Who needs a pension?

There's more than one way to ensure a comfortable old age. Many people are opting out of both state and private pension schemes, deciding that tax-free savings and property investments could be a much better bet

An old age filled with buying your weekly shopping from the supermarket's budget range, followed by sitting in front of the telly because you can't afford to go out, is not an inspiring picture. But, experts warn, this could be the fate of many people working today, and not just those who have only the basic state pension of £67.50 a week to look forward to. Many people who are paying religiously into their pension fund may still find it is not enough.

An old age filled with buying your weekly shopping from the supermarket's budget range, followed by sitting in front of the telly because you can't afford to go out, is not an inspiring picture. But, experts warn, this could be the fate of many people working today, and not just those who have only the basic state pension of £67.50 a week to look forward to. Many people who are paying religiously into their pension fund may still find it is not enough.

Does this message of gloom tempt you to stop paying into your existing pension scheme? A growing number of people are deciding to do just that. According to the independent financial advisers (IFAs) we spoke to, opting out of a pension scheme to put your money into other investments makes more sense now than at any time in recent years. There are no miracle schemes, but there are realistic alternatives to pension schemes which will still ensure a safe and comfortable retirement.

The most common alternative are Individual Savings Accounts (ISAs), which allow you to save a maximum of £7,000 a year tax free. Other tax-saving options include unit trusts and tax-free savings plans offered by friendly societies. Alternatively, you could buy some property and let it out.

Jon Briggs, assistant director of Bath-based IFAs Chartwell, says: "A pension is merely a savings scheme. A pension need not be the be all and end all of retirement planning. I deal with people who have put money into PEPS and ISAs, unit trusts and building society accounts. My father doesn't have a pension, he has a number of properties he is using for his retirement." As well as considering how much your investment will grow to, key criteria should be: "Accessibility, flexibility and volatility," he says.

Gaining access to a pension scheme can also be a problem. While it is possible to go out and buy a private pension, getting one out of your employer is becoming increasingly difficult. As the inflation and interest rates have fallen to historic lows, companies find funding a pension scheme for their employees has become increasingly expensive. Hence new staff are frequently denied access to the company pension scheme.

Another big drawback to orthodox pension schemes is once you have paid your premiums, you cannot get your hands on the money until it is paid out to you on retirement. In effect this means taking a 30 or 40 year bet on how well a pension company will perform. "Charges can be high up front and then you can't get to your money for the 30 years or so it is tied up. Also, it can be very expensive to terminate the plan before it is due", warns Deborah Simon, a consultant at London-based IFA, Arbuthnot Weinel.

Pension plans are not known for their flexibility. Research by Barclays Global Investors shows nearly half of people in occupational schemes are offered a choice of only three to five of all pension schemes on the market. Michael MacDonald-Smith, head of defined contributions at Barclays, says: "For the vast majority of people indexation (a fund that tracks an index rather than being actively managed) is appropriate." But, he says, only 20-25 per cent of defined benefit schemes are index linked.

Once you have built up your pension, you also do not have much choice about how you spend it. You must purchase an annuity by the age of 75 with all but 25 per cent of the fund. The annuity is then released in yearly amounts until you die. Ms Simon says: "If you live until 110, you will be jolly glad that you have an annuity. But it would be more appropriate if you had more choice."

The government is under growing pressure to do away with compulsory annuities but currently there has been no movement. This is particularly unsatisfactory, Ms Simon says, because people are not encouraged to shop around: "Your life company writes to you to ask you to consider buying an annuity with them. They do say you can take it with another company, but they do not shout it out. Companies that are good for pensions are not necessarily good for annuities, the difference between the best and worst in the market can be as much as 10 per cent."

Compare this to an ISA or a 10-year tax-free saving plan from a friendly society like Liverpool Victoria, which are both outside a pension fund and so do not require you to buy any annuity. An ISA offers nearly complete flexibility. If the fund performs badly you can cash it in and take out a different one. This is particularly valuable when under-performance in a pension makes a big impact on the final pot. Barclays Global Investors shows that an £800,000 fund shrinks by a quarter to £650,000 if the investment return drops by just 1 per cent from 9 to 8 per cent.

