We're not all offered the same pension to fund our retirement. Here we outline the pros and cons of the four main options open to you.
Many hard-core Fools get quite heated about the best way to save for retirement. The truth is that it varies depending on our personal circumstances, our investing ability (or lack of it), our willingness to devote time to setup and maintenance, and the options we have on offer. Here's a run down of the four main ways.
1. Company pension schemes
Company pension schemes are suitable for many people. You require little knowledge in order to start saving for retirement and the trustees should look out for your best interests. There are two main types of company scheme: defined benefit and defined contribution.
Defined-benefit schemes (otherwise known as final-salary schemes) are the ones that have had a lot of bad press recently, because they have been hugely under-funded and companies have been closing them down.
However, it is a generous type of pension if you can get it, often guaranteeing to pay two-thirds of your final salary when you retire, or a proportion of this if you don't work at the company for long enough. With this kind of pension scheme you don't have the risks of investing in the stock market, but you do have the risk that the company goes bust.
In the other kind of company scheme, a defined-contribution scheme, you pay contributions from your salary into a fund which invests your money, typically in shares. Most companies will also contribute to your scheme. Corporate generosity varies, but you often find that they'll match your contributions up to 5-7% of your gross salary.
As with all pensions, the government tops this up with tax relief on your personal contributions at 22%, and higher-rate (40%) taxpayers can reclaim a further tax rebate of 18%.
Between your company's donations and tax relief, this means that for every £1 you contribute, you get £2.28 in your pot, plus a further rebate of 23p per £1 for higher-rate payers. However, you will have to pay this income tax at a later date. (More details a little further down.)
2. ISAs
You can save for retirement just as easily with ISAs. People taking this route typically invest in funds that invest in shares, or pick individual shares themselves, so it's usually more hands-on.
With pensions, you get tax relief when you pay into the scheme, but you pay tax on your pension income later. ISAs work in reverse. You pay into ISAs from your net income (i.e. you've already paid tax), but when you cash them in they are not subject to tax. As the Fool School article Pensions vs ISAs explains, if you ignore differences in income tax levels and personal allowances, the two methods work out equally.
However, there are lots more issues, and the question of pensions vs. ISAs is a hot one. Here are some factors you should consider:
The case for ISAs
- With ISAs you have greater flexibility with and control over your money. Once your money is in a pension, it's pretty well stuck there.
- If ISA rules appear to be changing for the worse, you should hopefully have time to move your money to a more suitable savings vehicle before the worst happens. It will be a lot harder with pensions.
The case for pensions
- You can get tax relief on up to 25% of your pension pot when you retire (which means you will never have paid tax on this portion of your pot).
- If you're a higher-rate taxpayer now you'll get tax relief at that rate when you pay into your pension. However, chances are you'll be a basic rate taxpayer when you retire, so you'll pay less tax overall.
- The first part of your pension will not be taxed, because of the tax-free personal allowance.
- Pensions stop those with little willpower from raiding their funds, which could be disastrous. See Miss A Year's Pension Contributions And Lose £64,000!
- You (probably) don't need to think about your pension or maintain it as much as you would if you're using ISAs - so long as you get the right pension in the first place.
- This applies to defined-benefit pensions only - a guarantee of, say, two-thirds of your final salary is hard to beat.
- Sadly, it's not normal for employers to contribute to ISAs at present, which means that you're just relying on your own contributions.
The fact that pensions have more pluses in these lists does not necessarily make them the best option for you. Also, there's no reason why you can't invest in ISAs for the flexibility and then transfer the pot later on into pensions. This way you can take advantage of the flexibility of ISAs and then the benefits of a pension later.
3. SIPPs
Much of the basics about pensions mentioned in Section 1 (Company pension schemes) still apply here, as does the comparison between pensions and ISAs I made in Section 2 (ISAs).
SIPPs are self-invested personal pensions. With these you have greater control over what you can invest in than any other pension. Just like ISAs, you can choose funds from a variety of providers, or even pick individual shares.
You might use SIPPs because you want to choose the companies you invest in. With a SIPP you may also find that it's easier to invest for the future in other things, like property. As with ISAs, you don't usually get contributions from your employer, although it does happen.
4. Personal stakeholder pensions
Sadly, not all Fools are comfortable with SIPPS or ISAs, and they don't all get offered a company pension. They may also be less than willing to spend time maintaining their retirement funds (although I'd urge you to do so!) and to move money around when necessary. Stakeholder pensions are most suitable for these people. They are pretty cheap (although SIPPs can be comparable or cheaper) and they're easy.
If you want something basic that requires little maintenance, and you don't want to pay repeated visits to your adviser for up-to-date information, this is a suitable vehicle. However, there's no getting away from it, some knowledge and maintenance is necessary if you want to avoid advisers' fees.
I don't want to talk down stakeholder pensions too much though. I like their simplicity; simple products are usually the most Foolish ones. The complex ones almost always hide all sorts of charges.
Don't feel confined to saving in just one of these four ways. Do your research, and find a way that you feel comfortable with. Whichever route you choose, you will also have to keep an eye on your retirement fund, and keep reading articles from sites such as The Fool to stay up-to-date on any changes that may affect you.
More: Boost Your Income By Up To 30% | Perking Up Past Pensions