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Are Pensions Always The Right Way To Save For Retirement?


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The government and the pensions industry would have us believe that the right way to save for retirement is through a pension. I was however thinking that this might not always be the case.

IMO what actually matters during both the accumulation phase and then the drawdown (if you don't buy an annuity) phase is to generate an acceptable return for an acceptable risk (asset allocation), minimise fees, minimise taxes and protect from inflation. Then it's a matter of allowing compound interest going to work.

I therefore ran a couple of simulations to study if pensions are the be all and end all with full details, calculations and explanations here http://retirementinvestingtoday.blogspot.com/2010/03/are-pensions-good-retirement-planning_07.html

In summary though the results were quite surprising.

Simulation 1 was a person like myself. A 40% tax payer who is planning on being a 20% (or whatever it is by then) tax payer at retirement, salary sacrificing and employer matching contributions. When compared to saving in say an ISA under the simulation conditions I am 178% better off which is very significant. I am therefore prepared to accept all the risks and negatives of pensions in exchange for attempting to pick up this extra gain. Even with this benefit though I'm not putting all my eggs in one basket with around 1/3 of my net assets in pensions.

Simulation 2 was the big surprise. A 20% tax payer who will be a 20% tax payer at retirement, net pay scheme and no employer contributions. When compared to saving in an ISA this person would be 3% better off by not using a pension. This is mainly due to the fact that within the S&S ISA you generally can invest for lower annual fees than a stakeholder (or similar) pension coupled with the effects of compound interest over a long period. So in addition to being worse off this person also picks up all the pension negatives and risks. The ISA method however cuts out the pensions industry and all those commissions so you can see why this method is not so talked about.

Thoughts?

As always DYOR.

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The government and the pensions industry would have us believe that the right way to save for retirement is through a pension. I was however thinking that this might not always be the case.

IMO what actually matters during both the accumulation phase and then the drawdown (if you don't buy an annuity) phase is to generate an acceptable return for an acceptable risk (asset allocation), minimise fees, minimise taxes and protect from inflation. Then it's a matter of allowing compound interest going to work.

I therefore ran a couple of simulations to study if pensions are the be all and end all with full details, calculations and explanations here http://retirementinvestingtoday.blogspot.com/2010/03/are-pensions-good-retirement-planning_07.html

In summary though the results were quite surprising.

Simulation 1 was a person like myself. A 40% tax payer who is planning on being a 20% (or whatever it is by then) tax payer at retirement, salary sacrificing and employer matching contributions. When compared to saving in say an ISA under the simulation conditions I am 178% better off which is very significant. I am therefore prepared to accept all the risks and negatives of pensions in exchange for attempting to pick up this extra gain. Even with this benefit though I'm not putting all my eggs in one basket with around 1/3 of my net assets in pensions.

Simulation 2 was the big surprise. A 20% tax payer who will be a 20% tax payer at retirement, net pay scheme and no employer contributions. When compared to saving in an ISA this person would be 3% better off by not using a pension. This is mainly due to the fact that within the S&S ISA you generally can invest for lower annual fees than a stakeholder (or similar) pension coupled with the effects of compound interest over a long period. So in addition to being worse off this person also picks up all the pension negatives and risks. The ISA method however cuts out the pensions industry and all those commissions so you can see why this method is not so talked about.

Thoughts?

As always DYOR.

The only benefit to a private pension I can see is that you put off paying the tax until later and that savings in your pension do not disqualify you from benefits.

Hardly worth tying up your money in a product for decades. The fact that you have to then purchase an annuity later also turns me off the idea.

My retirement plan is to poor my heart and sole into the business I have just started, avoid sinking my savings into an over expensive house and carry on smoking so I don't have to pay for 35 years of retirement.

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..the problem with pensions are the crippling management fees....are there any plans to control these....?

Agreed. Small fee differences, say 0.5%, don't sound much but when compounded over a long period end up making a large difference to the final pension pot. For my simulation I used 1% for the simulation and 0.5% for the S&S ISA both of which IMO are realistic.

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The big problem for me is that they can arbitrarily move your retriemement age. For instance, I can't retire till I'm 68 (this changed about 2 yrs ago) and yes, two years later, they are talking about moving the age to 70.

Sod them, I put the minimum in possible into my pension so I can keep control of my assets. And most of them are either bricks&mortar, gold and silver.

