Why saving for the future is set to become simpler
Next month's pension reforms should make it far easier to save, says David Prosser
Saturday 18 March 2006
The most fundamental shake-up in pensions for almost 20 years happens on 6 April. On day one of the new financial year, the Government will finally dump some of the most tortuous tax rules on the statute book - and replace them with a single tax system for pensions. The reforms - known as A-day to pensions experts - will genuinely make it easier for people to save for old age.
The new rules will create opportunities for savers - as well as some nasty traps - and, just as importantly, make pensions far simpler.
To Charlotte Speedy, a 29 year-old public relations agency worker from Putney, south-west London, simplicity is the key. "I've not paid into a pension because everything seemed so complicated," she says.
Earlier this year, she started paying into a stakeholder pension run by Virgin Money. "I've been feeling scared about pensions for some time," Charlotte says. She chose Virgin because she felt more comfortable trusting the company than conventional pension providers.
One of next month's reforms could prove particularly useful to her. She plans to take time out of work to go travelling at some stage in the future. While she's away, Charlotte won't be earning, which under current rules would stop her making pension contributions.
However, under the new rules, even non-taxpayers will be allowed to contribute up to £3,600 to a private pension and still get tax relief. As Charlotte pays £55 a month into her stakeholder plan, her pension planning won't have to be put on hold.
When she returns, Charlotte may be able to take advantage of a second A-day reform. At the moment it is not usually possible to take out an individual plan, such as a stakeholder or personal pension, if you are a member of a company scheme. That rule is being abolished next month - instead, a single annual pension contributions allowance will apply (see story opposite).
As Charlotte's employer offers a scheme, this rule could be to her advantage.
The reforms will also benefit older people whose pension planning is more advanced. Pension experts expect self-invested personal pensions (Sipps), to play a much bigger role in many people's plans following the reforms. Stakeholder plans provide the base for saving, but Sipps offer a much wider choice of returns and are increasingly available for low charges.
They allow pension savers to invest in unit and investment trusts as well as individual shares, if they have the confidence.
John Francis, a 42-year-old double glazing salesman from Edmonton in North London, has had a Sipp with Alliance Trust for around five years. "What appeals to me most is that I'm in control of my own money," he says. "I used to have an Equitable Life pension and the collapse of that company hit me really hard."
John holds a range of investments through the Sipp, including holdings in Alliance's own investment trusts, a number of other unit trusts and a small portfolio of equities.
And from next month, pension savers will, for example, be able to invest in residential property for the first time - not directly in bricks and mortar, but through funds such as real-estate investment trusts.
See www.sippsupermarket.com for details of providers' plans.
What to do with your existing pensions
If, like many people, you have several pension plans, rather than all your savings in one place, it may make sense to consolidate them.
Tom McPhail, head of pensions at independent financial adviser Hargreaves Lansdown, says: "If you have several money purchase pensions [but not final salary plans run by an employer] bringing them altogether will simplify your administration and make it easier to get a good overview of your investments."
McPhail recommends savers make regular use of pension calculators such as the FSA's online service (see above right) to monitor how well their plans are progressing.
Savers who have with-profits pension plans also need to consider their options. Many of the insurers that offer these products have struggled to produce decent performance in recent years and some have introduced exit charges to prevent people taking their money elsewhere.
Working out what these pensions are likely to produce can be difficult, though in general, the higher the proportion of your money that is invested on the stock market, rather than in bonds or cash, the better your potential returns.
Weaker insurers have reduced the amount of money they invest in shares, so they are less likely to perform well. Depending on the penalty charges you would face to transfer, it may be better to move your savings.
What you can save each month - and what you need to put by
The rules on pension contributions are currently ridiculously complicated - how much you may invest depends on all sorts of factors, including your age and what type of pension you have. But from next month, life will be much simpler.
You'll be entitled to tax relief on contributions worth up to 100 per cent of your earnings each year, as long as your investment (including anything your employer offers) does not total more than £215,000. The only other restriction is a lifetime pensions cap (see story on page 15).
However, while this limit will be raised each year, to £255,000 by 2010, most people will be able to pay in far less. Tom McPhail, of Hargreaves Lansdown, says savers should aim for more realistic targets.
"As a broad rule of thumb, if you want to retire at 65, you should contribute a percentage of your earnings equivalent to half your age when you start saving," he says.
For a saver earning £20,000 at age 25, for example, an annual pension contribution of £2,500 makes sense. After tax relief, that would cost around £160 a month. Someone starting saving at 40, however, earning £40,000, might need to find £500 a month.
Every bit helps. According to the Office of National Statistics, the average household in Britain spends around £22,500 a year, or £1,875 a month.
The Financial Services Authority, which has a pensions calculator on its website ( www.fsa.gov.uk) suggests a basic-rate taxpayer earning £30,000 and starting a pension at age 35 would have to find £377 a month to generate such an income.
That assumes the saver is a man, that his pension has average investment returns and charge, and that he increases his contribution in line with inflation each year until retirement at age 65.
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