Mr Briggs says: "The choice is not what you put your money in - most of these things (pensions and ISAs) are invested in equities - but what type of fund". Few pensions offer the chance to invest in specialist funds, while an ISA wrapper can be used around an almost unlimited number of funds.

Which brings us to volatility. Advisers agree that the type of investment you make for old age should be guided by how near you are to retirement. Mr Briggs says: "If you have more than 10 years to go you should be investing in equities." An ISA, for instance, is no riskier than a pension, which is also invested in shares. As you get closer to retirement, you should be putting more into less risky investments, such as bonds.

The level of flexibility and accessibility offered by ISAs seems to make sense as a long term alternative to a pension fund, especially for the growing number of people holding part-time jobs, and the self employed, who will want to put different amounts in at different times.

This leaves the return on your investment - the biggest issue for people who want to maximise their retirement income. Today's buoyant stock market has been good news for anyone investing in shares, including pensions and ISAs. Anyone investing in equities in 1998 enjoyed a 21 per cent real return on their investment by the end of 1999.

Residential property, perhaps surprisingly, has returned less. Average UK house prices have risen between 1.5 and 2 per cent above inflation over the last 30 years. The picture changes depending on where you live, the Nationwide's quarterly house prices survey shows that in hot spots like the South-east, an average property has increased in value from £12,848 in 1973 to £140,148 today.

Clearly the bumper returns are to be had on the stock market and ISA investments have largely reflected this. Yet pensions experts are warning people should be putting a lot more, not less, into their pension. Winterthur Life recently produced figures showing a 25-year-old should put 25 per cent of their income into their pension, while a 40-year-old should be ploughing 32 per cent in, if he or she wants to retire at 60.

The reason is pensions are dropping dramatically in value because of the compulsory annuity that is bought at the end. Today, a 65-year-old pensioner with a £100,000 fund would get an annual income of £9,000. This compares to £15,000 with the same amount 10 years ago. This is due to the UK's low inflation, low interest rate economic environment, which has driven down the value of gilts from returning 12 per cent at the beginning of the decade to just 5 per cent now.

Harvey Brown, chief UK actuary for William Mercer, predicts this will not change: "Gilts are expensive because pension companies are obliged to buy them to back up their annuity guarantees. But there are less gilts in the market because the government is working to reduce government debt. This has increased their price. This would only change if the government said companies could guarantee their promises with corporate bonds. But I can't see this happening within the next five years and probably not for 20 years."

Mr Brown also says the one major advantage pensions have - the ability to save tax-free in your pension - is not as substantial as it might seem. "It is a deferred tax as, apart from 25 per cent of your fund which you can take tax free, you will pay tax at the level of your income band on retirement. If tax rates go up between contributions and taking your pension, you will pay more." If Britain joins the euro and adjusts to the higher rates paid on the Continent, some say, this could well happen. In contrast, contributions to an ISA would be taxed as part of your income, but any capital earned on the ISA would not be taxed.

Mr Briggs makes two points about orthodox pensions: Firstly, you get a quarter of the entire pension as a tax-free lump sum. Secondly, this tax-free lump sum will be extremely attractive to higher rate tax payers. But, he says, pensions certainly hold less advantages for other groups. "If you are a basic rate tax payer there are no substantial benefits to a pension. It is pretty tax neutral."

But some pension schemes make sense to belong to. Ms Simon says: "If you are offered a scheme by your company, take it as they will be putting in a contribution." Mr Briggs says stakeholder pensions, already introduced by Marks & Spencer and HSBC and to launch generally next April, are good news. "There should be no up-front costs and an annual management fee of 1 per cent. This is less expensive than an ISA, which can cost about 4.5 per cent with an annual fee of 1.5 per cent." Both say nothing rivals the flexibility you get with ISAs.

