some detail. After all, it is your money.

More: Pension Centre