By Dan Hyde – http://www.thisismoney.co.uk/pensions/
Overrated, out-of-reach, a ‘false economy’. Pensions are different things to different people, but one thing’s for sure – they’re not very popular with British savers right now.According to the most recent reports, millions of over-50s are on a ‘collision course with an impoverished retirement’, with almost eight in ten set to receive an annual income of just £8,000 having failed to save enough for retirement.
A good portion of the blame can be laid at the door of our politicians. Constant meddling and rule-changing by various parties has made it difficult to trust pensions as a safe and beneficial way to save for old age.
And for many, the restrictions placed on pensions – you can’t withdraw your money before 55 and you’re forced to purchase an annuity with the pot – have made them practically unviable.
Of course, company pensions are still great value, and you should take advantage. Saying ‘no’ here is effectively the same as turning down free money, as almost all employers offer to pay into the scheme on your behalf.
- How to fine tune your company pension
But if pensions don’t seem your cup of tea, which way should you turn? After all, each of us needs to make provision for retirement, regardless of whether it involves saving into a pension scheme or not.
Jason Witcombe, an independent financial adviser, says: ‘There is a general misconception that retirement planning means paying money into a pension. A pension is simply a tax-advantaged investment wrapper.’
And he’s right. Pensions these days should be considered as part of a retirement saving strategy – not the sole element. We take a look at four ways to save that don’t involve the dreaded p-word.
1. Saving into an Isa
One of the best alternatives to a pension is an Isa. If used properly, an Isa has the potential to take you all the way to retirement on its own.
Like pensions, Isas are ‘tax-free’ savings vehicles. In reality this means that the Government only taxes you once on your savings – in the form of immediate income tax on the earnings that you save from. With pensions, you’re also taxed once, but in place of being taxed on earnings as you save, instead you are taxed only when you draw your income in retirement.
The reason people talk of the ‘tax incentives’ of saving into pension is because those earning more while they’re young (and saving) may pay a lower level of income tax when their income drops during retirement (and drawing on those savings). This means that you could pay just 20% on retirement income, despite being a higher rate taxpayer when you initially save it.
However, with governments changing the pension’s rules on a regular basis, there is nothing to say that the tax relief rules won’t change by the time you pack it all in. And there are suspicions that the new coalition government might make changes this month. This could restrict the tax advantages higher rate earners have.
With Isas you’ve already paid your tax and can rest assured that the rules won’t change in this regard and the returns in the pot should remain tax free.
You can put your money in either a cash Isa, which is basically a savings account, or into a stocks and shares Isa – normally a fund that will pick shares, property or bonds on your behalf.
From April 2010, everyone over 18 years of age has been able to save up to £10,200 per annum, of which £5,100 can be in cash.
Think of Isas as long-term savings account – a growing fund that shouldn’t be touched unless it’s absolutely necessary, and even then, replaced when possible.
- How to pick the best Isa
Alan Smith, an independent adviser at Capital Asset Management, explains: ‘The most obvious alternative to a pension is an Isa. Although the tax man doesn’t offer tax relief on the investment as he does with pensions, growth is generally tax free and you can have access to your fund at any time. With a pension you are restricted to taking benefits from age 55 at the earliest and only 25% in cash, the remainder as a taxed income.
‘A couple can now invest up to £20,400 each year into stocks and shares Isas which is sufficient for most savers. Like most pensions, investors need to ensure that they are comfortable with the level of risk they are taking as all the tax efficiency could be wiped out if the wrong funds are chosen and fund values fall significantly. However over the long term, Isas have proved to be an excellent and highly tax efficient way of saving for retirement.
Danny Cox, an independent financial adviser at Hargreaves Lansdown, adds: ‘Regular savings stock market Isas start from £50 per month and are far more flexible than the old style endowment savings plans.
‘The whole of a stock market Isas can normally be cashed in at any time – investors don’t have to wait until age 55 as with a pension. The tax free income element to an Isa is often used to supplement retirement income: tax free also means no need to record on a tax return and no impact on age related personal allowances.’
What’s the downside?
As with any stock market investments, says Cox, choosing the right funds will make all the difference. ‘Of course, shares will go down as well as up and this must be considered,’ he says.
2. Your employer’s Save As You Earn scheme
One interesting alternative to pensions is to join your employer’s ‘save as you earn scheme’, says Jason Witcombe.
‘Offering employees share option schemes is an increasingly popular way of giving staff a stake in the companies they work for,’ he says.
‘Many large firms will offer SAYE or ‘Sharesave’ schemes. These allow employees to save between £5 and £250 per month for three, five or seven years. Employees get a tax-free bonus if they complete the savings plan, on top of the money they have saved.
Take control: There are plenty of ways you can ensure a richer retirement
‘Employers grant employees an option at outset and can give a discount of up to 20% of the share price at launch. At the end of the period, employees choose either to use the money saved, plus the bonus to buy shares, if buying the shares would generate a profit, or have their contributions and bonus returned, if this would give the higher return.’
What’s the downside?
Witcombe says there is relatively little risk involved in a SAYE scheme. In fact, the only risk is that you don’t get as much for your money as you would have done elsewhere.
He says: ‘SAYE schemes offer huge upside potential with very minimal risk. Essentially, if the share price falls during the period, you will still get your savings back plus a tax-free bonus so the only ‘risk’ is the fact that you could have received a slightly higher return through a conventional savings account.’
3. Investing through funds and VCTs
Another approach is to use the stock market directly. According to Alan Smith of Capital Asset Management, an interesting option for the investor prepared to take on a larger degree of risk is the Venture Capital Trust (VCT).
The VCT scheme started on 6 April 1995. It was designed to encourage individuals to invest indirectly in a range of small higher-risk trading companies whose shares and securities are not listed on a recognised stock exchange, by investing through VCTs. So, if you invest in a VCT, you spread the investment risk over a number of companies.
Opting to save for retirement by investing in more risky assets like VTCs are best left to those who are younger, as those closer to retirement should be looking to secure their savings.
Even so, says Smith, they offer up a useful tax-free incentive.
‘Venture Capital Trusts (VCT) provide income tax relief at 30%, although the underlying assets are usually shares in small companies which can be very volatile,’
Lower risk investors, Smith says, should look for funds which buy companies with real assets such as property to avoid added security and lower risk.
‘Also, Offshore Bonds usually managed by the (often Channel Islands or Dublin) subsidiaries of the major UK life assurers can be very tax efficient and very helpful for investors who plan to retire abroad,’ says Smith.
What’s the downside?
This is a tricky area to get right, and with something as important as your retirement savings, it might not seem worth the risk. Smith says: ‘These areas can be very complex and they may not always be suitable for your risk profile. Investors should always seek guidance from an independent and fee-based professional financial planner, in order to work out the best products and retirement plan for you.’