FOOL'S EYE VIEW

You Can Have A Decent Retirement

By Neil Faulkner (TMFVertigo)
April 6, 2006

There's a lot going on in pensions right now. Whatever you do though, don't turn a blind eye to it. In this article I'm going to summarise some of the recent changes but first I want to highlight the importance of saving early, because the truth is rather shocking!

You may think that you can make up for not saving in your twenties by contributing more later, perhaps when you're better paid. Unfortunately, this can be harder than you expect. The best illustration of this I've ever come across was here at The Motley Fool. It goes something like this...

Sarah is 20 and she's just started putting away £78 into a pension every month. The government tops this up to £100 with tax relief. At 30 she gives up work to look after her children and stops contributing to her pension.

Her husband David, also now 30, decides to make up for this by taking out a pension. He contributes £78 a month as well. They both retire and claim their pensions at 60. Let's assume both pots grow at the same average rate of 8% per year after charges. This is how their pension pots look:

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

Sarah invested a total of just £9,360. David invested three times as much at £28,080. But despite this, and despite the fact that Sarah didn't contribute for thirty years, David's pot is worth £40,000 less than Sarah's.

Now those of you in their thirties or later will be thinking, "So it's too late for me then?"

Not so! Although this is a simplistic example and does not take inflation into account, David's pot still grew to five times more than he contributed. It's never too late to save, but if you want to be confident of a comfortable retirement, it's advisable to start early.

Pension simplification

It's A-Day today -- the day on which the government is simplifying pension rules and making it easier for us to save for our retirement. Some of the main changes are:

Choice and more contributions

You can contribute as much as you want to as many pension schemes as you want (although you'll only get tax relief up to a certain level, as described immediately below). Don't worry too much if your pensions are spread over lots of schemes. It's inconvenient, but you're better off than about half the country, who have no pension whatsoever, other than their state pensions.

Tax relief

You get tax relief up to your total earnings, as long as your contributions don't exceed £215,000 this year. This maximum limit, which obviously will only concern a tiny proportion of the population, will increase each year to £255,000 by 2010 and will reviewed every five years thereafter.

Tax relief is 22p for every 78p you contribute for basic-rate payers and 40p for every 60p contributed for higher-rate payers.

If you're a lower earner and are in a 'relief at source' scheme, you can still contribute £2,808 and get tax relief, which means your contributions are boosted to £3,600 per year.

Lifetime allowance

A new concept is the 'lifetime allowance', which is set at £1.5 million this year and will rise to £1.8m by 2010. Pension pots over this amount will suffer additional tax however, again, this will only concern a tiny minority.

Lump sums

Up until age 75, you can take up to one quarter of your pension in a tax-free lump sum (or one quarter of the lifetime allowance, whichever is lower). Anything more than this is usually taxed at 55%.

If possible, you might want to avoid taking a lump sum, particularly from a company scheme, as it may result in significant reduction (i.e. more than a quarter) in the monthly pension payments you'll subsequently receive.

Monthly pension income

As before A-Day, your monthly pension income (called an annuity) will be taxed like a paid salary. If you've exceed your lifetime limit, the excess will be taxed at an additional rate of 25%.

Reaching a milestone: the retirement age

You can retire when you like, but the age in which you can claim your pensions will rise from 50 to 55 by 2010. Some pension schemes may choose to step up the increase gradually between then, so check with your scheme administrator if you're around this age. Also, you can continue to work and claim your pension from the same company if you want.

The Future Of Pensions: The Turner Report

The changes proposed by Lord Turner earlier this week aren't guaranteed, particularly because of political pressures to ignore the more potentially unpopular suggestions. But something has to be done and it's going to cost us either directly through saving or indirectly through taxes. Or, as Lord Turner would have it, through both. Here are the details...

State pension age

The state pension age will rise with our life expectancy from 2020, which means it could hit 69 by 2050. You'll still be able to retire earlier, you just won't be allowed to claim your state pension till later. (On a related note, between 2010 and 2020 the minimum age at which women will be able to take their state pension is already due to gradually rise from 60 to 65).

State pensions will be more generous

Lord Turner doesn't sell the state pension as a means for comfortable retirement. At present, the distribution of the state pension is unequal. This is because it's largely based on how much you've earned in your lifetime, so anyone who's had interrupted working lives (especially a very large group of women who have stopped work to care for children) receive poor state pensions.

Turner wants the state pension to be used to keep older folks out of poverty. He wants to do this in two ways. Firstly, he wants to make it as non means-tested as possible. This is because about a third of pensioners aren't claiming their pension credits, because they don't want to suffer the indignity of means-testing.

Secondly, he wants to link the basic state pension to earnings, rather than prices. As our earnings have been going up faster than prices, this means the state pension will rise more quickly. This'll cost us more, which can only realistically be paid for with higher taxes.

Opt-out of pensions, not opt-in

While the state pension should ideally keep us out of poverty, if we want to be comfortable, we have to make our own provisions. The centre-piece of the report is the proposal of a National Pensions Saving Scheme (NPSS). Anyone who isn't in an adequate pension scheme will be signed up automatically, with the option to opt-out. Auto-enrolment is to encourage us to save more, which is exactly what we at The Fool have always said you should do.

If you're in this scheme, you'll contribute at least 4% of your salary, the government pays 1% and your employer 3%. Obviously this will cost businesses and could result in job losses. Additionally some people may feel that they can't save as much as 4%.

Final thoughts

As a nation we still have a long way to go before we sort out our pension situation. Perhaps we'll never manage it. These changes are a step in the right direction, although pension simplication has, in fact, introduced some new complexities and it also remains to be seen how much of Turner's recommendations will eventually take effect. Regardless of what happens, the main story remains the same. You are the only person who can ensure you get a decent retirement -- so start saving!

Visit our Pensions centre for more information.