Pension power

Step up your contributions, Clare Arthur advises
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The Independent Online
YOUR pension is the most important investment you will make during your lifetime, for three very important reasons.

First, by the time you retire it is likely to be worth more than your house and, if you have planned carefully, it should keep you financially secure for as long as you live.

Secondly, saving money in a pension is one of the most tax-efficient ways to invest. You receive full tax relief on premiums, and the money then grows tax-free until your retirement when you can usually take up to 25 per cent as tax-free cash.

But most importantly, the government will not pay the same value of pension to you as to pensioners today. Regardless of which political party is in power, the chances are that by the time most of the working population retires, the state pension will not even represent a subsistence allowance.

Adrian Kemp, pensions consultant for independent financial adviser Berry Birch & Noble, says: "The population is ageing so fast that no government will be able to afford to fund pensions in the same way as today. State pensions may seem small now, but they will be worth even less in comparison to the cost of living."

He says people should invest as much as they can afford, as soon as possible, in their own pension - whether linked to your employer or arranged with an insurer or other investment company. The compounding effect of investment means that even small sums tucked away could grow into a sizeable fund later on.

There are two main types of pension - the company or occupational scheme, and the personal pension.

Generally, if employees are offered the opportunity to join a company scheme, they should accept. The employer, which runs the scheme on behalf of employees, usually makes generous contributions as part of the remuneration package. Such schemes often include free life insurance and income protection insurance, which pays out if you are unable to work through illness or disability.

However, you can only pay into a company scheme while you are employed by that company. As soon as you stop work or switch to another employer, you must stop contributions.

Personal pensions are sold by insurance companies and investment management companies. This type of pension is for someone who is self-employed, whose employer does not provide a scheme, or who frequently changes jobs. The investor can take this type of plan from job to job.

Both types of pension are subject to maximum investment levels. Employees who belong to a company scheme can invest up to 15 per cent of their income each tax year. Personal pensions have a range of maximum contribution limits, which vary according to the investor's age and salary. Anyone aged 35 or less can invest up to 17.5 per cent of their earnings in a personal pension. This limit rises as the investor gets older, and investors aged 61 to 74 years can invest up to 40 per cent of their earnings.

However, few people make full use of these allowances. For example, of all those who contribute to company pension schemes, only one-tenth retire on the full pension permitted under Inland Revenue rules.

It seems a shame to work hard all your life to achieve a good standard of living, only to suffer a drop in that standard when you retire. But there are several ways in which you can top up your pension later to ensure you retire on a more comfortable income.

Many employers offer other ways to allow employees to top up pension savings - additional voluntary contribution schemes, for example. AVCs offer the advantage of low or no charges. Free-standing AVCs are independent plans sold by life insurance companies and they offer the advantage of providing enormous choice.

Both types of AVC benefit from the same upfront tax relief and tax-free growth, but investors cannot take tax-free cash from schemes started after 1988. And employees may still only invest up to the 15 per cent limit in any one tax year.

People investing in a personal pension scheme can invest more than their annual limit by mopping up tax relief that has not been used in previous tax years. Known as "carry forward" or "carry back", these arrangements are quite complicated, and investors should consult an adviser before embarking on this course.

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