Edited by chris c-t
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I do have a couple of partially funded employer pension schemes but haven't contributed myself for many years. Why?

Having done some similar calculations to yourself I can only conclude that the only reason to choose a pension over any other form of investment is the tax relief and then only if your contributions are given relief at 40%. For all others I think the best savings vehicle is an ISA- if only for the flexibility. Effectively on a pension you get tax relief at your highest marginal rate when you make your contribution whereas with as ISA you effectively get the tax relief when you draw the benefits

I think the formal money purchase pension scheme is a con waiting to be exposed. If you exclude the tax relief element the average (typical) money purchase pensions have actually LOST money over the last decade - effectively the 20% tax relief pay various commissions but is 'proudly shown' by the provider as though it is part of the return they have achieved.

I read some years ago that the average money purchase pension scheme pot matures at less than £30k. At this level frankly you would be better off NOT to save anything and rely on means tested benefits! Another smack in the eye for the prudent!

I don't like the inflexibility of a pension scheme. I don't think its fair to reward the rich over the poor - I'll try & explain with perhaps an over-simple example.

Suppose an employer gives £100 pay rise - to be used as a pension - to two employees, one a 20% the other a 40% taxpayer. The 20% taxpayer gets £100 less £20 tax plus 20% tax relief less 11% NI = £89 net pensions benefit. The 40% taxpayer gets £100 less £ 40 tax plus £40 tax relief less 1%NI surcharge = £99 pensions benefit. ie the lower paid employee pays a higher marginal rate of taxation/NI!

Why do the Government promote such a scam. For the same reason as why cash ISA allowances are half equity ISAs (£3600/£7200) - simply to help the rich (who are more likely to be able to afford to invest larger sums and take risk (and get advice) than the average Joe.) And of course help their 'friends in the city'........._

Edited by Leo Dumpmen
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The only benefit to a private pension I can see is that you put off paying the tax until later and that savings in your pension do not disqualify you from benefits.

Agreed, they are just a tax deferral scheme. One way they might work is if you are going to pay lower tax in retirement (say 40% to 20% or 20% to 0%). One benefit in the pension structure (ignoring things like employer contributions etc which are effectively just salary and not generated by the pension structure) is the 25% tax free lump sum at retirement. Although how long that will last is anyones guess as future governments grab for revenue.

Hardly worth tying up your money in a product for decades. The fact that you have to then purchase an annuity later also turns me off the idea.

Annuity is not the only option - USP's and ASP's now available but with lots of restrictions.

My retirement plan is to poor my heart and sole into the business I have just started, avoid sinking my savings into an over expensive house and carry on smoking so I don't have to pay for 35 years of retirement.

I wish you much success with your business.

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Agreed, they are just a tax deferral scheme. One way they might work is if you are going to pay lower tax in retirement (say 40% to 20% or 20% to 0%). One benefit in the pension structure (ignoring things like employer contributions etc which are effectively just salary and not generated by the pension structure) is the 25% tax free lump sum at retirement. Although how long that will last is anyones guess as future governments grab for revenue.

Annuity is not the only option - USP's and ASP's now available but with lots of restrictions.

I wish you much success with your business.

Thanks WICAO. I wasn't aware that you had other options than buying an annuity. It doesn't change my mind on pensions though.

I think the thing people miss with pensions is that they are becoming culturally irrelevant. What I mean by that is:

1) People my age (27) have seen their parents get ripped off by pension products and are naturally suspicious of the whole industry.

2) Employers these days are not offering the final salary pensions they used to, accept in very few cases. This leads to pensions becoming a periphery benefit when considering a new job.

3) People in my generation do not stay with an employer long enough for it make sense paying much attention to an employers pension scheme. I'm an example of that. Since I left Uni in 2003 I've worked at five different 'proper' jobs (and countless temp ones), I needed to to work my way up. This is becoming the norm.

I wouldn't be surprised if people's attitudes to pensions reverts to simply pumping out lots of kids and hoping they are nice to you when they get old.

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The government and the pensions industry would have us believe that the right way to save for retirement is through a pension. I was however thinking that this might not always be the case.

IMO what actually matters during both the accumulation phase and then the drawdown (if you don't buy an annuity) phase is to generate an acceptable return for an acceptable risk (asset allocation), minimise fees, minimise taxes and protect from inflation. Then it's a matter of allowing compound interest going to work.

