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27 November 2013
Negative press commentary concerning pensions is undoubtedly persuading some people to suspend contributions to their pension policies and to seek alternative methods of funding retirement. However, with income tax relief of up to 40 per cent on contributions, pension funding has a head start over alternative retirement planning investment methods, so the opportunity should not be given up lightly. Besides, I believe there is a useful investment solution which gives security and optimises the tax breaks. Given that we are at the start of a new tax year, it is a good time to reappraise your pension options.
Much of the adverse pensions publicity stems from the dire performance of the stock market in recent years. Pension contributions invested this way a few years ago have fallen by a third or more and, understandably, policyholders are wondering if the advantages of the income tax relief will be negated by investment losses. Luckily, there is a way round this problem.
Most pension policies offer a wide range of investment funds that policyholders can choose from, including a cash fund which is as secure as money held in the bank or building society. A contribution to this fund will secure the current year's tax relief without exposure to investment risk. As and when confidence in the stock market returns, money can be switched out of the cash fund into an equity fund.
Despite the fund choices available to policyholders, the majority contribute to either the managed fund or the with-profit fund. It is important to review these fund selections regularly to ensure they remain the best option.
One of the first things to consider is asset allocation. This means the split between various asset classes such as bonds, equities, property and cash, and the geographical spread of the investments. The asset allocation should reflect attitude to risk and proximity to retirement. Generally, the lower an individual's tolerance to risk and the closer they are to retirement, the greater the proportion of funds they should hold in cash and bonds. Some companies now publish the asset allocations of their funds designed for cautious, balanced and adventurous investors and these can be useful as a general investment guide. However, there are no hard and fast rules and most investors should seek professional advice.
The investment performance of individual funds should also be reviewed. The reason why a fund may underperform or outperform others can often be largely due to the investment style adopted by the fund manager (in other words, the technique adopted for stock picking) and this can produce significantly varying returns at different points in the business cycle. A blend of styles should help to produce more consistent investment returns.
If your existing fund choice is unsuitable, you can switch funds quite easily, whether you have a personal pension, are part of a corporate plan or a self invested pension scheme (SIPP). Most companies simply require a letter of instruction signed by the policyholder. However, before switching funds, check with the pension fund provider that you will not be penalised.
The importance of pension funding has been underlined by both the Pensions Green Paper and the Inland Revenue consultative document published towards the end of last year. Both papers pointed to the vast under-provision made by most people for retirement and the Inland Revenue document proposed radical reforms that will particularly affect high earners and those with significant existing pension funds.
A 'lifetime limit' on a person's pension fund has been suggested, of £1.4m at retirement. However, those with existing funds in excess of £1.4m would be able to register this higher value as their personal lifetime limit. The new proposals should take effect from April 2004 (although 2005 may be more realistic), so it might be worth grabbing available pension relief now, to beat the lifetime limit. Other Green Paper proposals include sweeping away the layers of pension legislation built up over years and replacing it by a universal set of rules. The simplification process would extend to pension contributions and the only limit to be placed on the level of funding would be a maximum of £200,000 per annum.
Hopefully, the proposed simplification will encourage investors to view pension savings as they do other investments.