In the old days, we had no control over our pensions. Pension fund managers decided where to invest the cash, though their decisions were tightly regulated by the government. The rules meant a proportion of the fund was to be invested in gilts which, in common terms, means lent to the government — no conflict of interest there, then.
And the government dictated how your fund was eventually to be turned into an income stream once you’d retired — which meant around 90% of pensions ended up invested in annuities. Now, I reckon annuities are dreadful things. Because of the emphasis on the cast-iron safety that’s supposedly needed to secure a guaranteed income, returns are typically disappointingly low.
So you worked all your life, and someone else got to dictate how the fruits of your labour were to be managed, regardless of your personal circumstances or preference. Disgraceful.
Moving on
Thankfully those days are now behind us, there’s no requirement to buy an annuity any more, and with most pension schemes we can take full control of our money. There are restrictions on defined-benefit schemes (schemes that are disappearing fast), but there are often still ways to gain control over those too.
We’re now allowed to to engage in what’s known as drawdown, which allows us to take whatever we want from our pension pots as we wish — up to the full amount if we feel like it, paying the appropriate tax, of course. So if you want to blow the lot on a flight into sub-orbital space, that’s up to you.
But what are people doing with their pensions? Well, in big mistake number one (actually, no, the space trip might be number one), many are just leaving them where they are and letting the old annuity method take its toll, instead of converting to a drawdown and managing their own needs.
But many of those who actually do convert their pension plans are making what is probably an equally big mistake. They simply get their existing pension provider to switch their fund to a drawdown one and do not spend any time checking out the competition and looking for better deals.
Charges can hurt
While management charges are generally relatively low across the industry, there can still be significant differences. If, for example, you have a £200,000 investment pot, the difference between a 1% annual management charge and a 0.5% charge is £1,000 per year — or £20,000 if you live for another 20 years. While that won’t get you into space, it could pay for some nice holidays for you, so why let it go towards paying for your fund managers’ yachts?
And if you want a further idea of the amount that could be lost by paying unnecessarily high charges, just think about the £24.8bn that was contributed to personal pensions in the 2016-17 tax year. If the owners of even half of that could cut their charges by the same 0.5%, we’d be looking at an annual saving of £62m.
That’s a potential £62m that could go into pensioners’ pockets every year rather than pension managers’ pockets.
Do it yourself
Even if you can secure the lowest charges for your pension, you could still be entrusting the long-term value of your cash to whatever investment strategy your provider chooses, no matter how good or bad it is, and irrespective of your personal desires. How can that be best for you?
I’ve recently been seeing complaints from pensions commentators that too many people are choosing their own pension providers without taking professional advice. The industry doesn’t like that — and there’s surely no conflict of interest there either!
Here at the Motley Fool, we are great champions of individuals making their own decisions and not being coerced by advisers.
And that freedom to choose our own pension investments, is, in my opinion, as much a fundamental freedom as being able to invest our ISA money wherever we want, wear whatever clothes we want, and engage in free speech.
Or in other words, in my personal view, most people don’t need to pay for professional advice.
So what do you do?
Thankfully, since pension rules were relaxed, here in the UK we’ve seen a burgeoning of financial services companies offering Self-Invested Personal Pension, or SIPP, accounts. And there’s only one manager of a SIPP account — you.
How do you transfer a qualifying pension to a SIPP? I did it myself a few years ago, and it was really pretty simple. All I had to do was open a SIPP with my chosen provider, then fill in some transfer forms — one for the existing pension company and one for my SIPP provider. And it was done very quickly.
Then all I had to do was choose my investments. One of the simplest, and one which attracts low charges, is an index tracker — a fund that attempts to emulate the FTSE 100, for example, or perhaps the FTSE 250.
And with a long-term view, you should do fine. The FTSE 100 has gained 20% over the past five years, and it’s provided dividends of around 3%-4% per year on top of that. The FTSE 250 has done even better, with a 42% gain over five years.
Pick your own
Or you can do what I do and just pick your own shares in individual companies. My preferred strategy is to go for FTSE 100 companies offering high dividend yields, choosing them from different sectors, and then reinvesting my dividends — and I hold for the long term. I’m not retired yet, but when I am I intend to take my dividends towards my income. Oh, and I go for the occasional growth candidate with a small amount of money now and then, just for a bit of excitement.
The bottom line is that if you can get your pension cash into a low-charge SIPP, you are then in control of your money, and you are not beholden to some suits in the City.
