Freedom. You don’t usually get much of it with a pension. You get bullied endlessly by the financial industry, by the government and by the likes of us, to save. And then to save some more.
But if you do as you are told, you might feel you don’t get much out of it, largely because the whole process is very carefully controlled. Come age 77 you have to buy an annuity whether you want to or not. That means that your life savings are instantly and irrevocably converted into a stream of income – mostly not a very big one – and you have no control at all over them.
Good news then that there are changes afoot. From next April the compulsion to buy an annuity is to be scrapped. Instead, as long as you can show that your fund plus your state pension will generate an income of around £20,000 a year, you will be allowed to do as you wish with your pot.
You’ll also be able to leave anything you don’t spend to your heirs with a tax charge of 55%, an excellent deal for those who are 40% or 50% tax payers. This doesn’t exactly benefit everyone. You’ll need around £300,000 to buy an income of £15,000 a year and if you have only had basic tax relief of 20% while building up your pension, 55% seems a pretty penal rate for your family to have to pay on any leftovers when you die. But it does at least put the beginnings of some flexibility into the system. That’s good.
Cost is the real problem
However the truth is that the real problem with pensions for most people is not really the annuity system in theory. After all if you are going to live to 95 – and there is apparently a 50% chance that one member of a healthy 65 year old couple will – is it really so bad to be getting a guaranteed annual income?
The real problem has long been the fact that annuities are perceived as being – and very often are – very bad value. And that the pensions are very expensive. Most of us worry far too much about how we might draw our money down. But not nearly enough about how much we pay to build it up.
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Fund manager Vanguard has just run the numbers on this again. Let’s say you put £100 a month into a pension over 30 years and the investments inside it grow at 7% a year. If you do this via a workplace scheme of some kind, which charges say 0.3% a year, you’ll end up with a total pot of £110,846. Do it via a standard fund of some kind – for which you will generally be charged 1.5% of the value of your pot every year – and you will end up with £87,826. But go for specialist funds instead – as financial advisers often suggest – and there is a good chance you will end up paying 3% or so. In which case your final sum will be a mere £61,656, says The Sunday Times. You will say that the specialist funds will perform better, something that will cut or eliminate the differential. But, while that is possible, history suggests that it isn’t particularly likely.
Look to the Dutch for inspiration
The point? That we should all worry about how we will get our hands on our pension money in the end. And we should be lobbying for a better deal across the board. But before we do that, we should be making sure that we aren’t throwing money away by paying unnecessary fees while we save.
The Dutch pay an average fee on their pensions of around 0.5%, says The Daily Telegraph. As a result they end up with around 50% more in retirement income than most of us do, even if they only save the same amount.
We don’t seem to be able to make the UK financial industry as a whole accept that it regularly overcharges, and to cut its fees. However, there are now enough cheap funds on the market – think investment trusts and exchange-traded funds – for us all to go Dutch if we put our minds to it.
So think about using a few hours of the quiet days between Christmas and New Year to take a look at your pension savings. If you have a cheap work deal and it looks reasonably well invested, then fine. If you do not, you might make sure that you have a low-cost pension with a discount broker or fund supermarket; and that you own more cheap investment trusts on fees of 0.5% or so than expensive unit trusts on 1.5% plus.
Also check that you are getting all the tax relief you can. If one partner is a lower-rate tax payer and one a higher-rate tax payer you might want to save only into the latter’s fund and get 40% instead of 20% relief for example. And finally, make sure that if you do buy an annuity you get the best possible deal. Shop around and you’ll find that rates vary by 30% plus.
Arranging all these things will take a few hours now – which is boring. But they may also mean you have a much richer retirement than you might have otherwise. That’s worth it.
• This article is taken from our weekly MoneyWeek Saver email.
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