This article is taken from Merryn Somerset Webb’s free weekly personal finance email, MoneySense. Click here to sign up now: MoneySense
Well quite. Seven grand is barely enough to pay for a properly glamorous birthday party these days (note that it cost Philip Green around £6m to fly all his mates to the Maldives for his 55th), let alone to keep you in champagne through your 70s.
Abbey’s aim in telling us this is to promote its 50+ Saver account designed, it tells us, to “reward those over 50 who want to save more.” But most of us might be better off ignoring this advice. The account’s marketing material indulges in the usual trick of making its interest rate seem higher by chucking in a bonus paid in the first year only and of paying smaller deposits lower rates than larger deposits.
Instead the over 50s – just like the rest of us – should be thinking more about the core message offered by the Abbey numbers – that we all need to save more for our retirements and that we would probably be wise to do so via the pension system. Too many people don’t do so, often not because they can’t afford it but because, convinced that pensions are both boring and complicated, they can’t face it.
They are right on the first count (pensions are very boring) but wrong on the second – despite the best efforts of the financial services industry to make them complicated, pensions are really very simple. In its structure a pension is no different to an ISA. The pension providers all talk about buying a pension as though a pension were an investment in itself. But it isn’t. It is simply a box, a ‘wrapper’ into which you put investments. The box protects the investments you put into it from tax (pension money is invested free of income tax) and has a lock on it to stop you from taking any money out of it until you retire. The box and the investments are two different things. That means there are two vital points to bear in mind when you are looking at your pension arrangements. What kind of box have you got or are going to get, and what investments are going to be put in it?
There are effectively three kinds of pension boxes around: the company pension, the traditional personal pension and the Self Invested Personal Pension (SIPP). A good company pension is a wonderful thing to have and the best of all the company pensions is the final salary plan. These are a bit different to most pensions in that for you the kind of wrapper used and what goes in it is irrelevant. You just get, on retirement, an annual amount based on the length of time you have worked at the firm and your salary when you left it or retired from it. It doesn’t matter how much you have paid into the pension or how the stock market has performed since. You get your money anyway. Final salary schemes cost employers a fortune but are fantastic for employees. If anyone ever offers you one grab it.
The next kind of company scheme is the money purchase or defined contribution scheme. With these your employer chooses the wrapper and pension trustees usually choose the investments to put in it. You and your employer then both contribute money into the wrapper to be invested. What you get paid out when you retire will then depend entirely on how the investments chosen have performed and how much the pension firm that provides the wrapper manages to cream off in fees and charges. The lump sum left at the end is used to buy you an annuity that pays you an income for the rest of your life.
Traditionally anyone who hasn’t had a company pension has been encouraged to take out a personal pension instead. This basically involves going to one of the big pension providers, buying one of their wrappers and then filling that wrapper with a selection of the investment funds they have on offer for that purpose. The problem with these is that they are expensive – you pay high commissions when you arrange them and massive annual fees.
I wouldn’t touch an old-fashioned pension like this with a bargepole; thanks to the general public’s inertia and ignorance when it comes to pensions the providers use them as an opportunity to fleece investors at every turn. Buy one of these and you are pretty much guaranteed to get ripped off somewhere down the line. You can find yourself paying up to 2.25% a year in annual charges, to say nothing of a whole host of other more opaque charges (total charges on one of these can add up to 5% a year) something that could end up making your retirement a great deal more miserable than it needs to be.
Note that if you invested £2,400 in a pension and managed to make 8% a year on your investments, after 20 years you would have £119,000. If you paid charges at 2% a year and so made only 6% you’d have over £25,000 less – a mere £93,500. If you do decide to take out an old-fashioned personal pension you need to keep an eagle eye on it to make sure the charges are low enough and returns high enough to make it worthwhile. If not, move on.
It shouldn’t be complicated to move your pension investments from one provider to another. There is also one kind of personal pension that might suit a great many people – stakeholder pensions. These are offered by the same providers as most other personal pensions but they are simpler and cheaper. The charges are not allowed to be more than 1% a year and you can put in as little as £20 a month. The fact that they are both easy to access and easy to understand makes stakeholders well worth looking at: almost anyone working or non-working is allowed to get one and for people who are just starting to save or have only small funds stakeholder pensions are probably a good option.
The final type of pension – and the kind that I have and I think is the best option for most people – is a Self Invested Personal Pension or SIPP. You go to a provider, you arrange to set up the wrapper and then you put into it whatever investments you like – from individual shares and bonds to investment funds and commercial property. You are entirely in control.
SIPPs used to be expensive to set up and as a result be used more by the rich than by ordinary people, but their costs have now come right down: you can arrange a SIPP online and manage it online just as you would a Self Select ISA. You put in as much money as you like (up to the equivalent of your salary with a current top limit of £225,000 a year) as often as you like and then invest as you like using the SIPP provider as your broker for buying and selling investments. It’s simple, it’s reasonably cheap, it’s flexible and best of all it means that you can save for a pension without having to leave your money hostage to the whims of the charging systems of the big pension providers.
All in all, SIPPs seem to me to be a great way to save. In 20 years everyone will probably have one. I have bought my own SIPP wrapper from Hargreaves Lansdown and it is currently stuffed with shares in Shell, precious metal and grain exchange traded funds (see How to profit from the commodities bull for more on these) and shares in Lonrho (see: How to go off the beaten track for more).
If you’d like to read more personal finance advice from Merryn, click here for previous issues of MoneySense: MoneySense