Why should I bother taking out a pension?

We are often asked whether pensions are a good idea. Many people are discouraged from making adequate retirement provision through lack of understanding of the issues and also incorrect pre-conceived ideas. Some of these are as follows:

‘The State will look after me when I retire’

‘My business is my pension’

‘Pension plans offer poor value for money’


Let us first consider the problem. According to the Office of National Statistics a baby girl born today will have an average life expectancy of 81.5 years. A baby boy born today can expect to live, on average, for 77.2 years. If we assume that each will work until they are 60 then the amount of time spent in retirement as a percentage of their lifetime will be 26% for the female and 22% for the male.

The fact that a person has stopped working will not alter their need for income. It is true that in many cases the income requirement will be lower as the mortgage will probably have been repaid and the children will have left home. On the other side of the coin, retired people have more time to enjoy themselves and may want to go on more foreign holidays, take up new hobbies and spend more time socialising. All these things cost money. Where will it come from?

If you have worked throughout life and paid National Insurance contributions you will be entitled to a State Pension from age 65. The rate for the Basic State Pension is currently (2009/10) £95.25 a week for a single person and £152.30 a week for a couple. There may also be an additional entitlement to an earnings related state pension known as the ‘Second State Pension’. For those with no other income and limited savings the total pension will be topped up through ‘Pension Credit’ to £130.00 a week for a single person and £198.45 a week for a couple. To put this into perspective, the current minimum wage is £5.73 an hour which would equate to £229.20 for a 40 hour week.

The average wage for a full time male employee is currently £521 a week (Office of National Statistics). The question to ask then is can you afford for your income to fall by 75% on the day that you retire?

It now becomes clear that in order to enjoy a decent level of income in retirement, some form of long term savings strategy needs to be put in place. One of the best ways to achieve this is by contributing to a pension arrangement.

Many people enjoy the benefits of a pension arrangement provided by their employers. Civil Servants, Local Government Officers, Teachers and NHS staff are eligible to join generous ‘final salary’ pension schemes where their pensions are directly linked to their earnings and length of service. Other occupational schemes may not be as generous but often include a contribution from the employer.

For those who either run their own businesses or work for smaller companies then the usual option is a Personal Pension.

So why use a pension arrangement at all? Why not just put the money in the Building Society or Bank? The answer to this is TAX. A pension plan is by far the most tax efficient long term savings vehicle available.

To start with, every £100 put into a pension plan by an individual will be topped up by £25 to £125 by the taxman. In addition, if the person making the contribution is a high rate tax payer then a further £25 can be reclaimed making the net cost of the £125 contribution £75.

If a contribution is made to a pension plan by a company for one of its employees then this can be offset against Corporation Tax in the year that the contribution is made.

Secondly, most investment returns within a pension plan, both income and growth, are free of tax, the exception being the tax payable on dividends from UK shares. There will be no tax deducted on the interest paid on deposits or fixed interest securities and none on rental paid on commercial property held within the pension plan. When assets are sold by the pension no Capital Gains Tax will be charged. The effects of these tax reliefs over a long period of time can be considerable.

Finally, when an individual comes to retire and take the benefits from their pension plan, 25% of the accumulated fund can be taken as a tax free cash sum.

Investments into a pension arrangement ultimately can only be used to provide retirement benefits. Some would say that this restricts access to capital, but I would argue that the purpose of a pension plan is to provide income when it is needed, when an individual no longer wishes to or is able to work. Any other, shorter term requirements should be funded separately.

We are currently experiencing a Global recession, the like of which most of us have never experienced before. Share prices have tumbled over the last 18 months, property prices have slumped and interest rates have fallen to a level not seen for hundreds of years. As a result many people are put off making any form of investments at this time. But, as bad as things are currently, we have not heard of anyone who predicts that things will never get better. A pension plan is a long term savings arrangement and there will be times when the underlying investments will fall in value. Equally, there will be periods of strong growth. Money that is invested at times when assets are cheap should produce gains when markets are buoyant.

Most pension arrangements offer a wide choice of asset classes to invest in such as UK and International Equities, Commercial Property, Fixed Interest Securities and Cash. It is therefore possible to invest in a pension arrangement and enjoy the benefits of the tax savings without exposing yourself to excessive risk.

Pension plans have been steadily evolving over the years mainly as a result of changes in government legislation. In 2001 ‘Stakeholder’ pensions were introduced. These provide a simple, low cost route to pension planning and should be considered as a good starting point for pension savings. Personal Pensions build on the Stakeholder concept and offer additional investment opportunities through links to ‘external’ fund managers.

Finally, Self Invested Personal Pensions ‘SIPP’s’ can provide a fully bespoke opportunity for those wishing to adopt a ‘hands on approach’ to pension planning. Using these arrangements it is possible to buy commercial property for the use of the member and his business or as an investment.

If you would like to discuss your pension requirements with one of Prime's Financial Advisers simply send us an email and we'd be happy to arrange an appointment for you.