I therefore ran a couple of simulations to study if pensions are the be all and end all with full details, calculations and explanations here http://retirementinvestingtoday.blogspot.com/2010/03/are-pensions-good-retirement-planning_07.html

In summary though the results were quite surprising.

Simulation 1 was a person like myself. A 40% tax payer who is planning on being a 20% (or whatever it is by then) tax payer at retirement, salary sacrificing and employer matching contributions. When compared to saving in say an ISA under the simulation conditions I am 178% better off which is very significant. I am therefore prepared to accept all the risks and negatives of pensions in exchange for attempting to pick up this extra gain. Even with this benefit though I'm not putting all my eggs in one basket with around 1/3 of my net assets in pensions.

Simulation 2 was the big surprise. A 20% tax payer who will be a 20% tax payer at retirement, net pay scheme and no employer contributions. When compared to saving in an ISA this person would be 3% better off by not using a pension. This is mainly due to the fact that within the S&S ISA you generally can invest for lower annual fees than a stakeholder (or similar) pension coupled with the effects of compound interest over a long period. So in addition to being worse off this person also picks up all the pension negatives and risks. The ISA method however cuts out the pensions industry and all those commissions so you can see why this method is not so talked about.

Thoughts?

As always DYOR.

ahhh qrops, 12 more months and its all mine mine mine, best and only decent thing this govt has ever done :D

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Thanks WICAO. I wasn't aware that you had other options than buying an annuity. It doesn't change my mind on pensions though.

I think the thing people miss with pensions is that they are becoming culturally irrelevant. What I mean by that is:

1) People my age (27) have seen their parents get ripped off by pension products and are naturally suspicious of the whole industry.

2) Employers these days are not offering the final salary pensions they used to, accept in very few cases. This leads to pensions becoming a periphery benefit when considering a new job.

3) People in my generation do not stay with an employer long enough for it make sense paying much attention to an employers pension scheme. I'm an example of that. Since I left Uni in 2003 I've worked at five different 'proper' jobs (and countless temp ones), I needed to to work my way up. This is becoming the norm.

I wouldn't be surprised if people's attitudes to pensions reverts to simply pumping out lots of kids and hoping they are nice to you when they get old.

Agree.

I stopped paying into a pension years ago; better to take the money and do something either very wise or very foolish with it. Store it up and it'll be taken from you by Socialists later; it's what they do.

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Agreed. Small fee differences, say 0.5%, don't sound much but when compounded over a long period end up making a large difference to the final pension pot. For my simulation I used 1% for the simulation and 0.5% for the S&S ISA both of which IMO are realistic.

0.5% fees are available on stakeholder pensions bought thru a discount broker, on godo index funds

Hargreeaves Lansdown do HSBC index funds on 0.25% in a SIPP pension - the only good ones are the UK and Europe ones as the others seem to mistrack

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one of the other benefits of deferred taxation is that the personal allowance tax free limit is MUCH higher for pension age individuals - from http://www.hmrc.gov.uk/rates/it.htm (of course this might not last, and it is qualified by the following: These allowances reduce where the income is above the income limit – by £1 for every £2 of income above the limit. For the 2008-09 and 2009-10 tax years they will never be less than the basic Personal Allowance)

Income Tax allowances 2008-09 2009-10 2010-11

Personal Allowance (1) £6,035 £6,475 £6,475

Personal Allowance for

people aged 65-74 (1)(2) £9,030 £9,490 £9,490

From a tax-efficiency perspective, you don't want to take more income in total than the £9490 and get other income from ISAs or implicitly from owning outright your own home. Multiplythis over a couple and it gets more compelling.

(it makes sense to own your own home to retire in as a tax-break in addition)

Edited by Si1
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The big problem for me is that they can arbitrarily move your retriemement age. For instance, I can't retire till I'm 68 (this changed about 2 yrs ago) and yes, two years later, they are talking about moving the age to 70.

Sod them, I put the minimum in possible into my pension so I can keep control of my assets. And most of them are either bricks&mortar, gold and silver.

You're talking about the state pension which you have no choice but to contribute towards (via NI contributions). You can draw a private pension at any age from 55 and up (of course this is subject to change, it used to be 50!)

