Pensions

A Pension isn't exactly an investment vehicle in itself but is a wrapper for a variety of other investments. A typical pension fund will be invested in unit/investment trusts , cash, bonds & gilts (treasury bonds). Usually, if you have a company pension, you will be given a limited choice as to how you'd like your pension fund to be invested. Typically, you're given the choice of high, medium and low risk with the high risk choice being more heavily invested in unit/investment trusts and low risk heavily leans to cash & gilts. Sometimes, they'll allow the more experienced investor to choose their own investments but there's usually a limited number of investments available and the buy/sell costs tend to be higher than on the open market.

You may want to think about investing in a pension if 1 of these 2 is true:-

1. You're unlikely to accumulate more than £50k - the issue here is that if you have no savings at all, then you'll get the basic state pension plus a top up in pension credits worth the equivalent of a £50k pension pot.

2. You are a basic rate taxpayer - if so, the government will pay back any tax on your pension contributions. However, when you retire you'll be taxed on your annuity (insurance bought using your pension fund) at the basic rate. There's an argument that you're only deferring tax, and the other disadvantages of pensions may negate the advantages.

The main disadvantage of pension funds is that your investments are out of your reach until your designated retirement age. Up until April 2010, the earliest you were allowed to retire was 50, and from that date it will be 55 unless your existing pension contract already specifies an earlier retirement date. The government has historically, and probably will continue to change the options on investing for a pension, tax advantages associated with pension contributions, minimum retirement dates, rules on how long you can hold off taking an annuity and rules on what you can do with your pension fund.

When a pension contributer's retirement age is reached, he/she will either have to buy an annuity or delay the annuity for a set period of time defined by the pension fund trustee or can opt to have an income drawdown.

An annuity is effectively an insurance policy that a pension fund holder can take it. If say, you have £100k in your pension fund, then an annuity provider may promise to pay you 6% per year for the rest of your life, say, if you buy an annuity with your pension fund. The actuary who works for the annuity company works out the percentage payable by looking at the typical lifespan expected for somebody like yourself (Factors taken in to account are gender, age and lifestyle) and the current price of gilts (treasury bonds) which the annuity provider legally has to invest in a substantial proportion in, as it's deemed low risk. If you die earlier then the annuity company profits from you and if you die later then it loses and has to pay out using the funds of those who died earlier. There are different types of annuities available and the percentage payable varies. Typical factors which again alter the payout rates are:-

1. If you want the annuity to be payable just to yourself or to you and dependents on your death.

2. If you want the annuity to escalate by RPI or a fixed rate.

An income drawdown allows you to take an income from the fund rather than having to buy an annuity. Currently, you can take an income of anywhere from £0 to 120% of what a typical annuity would have paid you. You can only take income drawdown, however, until you're 75 when you currently have to buy an annuity.

Whether to buy an annuity or opt for income drawdown is a difficult choice. Currently annuities aren't paying a lot mainly because the price of gilts is high and the yield on the gilt, consequently low. However, if you were to opt for an income drawdown, perhaps gilts could become even more expensive and/or typical lifespans could extend and you'd be offered less, or you could die, in which case a substantial portion of the remaining capital will be absorbed by the pension fund.

Sometimes, the fact that your savings are in a pension fund rather than unit trusts or cash is a good thing. For example, if you are made redundant, it's only your liquid capital which is taken in to account, so you could have a substantial pension fund but no cash or unit/investment trusts and still be given high benefit payouts.

http://www.pensionsadvisoryservice.org.uk has some up to date information about pensions and annuities. They are a voluntary organisation that receive a grant from the department of work and pensions (DWP). Although, their advice is nominally independent, it should be borne in mind that they may be heavily influenced by the financial services industry so you should always do other research before forming a complete opinion.

http://www.thepensionservice.gov.uk is a site run by the department of work and pensions itself. It doesn't provide so much information about pensions and annuities but it does have some useful calculators for calculating the age at which you'll retire and the amount of basic state pension that you could currently expect based on your contributions. As there's been a lot of changes recently (e.g. women can't retire until 65 but both men and women only have to pay a minimum amount of national insurance for 30 years rather than 44 to qualify).