FOOL'S EYE VIEW
Quick Guide To Pensions

By Maynard Paton (TMFMayn)
March 13, 2002

Carburton Street, London -- The State currently guarantees a minimum income of £92.15 in retirement. Can you survive on that amount? If not, then you'd better start saving for your retirement. Here's a rundown of the pension basics and your options.

Start early

Unless you're happy to join the ranks of pensioners in poverty, you need to do something about your financial retirement planning now. Simply, the earlier you start, the better off you'll eventually be.

Take the following example, based on the Miracle of Compound Returns from the Fool's Ten Steps:

Fay decides on her 20th birthday to start investing £100 a month in the stock market. Let's say it appreciates at 8% a year. At the age of 30, she marries Ferdinand, leaves work to have children and stops her contributions. She does, however, keep the money invested where it continues to grow.

Ferdinand, meanwhile, who has frittered away all his money in his twenties, decides on his 30th birthday to start contributing the same £100 a month into the same scheme and continues until he is 60.

The numbers pan out like this:

             Fay                        Ferdinand
             £100pm Age 20-30           £100pm Age 30-60 
             8% annual return          8% annual return

Age 20              £0                        £0
Age 30         £18,128                        £0       
Age 40         £39,137                   £18,128 
Age 50         £84,494                   £57,266
Age 60        £182,416                  £141,761 

Extraordinary, isn't it? Fay only contributed for 10 years and yet by age 60, she's got more in her retirement pot than Ferdinand.

In short, retirement planning does not belong solely in the realm of high earners. If you start early, your pension pot will largely be determined by how long you've been saving for, not the total amount you invest.

Occupational schemes

Okay. So you know why you need to plan ahead for your retirement, and why you need to start now. But where's the best place to begin?

For most people, the first port of call will be their employer. If you're lucky enough to work for a business that contributes to its employees' pension pots, then it's almost certainly worth signing up.

Such occupational schemes come in two varieties: defined benefit and defined contribution. Defined benefit schemes are generally the more attractive because the employer takes the risk of things not working out on the investment front. The employee simply gets a portion of his final salary at retirement in exchange for a monthly contribution.

Unfortunately, employers are no longer that generous with their pension provision. At the moment, most are busy switching to defined contribution schemes where the employee shoulders the investment risk. Nevertheless, if the employer makes a contribution too, then the risk of any substantial underperformance is likely to be severely reduced.

That said, occupational pensions are by no means perfect. They're not that portable for one thing, which means you could end up with a handful of occupational pensions, each paying out relatively little. But having an employer boosting your pension contributions goes a very long way to offset some of the inflexibility.

Pensions vs ISAs

If you're not fortunate enough to work for a generous employer, then you'll have to make your own provision for retirement funding. Traditionally, this has been done via the much-maligned (and rightly so) personal pension plan. Generally speaking, these plans remain the overcharging, underperforming and opaque products they always have been. But there are alternatives.

Low-cost, index tracker-friendly and transparent, the advent of the stakeholder pension and the e-SIPP should improve the reputation of personal pensions. But ISAs, too, exhibit Foolish characteristics.

While all three products have tax benefits, the main disadvantage of a stakeholder or SIPP, as opposed to an ISA, is that you're forced to buy an annuity on retirement. On the other hand, ISAs allow complete freedom in what you do with your savings -- and when you do them. 

Summary

There are plenty of pros and cons when judging stakeholders, e-SIPPS and ISAs (the Motley Fool's Pension and ISA centres give more details). But the fact of the matter is, whichever of these three product routes you decide to take, you shouldn't go too far wrong. In fact, contributing to a stakeholder or an e-SIPP, alongside an ISA, could be a good solution. Hedge your bets so to speak, rather than let confusion leave you in a state of pension paralysis.

As with most things to do with investment, there are few clear-cut answers as to how you should fund your retirement. But there are some general principles to bear in mind when weighing up the alternatives: 

* Take advantage of any employer benefits;
* Avoid high charges;
* Avoid the likelihood of prolonged stock market underperformance (a typical feature of managed funds);
* Keep things simple and transparent; and
* Start now.

Learn all about Pensions: Visit the Motley Fool's Pension Centre

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