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You're talking about the state pension which you have no choice but to contribute towards (via NI contributions). You can draw a private pension at any age from 55 and up (of course this is subject to change, it used to be 50!)

other thing is - what guarantee is there our generation will actually receive a state pension??

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i thought they were becoming compulsory in the uk at some point in the near future

Are they? I have an unapproved one, which is basically just my savings pot and I can take it when I like, no annuity required, etc. I guess that counts without actually being something I Iose control of and have to pay commissions on.

Edited by bogbrush
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The government and the pensions industry would have us believe that the right way to save for retirement is through a pension. I was however thinking that this might not always be the case.

Like all those people whose pension is their BTL portfolio.

In summary though the results were quite surprising.

Simulation 1 was a person like myself. A 40% tax payer who is planning on being a 20% (or whatever it is by then) tax payer at retirement, salary sacrificing and employer matching contributions. When compared to saving in say an ISA under the simulation conditions I am 178% better off which is very significant. I am therefore prepared to accept all the risks and negatives of pensions in exchange for attempting to pick up this extra gain. Even with this benefit though I'm not putting all my eggs in one basket with around 1/3 of my net assets in pensions.

Yep. In fact EITHER 40% tax saving OR employer contributions are sufficient to make it worthwhile. If you have BOTH, that's the icing on the cake.

Simulation 2 was the big surprise. A 20% tax payer who will be a 20% tax payer at retirement, net pay scheme and no employer contributions.

Small advantage from the tax-free lump sum. But right now you have to offset that against the likelihood of tax higher than the 20% you save.

When compared to saving in an ISA this person would be 3% better off by not using a pension. This is mainly due to the fact that within the S&S ISA you generally can invest for lower annual fees than a stakeholder (or similar) pension coupled with the effects of compound interest over a long period.

You're comparing a good ISA with an unnecessarily expensive pension there. Better to use a SIPP without the commissions.

Having said that, I'd stop my SIPP contributions if I wasn't getting the tax benefit of 40% now against the expectation of a lower rate when it becomes my income.

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You're talking about the state pension which you have no choice but to contribute towards (via NI contributions). You can draw a private pension at any age from 55 and up (of course this is subject to change, it used to be 50!)

Yes, they moved the state retirement age to 68 for me and the rest to 55 (from 50) ... which just makes my point; that they can move the dates arbitrarily to your disadvantage. It's my goddam money. I want it when I say.

Edited by chris c-t
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Simulation 1 was a person like myself. A 40% tax payer who is planning on being a 20% (or whatever it is by then) tax payer at retirement, salary sacrificing and employer matching contributions. When compared to saving in say an ISA under the simulation conditions I am 178% better off which is very significant. I am therefore prepared to accept all the risks and negatives of pensions in exchange for attempting to pick up this extra gain. Even with this benefit though I'm not putting all my eggs in one basket with around 1/3 of my net assets in pensions.

Simulation 2 was the big surprise. A 20% tax payer who will be a 20% tax payer at retirement, net pay scheme and no employer contributions. When compared to saving in an ISA this person would be 3% better off by not using a pension. This is mainly due to the fact that within the S&S ISA you generally can invest for lower annual fees than a stakeholder (or similar) pension coupled with the effects of compound interest over a long period. So in addition to being worse off this person also picks up all the pension negatives and risks. The ISA method however cuts out the pensions industry and all those commissions so you can see why this method is not so talked about.

Thoughts?

As always DYOR.

I think your model is slightly distorted by having the employer's matching contribution. This means that Mr 40%, for a sacrifice of £1200 gets $4000, while Mr 20% only gets £2000 for a sacrifice of £1600. While this is the reality for many, it does not really compare like with like.

Can you re-run without employer's matching contribution?

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Yes, they moved the state retirement age to 68 for me and the rest to 55 (from 50) ... which just makes my point; that they can move the dates arbitrarily to your disadvantage. It's my goddam money. I want it when I say.

It's not really all yours if you think that part of it includes the tax break (ie part is gov't money so they will have some say in what you can do with it). I agree that this can be frustrating but the answer is to forget about the tax break (ie ignore traditional pensions) and spend your money when you want. You can't have it both ways.

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Another thing to bear in mind, if you are on a low or average salary and have children, is tax credits.

Your net income is reduced by any pension contribution you make, meaning for each pound you reduce your salary by your tax credits increase by 37p. This may also increase the levels of other benefits too.

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