The danger of ignoring your pension!

by Bob Bullivant on 01 September 2011  |  1 comment
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Many of us are happy to forget about pension once it's opened and set up, but this can be an expensive error.

If ever there was a demonstration of why companies have been keen to ditch defined benefit (final salary) pension schemes it has come in the past few weeks, when we have seen violent fluctuations in world stock markets.

Those lucky enough to be given the promise of a pension based on their final salary can sit back secure in the knowledge that the extra costs associated with this fall in stock values will be picked up by their companies. For those in money purchase schemes the cost is all theirs – particularly for those close to retirement.

This makes absolutely clear the transfer of risk that occurs when a company closes its defined benefit schemes and moves to a basis where they pay a contribution to an employee’s individual pension fund (known as defined contribution) – all investment risk is passed to the employee in one swoop.

For many employees this is the only time they get anywhere near the stock market and so they are the ones who are most badly hurt when markets fall just as they reach retirement. It never ceases to amaze me the number of people who get to retirement and are still invested in equities. So much so that Annuity Direct commissioned some research into the probability of a stock market fall in the twelve months prior to retirement. Using stochastic modelling techniques the research estimates that there is a one in twenty chance of losing over 22% of the value of a pension fund in those 12 months.

My experience is that most people start a pension fund and then forget all about it. We call it ‘set and forget’. The problem is exacerbated by annual statements that are less than helpful, and a general lack of interest in pensions until the last minute when it is too late.

So when is the right time? What should be done?

The defined benefit scheme does have a significant advantage in that the fund runs continuously and can make investments for the long term – moving equities to bonds to meet liabilities when conditions are favourable. Some defined contribution schemes use so-called lifestyling which switches out of equities in the five years before retirement. This is comparatively new, having only been introduced in the nineties. For older policies, which are the ones maturing now, this does not exist.

The key is that in the ten years before retirement, pension funds should be reviewed at least annually. This is the time when there may be excess cash and the generous tax reliefs can be very attractive – particularly to higher rate tax payers. Policy holders should not be afraid to lock in gains and lose potential further growth in the equity markets. There are also arrangements which allow continued equity exposure but a guarantee against loss.

In short, do not set and forget – it can be very expensive!

Bob Bullivant is chief executive of Annuity Direct.