Understanding the complex world of personal pensions

The prospect of end­less work-free days may seem unre­al­is­tic when you’re head down in spread­sheets or prep­ping for anoth­er con­fer­ence call. And it’s fair to say there’s a lot of neg­a­tiv­i­ty about pen­sions in the press, from the hub­bub over tax rules to the ris­ing state pen­sion age.

But for many work­ing pro­fes­sion­als, being able to retire in your 60s, 70s and beyond is an achiev­able aim. You only have to look at the growth of the finan­cial inde­pen­dence retire ear­ly (FIRE) move­ment — where peo­ple live on the tight­est bud­gets and strate­gi­cal­ly build their assets, with the aim of stop­ping work as young as pos­si­ble — to see that it can be done. (Although most peo­ple aren’t plan­ning to quit work in their 40s, so embrac­ing min­i­mal­ism and extreme fru­gal­i­ty isn’t nec­es­sary!)

Achiev­able doesn’t mean easy. Plan­ning for retire­ment is a sci­ence; a pen­sion cal­cu­la­tor can spell out how much you need to put away each month and the rate of return your invest­ments will have to reach. But it is also an art; no algo­rithm can tell you which of the pletho­ra of accounts to use, from SIPPs to Life­time ISAs, work­place schemes
or prop­er­ties.

Pre­vi­ous gen­er­a­tions had a huge advan­tage over today’s work­ing age pop­u­la­tion: their retire­ment plan­ning was large­ly done for them through gen­er­ous final salary pen­sions and pub­lic sec­tor schemes.

The days when busi­ness­es and the state sup­port­ed indi­vid­u­als through their grey-haired years are long gone, mean­ing it’s now up to each of us to make our own plans. That’s a greater bur­den undoubt­ed­ly — being well-versed in pen­sions and sav­ing hard are essen­tial — but it also means poten­tial­ly greater free­dom when it comes to choos­ing what to do with your assets post-65.

For exam­ple, final salary and pub­lic sec­tor pen­sions (known as ‘defined-ben­e­fit schemes’ in indus­try jar­gon) gave retirees a fixed amount of mon­ey for life. They were fan­tas­tic in terms of assured future income, but inflex­i­ble for peo­ple who want­ed to with­draw a big­ger chunk of sav­ings to pur­chase prop­er­ty, gift to chil­dren or trav­el the world.

Those sorts of pen­sion arrange­ments are an endan­gered species today. Most younger work­ers will be pay­ing into so-called ‘defined-con­tri­bu­tion’ schemes, where the indi­vid­ual can decide how much to con­tribute each year, where it should be invest­ed and how much they want to with­draw each year in retire­ment. None of those deci­sions have to be made once — con­tri­bu­tions and with­drawals can be changed from year to year, much more like a bank account.

Becom­ing con­fi­dent that you’re able to make these deci­sions and be finan­cial­ly sta­ble in the decades to come means rethink­ing a few things.

Shaking off the notions of what ‘retirement’ is

Pen­sion­ers, retire­ment and the fuzzy con­cept of ‘sav­ing for lat­er life’ often bring to mind some stereo­types: cruise ships, bin­go halls and drink­ing sher­ry. Much as we love the senior cit­i­zens in our lives, we find it hard to pic­ture our­selves reach­ing that age or being part of that cul­ture.

The good news is that you will, in all like­li­hood, get to that age (no point fight­ing it) but the cur­rent gen­er­a­tion of work­ing peo­ple won’t age the same way our elders did. Each gen­er­a­tion takes some of their hob­bies and habits with them into old age — so ‘retire­ment’ in 30 years will be more about craft beer, adven­ture trav­el, oat lattes and cross­fit. You will want to have enough mon­ey to keep on doing the things you love, and that means retire­ment plan­ning needs to start decades in advance.

Not being put off by the jargon

Like many indus­tries, pen­sions and retire­ment plan­ning have devel­oped their own ver­nac­u­lar over the past 50 years, which can bam­boo­zle the unini­ti­at­ed. Jar­gon terms such as ‘crys­talli­sa­tion event’, ‘mon­ey pur­chase scheme’, and ‘life­time allowance’ actu­al­ly describe quite sim­ple con­cepts that any­one can under­stand – so don’t be daunt­ed.

Knowing that investing in pensions is a different kind of beast

You may know a good deal about invest­ing and already have stocks and shares ISAs, or oth­er assets. Although the gold­en rules of invest­ing are the same with pen­sions as with ISAs – invest for the long term in things that are eas­i­ly under­stand­able, while keep­ing an eye on fees – there are some key dif­fer­ences.

Invest­ing for a retire­ment that begins 30 years from now requires a dif­fer­ent strat­e­gy to invest­ing for a prop­er­ty pur­chase in five years’ time. Over those three decades your tol­er­ance for risk changes, along­side your need for growth-focused ver­sus income-pro­duc­ing invest­ments. Plus the invest­ment charges mount con­sid­er­ably with the sheer size of your pen­sion, which is usu­al­ly the biggest asset most peo­ple have after their home.

So be open to options that may be par­tic­u­lar­ly well-suit­ed to your pen­sion plans such as man­aged port­fo­lios or pas­sive invest­ments, even if you may not use them else­where.

Of course – this is just scratch­ing the sur­face of the com­plex world of per­son­al pen­sions. If this arti­cle has giv­en you food for thought, or you would like under­stand more ful­ly how crys­talli­sa­tion events, mon­ey pur­chase scheme or the life­time allowance could affect your pen­sion plan­ning then join us at Nutmeg’s free ‘Under­stand­ing the pen­sion life­time allowance’ webi­nar at 5pm on 26 April. You can reg­is­ter at nutmeg.com/webinar.

Pro­mot­ed by Nut­meg