Everyone knows that a pension plan can be a useful tool to help to provide for our income needs in old age. Many people use them to help accrue assets to fund financial freedom at the end of one’s working life. There are of course disadvantages attaching to them, such as they do take a goodly amount of funding (although that applies to all forms of saving)! They also have charges and costs attaching and a whole set of rules surrounding them that can be difficult to understand.
The main ‘pro’ of pension planning can be summed up in two words, “tax advantage”. This is generally understood by most and in practice means that contributions benefit from income tax relief and a pension fund that grows in a tax-preferred environment once money is in it. There are other taxation benefits associated, such as the fact that the fund is held outside your estate and therefore potentially not liable to inheritance tax on death. However, it is the tax relief on contributions that mainly drives people’s interest, certainly catching the eye of the accountants.
Pensions have other advantages too which are less understood, such as they do impose a saving self-discipline on an individual, as the money cannot be accessed prior to age 55 (in most cases). In addition a pension benefits from a statutory protection against creditors should there be a financial catastrophe in a pension holder’s life. Understandably, these are less talked about but are still clear, if more marginal, advantages.
The main ‘con’ of saving into a pension scheme can be summed up as “complication”. This is because the rules surrounding pension plans are more complicated in general than the rules for saving via other investments products such as ISAs or investment funds / trusts. Cash accounts, collective asset backed funds, commercial property and individual stocks and shares can all be held in pensions. The pension scheme becomes the wrapper within which to hold these but is the rules that apply to this wrapper that makes life more complicated.
In respect of tax reliefs available, there are maximum amounts that can be funded each year, a maximum amount of pension fund that can be funded for over an individual’s lifetime and complicated rules as to how benefits can be taken in retirement. These vary from scheme to scheme. This complication is somewhere an adviser can add value by interpreting and advising on but it is true that this in itself can be viewed as a potential disadvantage. Where the taking of advice can definitely add value it does also add another layer of cost, meaning that scheme administrators, fund managers and advisers all want paid and this can weigh down on fund performance.
However, there is also one other point to be aware of that I think worth remembering, one that is less spoken about; the fact that pensions are “political”. The politicians can’t leave them alone. This is mainly because of the tax reliefs they benefit from and thus the need for the Chancellor of the Exchequer to ensure that these reliefs do not get out of hand in terms of cost to the tax payer and that they don’t overly favour those who are already wealthy.
Over half of pension contribution tax relief accrues to higher and/or additional rate taxpayers and this fact is quite contentious for obvious reasons. In my career I have seen (and had to grapple with) many different regimes which control the amounts that can be funded and the maximum pension benefits that can be drawn. Almost always, revisions take place for political or taxation
This makes things more difficult for the pension plan holder. What will be the political and legislative background pertaining when a customer comes to retirement? Can we trust the politicians not to change the playing field again? The short answer is ‘no’.
Changes are still ongoing today. Witness the current argument over women’s state pension equalisation with men and the increase in the state pension age from 65 to age 66, 67 and beyond. It is frustrating because there is very little control an individual can exert over this.
Against this backdrop, I would like to take the opportunity to stress the following:
1. Current tax reliefs attaching to pensions are still very attractive, especially for higher rate taxpayers. These reliefs should be used to drive a far higher pension pot value than would otherwise be the case. In addition, where there is an opportunity to benefit from employer contributions as well, this ought to make pension saving particularly attractive.
2. No individual should put all their eggs in one basket, i.e. nobody should fund for income in retirement using only pensions. Other assets such as ISAs, cash deposits, buy-to-let properties etc. all have a role to play. Savings scheme or plan diversification is as important to be mindful of in a portfolio as investment asset type diversification.
3. Although pensions are political, most legislative changes made to date which affect pensions haven’t been retrospective in nature, changing future funding rules but not necessarily the rules surrounding the pension pot already accrued. Protection is given.
4. In my view further changes will happen, especially so if we have a change of government. The abolition of higher rate tax relief on pension contributions has long been mooted and a new Labour government may decide to make changes to this area quickly.
The message is that you should not let the meddling politicians put you off but rather be aware of their tendency to alter the playing field and importantly, try to take advantage of the current attractive tax regime that pertains whilst you can.