PENSIONS

In the simplest terms, there are two types of pension scheme, final salary and money purchase.

Final salary pension schemes

Final salary schemes are becoming less common and now it is only very large companies and government agencies that offer access to these. The pension that you receive from a final salary scheme will depend upon the number of years service with the employer and the earnings when leaving the employer. Final salary schemes provide annual benefit statements which show what the benefit might be worth at retirement.

In most cases, final salary schemes represent a reliable and low risk method of pension provision.

However, final salary schemes do not provide guaranteed benefits, as the insolvency of the sponsoring employer can lead to a pension fund deficit, and a corresponding reduction in member benefits.

Anyone concerned about this should enquire with their scheme administrators about the status of the scheme, whether it is in surplus or deficit. If in deficit, enquiries should be made about the payments being made to the scheme by the sponsoring employer.

Money purchase schemes

Money purchase schemes work very differently. In essence, each member has their own investment account into which contributions are paid and invested. The aim is to build up as large a pension fund as possible prior to retirement, using one or more of the investment funds available.

Statutory Money Purchase illustrations are now provided each year showing how much pension (in today's terms - inflation adjusted) may be received at retirement from a money purchase pension plan.

In addition, a State Pension forecast (in today's terms) can also be obtained either online at www.thepensionservice.gov.uk or by calling 0845 3000168.

Boosting the forecast income

If having looked at all the projected pension figures it is decided the forecast income is too low, some consideration can be given to:

• making additional pension contributions, and whether this can be afforded

• changing investment strategy to look for higher returns (although the investment risk will also be increased)

• building up assets elsewhere (e.g. ISA, buy-to-let etc) that will provide income to supplement the pension

Drawing pension benefits

Once at retirement, consideration must be given to how best to draw the pension benefits.

Tax free cash lumps sums are often taken in full, and can be used to pay off any outstanding loans, build cash emergency funds or invested for income &/or growth.

For money purchase schemes, the remainder of the fund must be used to provide an income. The most common route is purchasing an annuity, which is a policy that provides a monthly income. Purchasing an annuity is a one-off irreversible decision, so it bears careful thought.

There is no requirement to take an annuity with the insurer that has previously managed the pension fund, so if it can be established that another insurer is offering higher annuity rates, a switch can take place to allow them to be used.

Also, higher annuity rates are on offer from impaired life annuity providers, who will take into account medical conditions (e.g. diabetes, heart disease etc) or lifestyle conditions (e.g. habitual smoker). Individuals will want to investigate whether or not they are eligible for such enhancements.

The standard basis of quotation for annuities is with a 5 year payment guarantee. This stipulates that if the policyholder dies within 5 years of starting the policy, the income will continue to be paid for the full 5 years.

However, annuities can also be set up with a 10 year guarantee for little extra cost and this is often far more suitable.

Finally, there is an alternative to annuity purchase which is pension fund withdrawal (also known as income drawdown). Income drawdown allows the pension fund to remain invested, and capital withdrawals are made out of the fund to provide pension income.

Compared to annuities, income drawdown has higher charges and more investment risk. It is only generally suitable for pension funds in excess of £150,000 and investors prepared to accept the ongoing exposure to investment risk.

In very general terms, with income drawdown, investors (& their beneficiaries) will probably end up worse off if they live longer than the average.

With annuities, investors (& their beneficiaries) will probably end up worse off if they live shorter than the average.

For specific advice tailored to your own circumstances, we recommend that you seek independent financial planning advice.

For details of our Financial Planning Service click here.