Ms Simon offers a word of warning for anyone who thinks they can fund their retirement on a wing and a prayer: "I would encourage people to seek out alternative forms of investment. But people cannot get away with putting in peanuts to any funding for retirement if they want to have a decent standard of living."

Independent Partners: 10 top tips for retirement. Get your free guide here

Voices
On the last day of campaigning before the polling booths open, the SNP leader has written to voters in a final attempt to convince them to vote for independence
voicesIs a huge gamble on oil keeping the First Minister up at night?
Arts and Entertainment
Rosalind Buckland, the inspiration for Cider with Rosie died this week
booksBut what is it like to be the person who inspires a classic work of art?
Life and Style
techApple has just launched its latest mobile operating software – so what should you do first?
News
A male driver reverses his Vauxhall Astra from a tow truck
newsThe 'extremely dangerous' attempt to avoid being impounded has been heavily criticised
PROMOTED VIDEO
Arts and Entertainment
Lionel Messi in action for Barcelona
filmWhat makes the little man tick?
Arts and Entertainment
tvReview: An undercooked end (spoiler alert)
News
i100
Arts and Entertainment
Pharrell dismissed the controversy surrounding
musicThe singer said 'the last thing I want to do is degrade'
Sport
Cesc Fabregas celebrates his first Chelsea goal
footballChelsea vs Schalke match report
Arts and Entertainment
Toby Jones (left) and Mackenzie Crook in BBC4’s new comedy The Detectorists
tvMackenzie Crook's 'Detectorists' makes hobby look 'dysfunctional'
Life and Style
fashion

Olympic diver has made his modelling debut for Adidas

News
i100
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Trainee Recruitment Consultant Birmingham

    £18000 - £23000 per annum + Comission: SThree: The SThree group is a world lea...

    Trainee Recruitment Consultant - Birmingham - Real Staffing

    £18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

    Recruitment Consultant - Soho - IT, Pharma, Public Sector

    £20000 - £25000 per annum + OTE £35,000 first year: SThree: The SThree group i...

    Sales Executive

    £20 - 24k (Uncapped Commission - £35k Year 1 OTE): Guru Careers: We are seekin...

    Day In a Page

    Mystery of the Ground Zero wedding photo

    A shot in the dark

    Mystery of the wedding photo from Ground Zero
    His life, the universe and everything

    His life, the universe and everything

    New biography sheds light on comic genius of Douglas Adams
    Save us from small screen superheroes

    Save us from small screen superheroes

    Shows like Agents of S.H.I.E.L.D are little more than marketing tools
    Reach for the skies

    Reach for the skies

    From pools to football pitches, rooftop living is looking up
    These are the 12 best hotel spas in the UK

    12 best hotel spas in the UK

    Some hotels go all out on facilities; others stand out for the sheer quality of treatments
    These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

    Widespread fear of Isis is producing strange bedfellows

    Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
    Topshop goes part Athena poster, part last spring Prada

    Topshop goes part Athena poster, part last spring Prada

    Shoppers don't come to Topshop for the unique
    How to make a Lego masterpiece

    How to make a Lego masterpiece

    Toy breaks out of the nursery and heads for the gallery
    Meet the ‘Endies’ – city dwellers who are too poor to have fun

    Meet the ‘Endies’ – city dwellers who are too poor to have fun

    Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
    Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

    Ian Paisley’s decision to make peace with his IRA enemies

    His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam
    'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

    'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

    Exclusive extract from Janis Winehouse's poignant new memoir
    Is this the role to win Cumberbatch an Oscar?

    Is this the role to win Cumberbatch an Oscar?

    The Imitation Game, film review
    England and Roy Hodgson take a joint step towards redemption in Basel

    England and Hodgson take a joint step towards redemption

    Welbeck double puts England on the road to Euro 2016
    Relatives fight over Vivian Maier’s rare photos

    Relatives fight over Vivian Maier’s rare photos

    Pictures removed from public view as courts decide ownership
    ‘Fashion has to be fun. It’s a big business, not a cure for cancer’

    ‘Fashion has to be fun. It’s a big business, not a cure for cancer’

    Donatella Versace at New York Fashion Week