I could not have picked a better day for my day off. I am enjoying a coffee and almond croissant, catching the early morning sun, when my reverie is interrupted by my phone…
“Good morning Ray, Tony here [a new client], do you have time to speak?”
“Yes, of course, what’s the problem?”
“I have just received a pension statement: my fund has hardly moved over the past year and I’m wondering if it’s worthwhile ploughing any more money into my pension?”
When your employment stops, your income also stops. Your future income will arise from a combination of state pension, employer’s pension and any private pensions you may have. Your family’s standard of living will depend on how well you have managed your pension arrangements during your working life.
Pension schemes have had a bad press in the past, but we remain convinced that contributing to a pension scheme still makes sound financial sense, providing you take advantage of the many opportunities that pensions offer and make informed choices.
Can I make pension contributions from previous years that I missed?
In a sense, yes, as there are generous carry forward allowances for both individuals and employees that allow for creative tax planning. If you have not made pension contributions in the previous three years, despite qualifying by way of earnings, you may carry these missed contributions forward. This will provide you with the possibility of making a higher contribution than the £40,000 annual allowance.
If you are earning less than £200,000 per annum in your present financial situation and will therefore be stung by higher rate of tax, it makes sense to pay a pension contribution that will eliminate your higher rate of tax, if you can afford to do so.
Pensions are a legitimate and authorised means of reducing your tax bill and the contributions are deducted from your highest rate of tax, so make sure you take advice to ensure that any pension contributions are tax deductible.
The advantages to high earners making pension contributions are considerable as contributions are deducted from the highest rate of tax. For example, if a 40% tax-payer makes pension contributions, any qualifying pension contributions will allow him/her to pay 20% less than the amount of contribution (the same as standard rate tax-payers). In addition, the taxpayer would receive a further 20% tax credit on his annual tax bill.
This is highly advantageous and it’s surprising that many higher rate taxpayers ignore this or simply do not act.
Let’s consider you are a high rate taxpayer and can fund £50,000 of pension contributions. You would normally pay a net figure of £50,000 but after-tax relief is added, you will end up with a total of £50,000 in your pension.
A further amount of £10,000 may be claimed via your tax return.
So, you have £50,000 at a net cost of £30,000.
Assuming your pension grows at 5% per annum compound, after all charges and expenses, after 10 years you will have accumulated a sum £81,445.
If the actual growth of you pension exceeded the previous assumption and grew at 6% compound over the ten years. then the accumulated sum would have increased to £89,542.
Considerably more than the cost of your net contribution.
Under current legislation you can withdraw 25% of your pension tax free, in addition with careful planning of your pension income withdrawals you avoid paying tax up to amounts within your personal allowance, and marginal tax on the remainder.
For those that are aware of the generous tax allowances and do make additional contributions, beware of squandering them by paying into pensions with poor fund performance.
Find out more about your pension before you make additional payments into your pot.
Some very large occupational pension schemes make considerable efforts to disguise where their monies are invested, yet many clients want to know where pension funds invest their money.
Spending time finding out more about where your money is actually invested will be time well spent, although it may surprise you to discover that 90% of the clients I interview have no idea (or only a vague idea) of where their monies are invested in their pension fund.
Yet on retirement the monies in your pension pot will depend upon three factors, the amount of contributions paid into your pension fund, the charges on your pension fund,
And the returns made by your pension funds.
Often the large occupational schemes funds are ‘white label’ versions of other funds.
That makes it difficult for pension fund members who, quite sensibly, want to find out how much they are likely to have in their pension funds in the next ten or 20 years, or when they reach retirement.
The other ‘white rabbit’ or distraction for pension fund members is that the trustees of their pension will phase their fund into ‘lifestyle mode’, five years or more before retirement.
This is not very reassuring for pension fund members, knowing that they will be phased out of their equity-based funds – which were at least making a return of sorts, and gradually phased into funds that have little or no yield.
Many years ago, if you were fortunate to live to retirement age, you would take your pension and enjoy it for four to seven years before you expired. Back in those days, ‘lifestyle positioning’ of the pension fund made perfect sense but nowadays, people generally live a lot longer, so their funds should be properly invested.
If you are a member of a large pension fund with Scottish Widows, Standard Life, Legal & General or Aviva, the chances are that your pension fund will be managed on a one-size-fits-all basis.
The problem with this is that does not provide you with any opportunity to influence what happens to your pension and your future lifestyle.
It is my opinion that many trustees of pension funds are merely exercising an administrative role and have little experience at investment. Yet they are responsible for millions of upon millions of pension investments.
I recently made enquiries about a very large occupational pension fund and was informed by a very helpful lady with a posh voice, “You do realise that our pension funds are ‘blended’”?
After research, it became clear that they had simply mixed the various Standard Life funds that they provided their pension members.
Result? Disaster! What were the trustees thinking?
Over 21 months they had made a return of 2.71%, whereas one of our portfolios returned 45.81% over the same period.
Given all the dramatic changes that Covid-19 has wreaked upon the global economies, I venture that they have made no changes whatsoever to their ‘blends’ of funds.
If they started their day with coffee blended as badly as they had blended their pension funds, they would stop drinking coffee!
I have been advising clients for many years, yet I still look forward with anticipation to the initial Discovery Meeting where the clients inform me what they want to achieve and I endeavour to find a strategy that will help them meet their goals.
The average person has 11 different jobs over their career and often ends up with 11 different pensions. It’s easy enough to become confused with one pension, so how confused are you going to be with so many more?
The comment that people often make is, “Well, at least my pensions are diversified”, until I point out that all their pensions are invested in similar funds.
To provide clarity we will input their different pension funds into the UnaVida Investment Matrix™. This will tell us how out of balance your combined pension funds are, compared to where you should be investing, according to your investment personality.
If your funds are out of balance, your portfolio will either be underperforming or be subject to too much investment risk. It’s a bit like a car engine being out of tune: first, we tune the portfolio and then we look at where we can improve its performance.
There is no point at looking at your pension schemes in isolation. We need to make a note of all your assets and put them into a cash flow model, which will enable you to make decisions with greater clarity in the years ahead. It will also enable both you and me to monitor the progress you are making.
I have been corresponding today with one of the UK’s most popular and successful financial journalists. He recently ran a half page column promoting a fund and extolling its virtues as a top-performing fund.
I sent him a message confirming that the fund was actually a very poor performer and that he had been misinformed. Despite his lofty position in financial journalism, he was man enough to admit that he’d made a mistake.
If a financial journalist of his standing can make such an error, what chance do members of the public have in selecting the better performing funds, from over 3,000 different funds available?
There is a vast difference in the fund performance getting it right could make a big difference to the amount you end up with in your pension fund.
To find out more, you may be interested in our very useful guide on “The Importance of Good Investment Performance” and you can download a copy by clicking HERE.
If you have pensions in money purchase arrangements of over £500,000 and are concerned, frustrated, or simply seeking a second opinion, please do contact us, in the meantime, we trust you find the book a good read.