Lump it and like it

Paying for your pension monthly is convenient but the final benefits are less. Janet Walford reports

A PENSION plan where regular monthly payments are deducted automatically from salary probably suits most people's requirements for simplicity and convenience.

But convenience can also be costly, so deciding whether to save for retirement with regular monthly payments or a series of single payments needs careful consideration.

One benefit of schemes where you pay monthly is the discipline. Once the appropriate fund or funds has been selected and the amount to be saved decided, it is a simple to set up a direct debit so that the pension provider deducts the money automatically every month and invests it on the individual's behalf.

Most pension providers have a large range of investment funds from which to choose, ranging from relatively low-risk "with-profits" or "managed" funds through to much more risky and highly specialised funds.

Unit prices of funds will rise and fall in line with the performance of their underlying investments. Monthly pension premiums also benefit from what is known as pound-cost averaging (see page 17).

Another important consideration, especially for the self-employed, is a valuable "waiver" benefit that can be added to regular-payment pension plans. For a small extra cost each month, this means your pension payments will be maintained by the pension provider if you are ill or unable to work. The benefit is not normally available on single-payment pension plans.

The problem with monthly payments, however, is that costs can be much higher than when paying the same amount as a series of lump-sum payments. Obviously it costs the pension provider much more to collect 12 monthly payments than a single one each year, and these costs are reflected in the benefits of the plan.

A large part of most pension providers' costs in the early years are taken up in commission to the sales agent or intermediary - usually up to two-thirds of the first year's monthly payments. An alternative, usually only available through independent advisers, is the "level commission" basis, where the commision is pegged at say, 8 per cent a year throughout the life of the plan instead of a large up-front charge. This amounts to about the same in the long run, but it can mean that your pension pot is worth more in the early years if you need to cancel your plan.

By comparison, single payments attract only about 4-6 per cent commission on each. Over time, this can make a big difference.

An example is shown in Figure 1. National Mutual Life, a specialist pensions office that deals only through independent advisers, has provided a comparison of projected benefits for a man aged 45 at outset, planning to retire in 15 years' time. The comparisons are based on pounds 2,400 being paid each year as a single premium (the first payment being made right at the outset), or pounds 200 by regular monthly payments assuming full commission is paid to the sales intermediary, or lastly pounds 200 a month on a level-commission basis. All the figures assume that the underlying investment fund grows at 9 per cent each year.

It can be seen from the figures that the difference in projected pension fund values after five years is marked. The regular single payments are projected to grow to pounds l,100 more than for the level commission monthly payment plan and pounds l,800 more compared with the full commission monthly payment plan. The difference in the two monthly payment plans is wiped out by year 10, but in all cases the annual single-premium payments are worth more.

Single payments not only have much lower costs, but are more flexible. Each year, you can select a different pensions prov- ider to place your investment with. You may, of course, switch funds within the same product provider's stable with a monthly premium plan, but you are usually stuck with the same invest- ment-management teams. With single payments, you can switch providers and management teams every time you make a payment.

Most pension providers now have fairly high minimums for their single- payment plans: the norm is now about pounds l,000 each time you make a payment - one even has a pounds 5,000 minimum.

o Janet Walford is editor of 'Money Management' magazine, which this month includes a large survey on the costs and performance of personal pensions.