Money: How to make your pension pay
Pensions are a topic of confusion and controversy for many. Andrew Couchman asks a few pertinent questions
Wednesday 19 August 1998
What sort of pension scheme or plan is this?
Pension plans fall into personal and company set up (or occupational) categories. Personal pensions are the simplest in concept. You decide how much you want to pay in each month, and the benefits when you retire depend on how well the insurance company's investments do and on the annuity rate (the annual income payable on your capital) when you retire.
In the past it often made sense to pay single or one-off premiums, because charges were lower than on small regular contributions, but as insurers have been stung by criticisms of over-charging and mis-selling, so value for money has generally improved. Executive pensions are set up by your employer but are personal to you. Both personal and executive pensions are money-purchase schemes. The premiums are a fixed amount and benefits are determined by investment performance. Occupational schemes cover a group of employees, and are usually set up to provide a percentage of your final salary on retirement.
How much is this costing me?
As well as what you pay in, your employer may also contribute, and on personal and executive plans there will be charges to pay. If so, you want to know what those charges are and, if you have a choice, whether you can get a better deal elsewhere?
Insurers are past masters at complex charging structures, so seek expert advice before taking any action you might regret later.
How good is your investment performance?
That does not matter on some occupational schemes that are linked to your final salary, as your employer is happy to go on paying. But it does for so-called "money-purchase", plus personal and executive plans. Performance will depend on the type of fund you invest in, where that fund invests and how much comes out in the charges.
The best way to check fund performance is by reference to one of the specialist personal finance magazines. Planned Savings and Money Management are the two top monthlies. Insurers may provide you with glossy graphs and tables confirming their performance, but you need to compare like with like, and look at a range of investment periods and the relative risk of the fund.
How much is pensions mis-selling costing, and who pays?
Pensions mis-selling has cost insurers billions of pounds, in both compensation and, for some, fines from their regulator. In the latter case, many insurers simply under-estimated the difficulty of the exercise, or were too slow to allocate the necessary resources. Some have now learned the hard way that the Treasury is serious when it says that excuses will not be tolerated.
The Prudential is currently under pressure because it is feared that its policy-holders rather than its shareholders will end up paying for the compensation. In reality, customers usually end up paying - a good reason why cost-effective regulation is something we should all be more interested in.
When can I retire, and how much will I get?
This is the key question. You want to know how much of a tax-free cash lump sum and how much income you will get, when you will get it and whether the figures are guaranteed. Most pension providers now let you choose which insurer will provide the annuity (income) at retirement, but with occupational schemes you do not get a choice as your pension income comes out of the scheme itself.
Can I buy more life assurance through my pension?
Buying life assurance through your pension is the cheapest way to buy it, because you get tax relief on what you pay in. With executive and occupational pensions, you can have life cover up to four times the value of your income, including benefits in kind such as a company car and any regular bonuses or overtime. Even if the scheme provides lower cover, you can often pay to have more. A pension will be payable to your dependants, but check how much.
What disability pension do I get if I cannot work because of illness or disability?
Many employers will pay full salary for just a few months, and any ongoing pension could be very small. If you don't like what you are told, ask if you can obtain better cover. If your employer has an insured income protection or permanent health insurance scheme, ask whether it includes a continuation option so that you can continue the cover even if you change employers later.
Can I buy extra pension benefits, or retire early?
If you change jobs, retire early or have benefits in kind, it is very unlikely that you will get maximum benefits from your employer unless you pay more.
That may be possible through additional voluntary contributions (where you pay more into your company scheme) or through freestanding additional voluntary contributions, where you pay into a separate insurance policy. The latter may provide poor value for money, especially if you only pay a few pounds each month.
What happens if I leave?
Despite improvements in recent years, occupational schemes still usually favour those who stay with the same employer until retirement. Do not be tempted to switch from a company scheme to a personal pension to improve things (that was what the pensions mis-selling scandal was all about) unless the reasons to do so are compelling, you understand precisely the downside as well as the benefits, and you get good, unbiased advice.
What happens when I die?
You want to know how much your heirs will get, and who will get it. Your scheme trustees will usually have a trust arrangement, so that your beneficiaries will get the money free of inheritance tax, but it makes sense to tell them your wishes, particularly if there are any previous partners or children to consider.
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