Become a pensions expert in five days - the final part
It's the final day of our 'become a pensions expert in five days' series.
So you may have heard that the government plans to introduce something called NEST in 2012.
The basic idea is that everyone who is working between the ages of 22 and 65 should be contributing towards a pension. It will be compulsory for all employees to make pension contributions unless they specifically opt out of the scheme.
Under the new rules, all employers will be obliged to operate some form of pension scheme. The scheme doesn’t have to be NEST - employers can continue with their current schemes as long as they meet the government’s requirements. The crucial point is that employers will also have to make contributions to all employees’ pensions. That’s apart from the employees who opt out of contributing themselves.
The introduction of NEST will begin in 2012. Initially, only larger companies will be affected but by 2017, all employers will be obliged to follow the new rules.
NEST is a controversial measure. Some people think it will be a flop and won’t increase the level of pension saving in the UK. Maybe they’re right, but I think it’s worth a try.
Pensions v. property v. ISAs
This is the last issue I want to look at: do you have to save for retirement via a pension?
As I said in part four of this series, I think most people should save for their retirement. I also think a pension is the best retirement savings vehicle for most of us. But there are disadvantages, and if you choose to save via a different vehicle, I don't see that as the end of the world. The most important thing is that you do save for your retirement.
So here's a quick rundown on the relative merits of pensions, isas and property.
The British have a love affair with property. That's understandable. Many people have made a lot of money from property. No doubt more will in the future. The biggest advantage of investing in property is that you can 'gear up.'
Here's an example of gearing up:
You buy a house for £300,000 with a £100,000 deposit and a £200,000 mortgage. You only pay interest on the mortgage for five years. Then after five years, the value of the house has risen to £500,000. Ignoring interest payments, you've made a £200,000 profit on an initial £100,000 investment.
That's a cracking return. You can gear up when you invest in the stock market, but it's harder and riskier.
However, in spite of the above example, I don't think that building a buy-to-let property portfolio is the best way to save for retirement. I think it's risky to put all your wealth in one asset class (property.)
ISAs are a great savings vehicle in many ways. You can use them to shelter cash and/or shares from tax and build a long-term savings pot.
ISAs are more flexible than pensions in some ways. You'll never have to worry about whether to buy an annuity or go for drawdown. And you can withdraw your savings at any time.
However, I’m not sure that flexibility is necessarily an advantage. I think it’s good to be in a situation where you can’t succumb to temptation to dip into your retirement fund early.
Everyone can save up to £10,680 a year into an ISA. That’s a pretty large sum, but a pension allows you to save more if you wish.
When people debate the relative merits of pensions and ISAs, the subject of tax normally comes up.
Basically, both pensions and ISAs give you good tax breaks. If you go for a pension, you get a nice tax break when you pay in to your pension. So if you’re a basic rate taxpayer and you paid in £100, the tax man would boost that sum to £125. However, when you draw an income from your pension, you have to pay income tax.
ISAs work the other way round - you get no boost from the taxman when you pay money into the ISA. But when you withdraw the money, no income tax is payable.
So it sounds like there’s no gain either way, you get the same tax break from pensions or ISAs, they’re just applied at different times. However, there are two tax facts which tip the scales in favour of pensions in my opinion.
Firstly, there’s the 25% lump sum that I mentioned on day three. That lump sum is tax-free, so you get a double tax break. You pay no tax when the money is paid into your pension pot, and you don’t pay any tax when you withdraw the sum from your pension pot. There’s no equivalent if you save into an ISA.
Secondly, pensions work well if you’re a higher rate tax payer while you’re working, but become a basic rate taxpayer when you retire. That means you get a 40% tax boost when you pay into your pension pot, but you’re only taxed at 20% when you withdraw income from your pension via an annuity or drawdown.
What’s more, saving into a pension means you can’t blow your money early. This is money that you can’t touch until you’re older. I see that as a positive thing, not a disadvantage at all.
And, of course, if you're in a scheme where your employer makes some form of contribution to your pension, I think there's a very strong case for signing up. Employer contributions turn pensions into a very attractive vehicle indeed.
I hope this series has helped a few people make pension decisions. If you're unsure about what to do next, I'd urge you to see a good independent financial adviser (IFA). For many financial decisions, I don't think an IFA is necessary, but it's different when it comes to pensions.
There's masses more information about pensions in our archives. Here’s a list of some of our best recent articles on pensions: