Pensions

An individual or personal pension plan, as the name implies, is a plan that you arrange yourself, not via an employer. A good individual pension plan will give you more options, often including:

• the choice to retire when you want to, without penalties;
• the flexibility to phase out work gradually, rather than sudden retirement;
• the opportunity to reduce or suspend your contributions.

If you are your own boss or move jobs quite frequently, arranging your own pension plan is often the most flexible option.

What Costs Are Involved?

Unlike company pension schemes, which often pick up the tab for administering and setting up the pension scheme, you will have to  cover these costs. The level of charges, choice of funds, and additional benefits will differ between different product providers. Most new pension plans have charges and terms similar to Stakeholder.

The amount you pay for this type of policy usually correlates with the investments you choose. Typically, the cheaper option is select providers that invest in their own funds. If the provider offers you access to other providers' funds, the charges rise slightly. Choosing specific investments, like individual company shares, will generally be the most costly.

When you retire your pension pot, accumulated over the years, is used to purchase an annuity, which will pay you a regular income.

You may have heard about stakeholder schemes, introduced by the Government in 2001. This low-cost scheme aimed to make pensions more accessible to people that can only set aside small amounts regularly.

The rules are the same as for Individual Pension Plans but the products must meet specified rules:

• minimum payment required must be no greater than £20;
• the charges must add up to no more than 1.5% of the fund value each year;
• the provider cannot charge for stopping or re-starting your payments or for transferring your fund to another provider.

In reality, most individual pension plans will meet these rules whether they advertise the plan as a stakeholder or not. However, only true stakeholder plans are prevented from changing the terms and future charges.

A group personal pension, or group Stakeholder pension is as it sounds - a group of individual pension policies administered together. It works exactly as if you'd selected your own personal pension plan. You own it, and if you move jobs, you can take it with you. But, they can be better value. Because your employer may be bringing bulk business to the provider, they can often negotiate a better deal than if you approached the provider directly.

Your employer will take your chosen contributions directly out of your wages and pay it straight into the policy. If your employer chooses to make a contribution, even better. Years on, these top-ups will increase the value of your overall pension pot, making you more financially comfortable. 

On a practical level these work like individual pension plans. You contribute a percentage of your salary  and this, combined with any employer contribution, is used to provide an income when you retire.

The difference is you do not own a pension policy yourself. Your money, with other employees is put into a large pension fund pot and your portion is earmarked for when you retire. A fund manager will be in charge of investing it. What you get out at the end will depend upon the performance of the investments selected. If you leave your employer, you will stop paying into the scheme. Over a lifetime of working, you may have several company pension schemes, which mature at retirement age.

With company schemes, you can still select the type of funds you want your portion invested in, although these are likely to be more limited than a savings investment. Overall, the charges may be lower, because your employer will often contribute towards the administration costs.

With Defined Benefit, or Final Salary schemes as their commonly known, the amount you receive when you retire is based upon the years of service and your final salary when you leave the company or retire. The calculation is normally one-sixteenth of your final salary, multiplied by the number of years you were in the scheme for.

The security element for employees is that you aren't depending on stock market conditions. The company is responsible for selecting fund investments. If the fund falls short of the amount needed to pay you your retirement income, it is up to the employer to make up the shortfall.

Poor stock market performance over the past five to ten years has highlighted to employers how much they might have to pay in these circumstances, so many have transferred over to Money Purchase occupational pensions.

This is an unsecured pension. It enables you to take a proportion of your fund and purchase an annuity, which gives you an income for up to five years. Meanwhile, the rest of your fund remains invested and exposed to the stock market.

The plus points

Once you have purchased your annuity, for the duration of the annuity's term, you will know what your income will be. Perfect for people who like some degree of certainty.

The minus points

The many plus points of short-term annuities are also their drawback. Signing up to a set income for the duration of the annuity, will reduce the overall value of your fund. If investments in your fund under-perform, it could result in a lower income when you finally purchase an annuity.

It is also worth noting that you get much less value for money with a short-term annuity. With lifetime annuities, the people who die sooner than expected subsidise the rates for everyone else. So you get more for your money. With an annuity of five years or fewer, the subsidies are very low, consequently lowering the rates. So, you get much less for your money.

If you're unsure whether short-term annuities are right for you, contact us by a quick phone call.

Income withdrawal, also known as income drawdown or pension drawdown is an option that allows you to take a taxable income directly from the pension fund, without buying an annuity.

The plus points

This would suit people entering retirement when annuity rates are especially low. Your fund remains invested and you take money directly out of the fund, using it as income.

There is no minimum amount, which makes income withdrawal reasonably flexible. If you don't need the income, you can stop withdrawing it at any time.

The pitfalls

The risk is that your income could be much lower in later years than it otherwise would have been. Success depends on strong investment growth and interest rates not moving in the wrong direction.

There are limits to how much income you take in this way. From 6 April 2011, the maximum is equivalent to 100% of the income you would get from a standard annuity.

A phased retirement plan works by dividing your pension pot into a number of segments. These are then treated as lots of little schemes, each offering tax free cash as well as annuity incomes, which you can draw upon at different stages.

The plus points

The benefits of phasing in your retirement benefits, is it enables you to build up your lifetime income gradually. This is particularly useful if you aren't going to stop work altogether but are intending to wind down to retirement by taking a lower paid, or part-time position, something which is becoming increasingly common as an alternative to stopping work entirely.

The pitfalls

Make sure you are clear on all the additional costs associated with setting up and drawing multiple smaller-pensions. The extra administration involved with phased retirement schemes will ultimately cost more. You must also be aware that leaving funds invested may not work if investment growth is poor or if interest rates move in the wrong direction. You could end up with a lower income overall.