It’s very easy to dismiss pensions when there are so many other things competing for your money – your mortgage, school fees and family holidays, to name just a few.
But, when it comes to pensions, my message is this: it’s never too late to start; and it’s usually always too early to stop.
Unfortunately pensions are shrouded by more than their fair share of jargon, and people can sometimes confuse this perceived complexity with increased risk. But, what people forget is that other investments can also have their drawbacks. Take property as an example: it’s not tax efficient; it’s not particularly liquid; and it comes with its fair share of (hidden) cost – think solicitors, estate agents, stamp duty on the way in, capital gains tax on the way out, and not to mention ongoing maintenance costs and the risk of not finding tenants.
Equally, if you are particularly risk averse, and decide to keep your savings in a bank account – even a high interest savings version – you’ll find it almost impossible to achieve a return that outpaces inflation, meaning that you are actually losing money over the longer term – not the type of return you were probably looking for!
There are some very powerful reasons why investing in a pension is essential for achieving your long-term savings goals. Here are a handful of them:
The power of compounding returns
When you invest your money in a multi asset portfolio, although you take on investment risk and the value of investments can go down as well as up, you stand a far greater chance of earning inflation-beating returns over the longer term. Add to that the power of compounding and it can really pay dividends. If, for example, you invest £200 a month for 20 years and achieve a modest annual return of 3%, you could achieve a return of 37% or £17,690 on your £48,000 savings. If you’re aiming for a 5% return over 20 years, it would give you a return of 72% or £24,059 on top of your capital.
If you contribute, others can contribute too
If someone you trusted offered you free money with no obligation, you would be crazy not to take it, right? And yet, that’s exactly what you are doing if you’re not saving into a pension. Taking the example above, your £200 a month investment only actually costs you £160 if you are a lower rate tax payer, and £120 if you are a higher rate tax payer, thanks to pension tax relief. In addition, many employers will also contribute money to your pension – sometimes matching your own contribution. And if you participate in a salary sacrifice scheme, where your pension contribution is taken from your salary before you pay tax, you will also pay less National Insurance.
Reducing your Inheritance Tax (IHT) liability
Pensions may protect some of your hard-earned savings from IHT. If you die, any money left in your pension will be passed to your beneficiaries, free of inheritance tax, depending on the pension you hold. If you die before you’re 75, any withdrawals they then make could be tax free. If you die after the age of 75 though, any withdrawals will be taxed at their individual rate of income tax. This is rather a complex area and will depend on your own circumstances, as well as the type of pensions you hold and the tax rules are subject to change, but it is definitely an area to investigate and plan around.
Staying invested in retirement
When you retire, it makes a lot of sense to keep your money invested in a pension for as long as possible. This may sound counterintuitive – isn’t your pension is for your retirement after all? But you could live for at least another 20 years and, over that period, your money has to be able to keep ahead of inflation at the very least.
The great thing is, you can access your money without having to cash the whole lot in. You could remain in your personal pension, or SIPP (self-invested personal pension), or invest in a flexi-access drawdown product. This means you can keep your pension fund invested while also drawing an income from it. You can take as much income as you like, when you like, and you can also choose how you want to invest your money according to how much investment risk you want to take. You can then choose to buy another type of retirement income product at any time, which is useful if you would then prefer to have some income guarantees later on down the line (such as those offered via an annuity). You should of course get independent professional advice and consider all the options before making any withdrawals from your pension.
Unfortunately the UK has a pension crisis on its hands. Not only are younger people simply not saving enough for their retirement, but those approaching retirement are making, what could be, catastrophic investment decisions based on the financial planning of past generations. Please don’t be one of them.
Justin Urquhart Stewart
Co Founder and Head of Corporate Development
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Important information: The information contained in this document does not constitute investment advice and it is not an invitation or inducement to engage in investment activity. The value of investments, and the income from them, can fall as well as rise and you may not get back the full amount invested. Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales No. OC378740.