How to review and manage your pension
Unless you are lucky enough to be in a final salary pension scheme, you will have to decide where you want to invest your money. Unlike a savings account, your money will be invested in the stockmarket and you will be given a range of collective investment funds to choose from.
Here your money is pooled with that of other investors and invested on your behalf by an expert fund manager, according to the objective and risk profile of the fund.
Some funds will cover a broad spread of assets - including cash, bonds and stocks and shares – while others hone in on specific countries or regions such as the UK, Europe or emerging markets. Some focus on smaller companies and the most niche on specific industries such as pharmaceuticals, natural resources or infrastructure.
Which funds should I choose?
While some more basic pensions only have up to 20 funds to choose from, more comprehensive schemes could have several hundred, or if you are invested in a Sipp, you could have access to the entire investment universe.
If you are in a workplace scheme, you may be lucky enough to get access to free advice from an independent financial adviser who will be able to recommend appropriate funds based on a thorough assessment of your personal circumstances and attitude to risk. Or you can pay for this service yourself, however with research from unbiased.co.uk suggesting the average fee for advising on a £200 a month pension contribution is as much as £500 this won't be an option for all.
If you are going it alone - as most of us do - the choices can be baffling, particularly if this is the first time you have invested. But, it doesn't have to be difficult. By breaking down the process into manageable chunks - taking into account your age and the level of risk you are prepared to take – you can quickly narrow down your options and start making sensible and well informed decisions. Find out how with our guide.
Of course pension providers are well aware of just how confusing it can be to select your own funds and for this reason they offer default funds - the easy option for those that don't want to make investment decisions. This is also where your money will be put if you don't tell your pension provider what to do with your contributions.
These default funds aim to grow your capital during your working years, then as you draw closer to retirement (anywhere between seven and 15 years) the focus shifts towards protecting your capital. Essentially this involves gradually moving money out of equities (which can suffer serious and untimely drops) and into safer asset classes such as cash and bonds, in a process known as de-risking. According to the National Association of Pension Funds, 84% of savers are invested in their pension's default fund.
Managing your pension in this way can make sense if you plan to use your whole fund to buy an annuity as soon as you retire, or if you plan to cash it in. However if you want to keep some or all of your money invested into retirement it may not make sense and see you miss out on vital growth.
The hard work is arguably done once you have chosen your desired pension funds. But unfortunately you can't put your feet up and forget about your pension altogether. Every once in a while you need to check in and see how it's doing.
This means checking out how your various funds are performing – comparing them against their peer group – and ensuring that your portfolio is still in line with your attitude to risk. Gradually as you get older you may want to start de-risking as your focus shifts from growing your fund to protecting it.
Most experts agree that this should be once a year, although if you're approaching retirement, it makes sense to increase this to every six months.
Topping up your pension
As you get older you will hopefully be earning more and having fewer drains on your income. This, along with the stark reality of an ever-closer retirement, may mean you want to start paying more in to your pension. Alternatively your pension review may make you realise you are not going to have as much as you expected to live off in retirement.
Topping up your pension is easy with a workplace scheme, but if you are a keen investor and want to take more control over your retirement savings it may make sense to explore the alternative options.
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Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.