Midweek Money: A personal dilemma

The occasional scandal should not put you off preparing for retirement.
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The Independent Culture
For many people, personal pensions are the best way to save for retirement. But some still view the products with suspicion since the pensions mis-selling scandal of the early Nineties.

Between 1988 and 1994, thousands of people were persuaded to leave occupational pension schemes, or not to join in the first place, and sign up for personal plans instead. Commission paid by providers to the advisers often proved too much to resist, and many people were worse off with their personal pensions as a result.

By choosing one of these new products over an employer's scheme, they lost out on the contribution the employer made, and also on the fact that the administrative costs of the scheme were shared, and other benefits, says Jackie Blyth of the Personal Investment Authority (the regulator dealing with the mis-selling affair and the compensation which is being awarded).

But it remains true that, because of the tax breaks they offer, personal pension plans are, for many people, the most efficient long-term investment vehicle.

"We're not saying personal pensions are a bad thing," says Ms Blyth, "Clearly people should be saving for retirement, and that is a good thing... but if there is an employers' scheme, that should be seriously considered."

"Personal pension plans are right for anyone who has no employer's scheme that they can contribute to," comments an independent financial adviser, Philippa Gee. "Only after discussing it with your employer and discovering that there is no scheme, or if you are self-employed, can you then consider personal pensions."

However, not all self-employed people can contribute to a personal pension. If you work for yourself but do not pay any tax, then a personal pension is not appropriate because you cannot get tax relief, says Ms Gee. And tax relief is the main attraction of any pension plan. Contributions to personal pensions carry tax relief at the basic rate of 23 per cent, and 40 per cent for higher-rate taxpayers.

Anyone thinking about starting a personal pension must be clear that this is a very long-term investment, says Ms Gee.

"You mustn't use money unless you are sure you won't need it," she points out. Once your money is invested in your personal pension, you cannot get at it until you are aged at least 50.

But in other ways, personal pensions can be quite flexible. You can choose to take the pension at any age between 50 and 75. A quarter of the sum which has built up can be taken on retirement as a tax-free lump sum, and it is up to you which type of annuity you buy. This may be one that rises each year, or one where the monthly income remains static. And you don't have to pay contributions monthly. You can pay them annually, once you have worked out how much you can really afford, says Ms Gee.

With a personal pension, you can often choose which fund your money is invested in. If you want to keep risk to a minimum, you could opt for a managed fund with a wide spread of investments, but if you can stomach more risk in pursuit of higher returns, you could choose a specialist fund with fewer holdings.

If you choose a fee-based independent financial adviser, he or she should be able to get the commission earmarked for the adviser reinvested into the pension.

When choosing a personal pension, you have to decide what features you are looking for, and what your attitude to investment risk is.

"That helps the IFA to decide if it should be a steady-as-you-go, with- profits fund, or you might go flat out with an equity fund," says Clive Scott-Hopkins, of IFAs Towry Law.

Other questions you should ask yourself are: when do you want to retire? Do you want regular monthly or lump sum contributions? How much can you afford to contribute? Do you want waiver-of-premium insurance, which pays your premiums if you cannot work due to illness or injury? Do you want to provide for dependants?

Types of pension fund

Unit-linked - money is invested in funds, such as unit trusts. There is no guaranteed minimum return, but these funds can choose from a wide selection of investments, which should mean you are rewarded with potentially higher returns.

With-profits - less risky than unit-linked. They are insurance policies where you also share in the profits of the insurer by means of bonuses. These bonuses cannot be taken away once added.

Unitised with-profits - a cross between unit-linked and with-profits, which is increasingly replacing with-profits.

Unit/investment trust - There is no guaranteed minimum return, but these tend to have low charges and are often highly flexible.