Question Of The Week #2: Is Now A Good Time For Me To Start A Pension?
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Thanks go to Moresweety for this week's question:
"I am 24 years old and have just reached the year point with my employer who has now offered me to take part in a pension scheme where if I contribute 3% of my salary they will contribute 6%. This is only an offer that can be taken up at the year point and would then change to a lesser offer.
Can anyone give me a bit of advice whether I should take the plunge and start it now or leave it a couple of years?"
My take on Moresweety's dilemma
I've always backed pensions as one of the best ways to save for retirement for many people, so this question was bound to catch my eye. Many people don't like pensions and don't trust pension companies. But if you don't do anything, your lifestyle in retirement could be pretty miserable.
In Moresweety's case the first question is whether a 3% deduction in salary is affordable. Moresweety may have large non-mortgage debts - perhaps from student days. If that's the case, you could argue that the debt should be paid down first.
"If what you say is true then your company scheme is extremely generous and you should take them up on this offer right away, assuming you can afford to do without 3% of your salary. Think of it as being like a savings account where your company put in £2 of its own money for every £1 you deposit."
(Read ThatLindseyGuy's response and others here.)
Assuming Moresweety can afford the contributions, the scheme on offer does seem particularly good. After all, many employers aren't willing to pay into a pension for their staff at all. And it's rare for employers to go beyond matching contributions £1 for £1 at best.
So Moresweety's scheme at £2 for £1 is an unusual and very tempting offer of free money. A large employer contribution will help to build up pension savings far more quickly than Moresweety could manage alone.
It's interesting that there's only one chance to accept the offer on these terms now. I wonder whether the company is trying to limit its pension liabilities by making the window of opportunity very small.
If Moresweety decides to go down the pension route the sooner, the better. Pensions need plenty of time to grow to work at their best, so getting started at 24 will give Moresweety an excellent head-start. Delaying, even for just a few years, can have a massive impact on the final value of the pension pot.
That said, on the other side of the argument, Highlifeinspain says:
"Unfortunately, speaking from experience, I would say: Don't do it. I am not saying don't save for your retirement, I am saying save in a vehicle other than a `very restrictive' pension. I saw the value of my pension pot crash to the point where I would have been better saving in a piggy bank. My suggestion [is] to choose a vehicle other than a pension. ISA's fit that bill perfectly."
(Read the full response here.)
What about the stock market?
Highlifeinspain's point is a pretty common criticism of pensions. It's true there's no way of knowing how your pension will perform, and the stock market has had a pretty rough ride lately. But I would say three things:
First, Moresweety's employer may offer access to a financial adviser for staff who need help in deciding where they should invest their pension contributions. If it's available, Moresweety should take it.
Second, there's no doubt millions of pounds have been wiped off the value of pension funds as the stock market has weakened. This is very bad news for people who have reached retirement or are close to it.
But Moresweety is only 24 so this pension could be invested in the stock market for over 40 years. This should be a sufficient timescale to build up a decent pension pot in spite of the peaks and troughs of the stock market over that time (although, there are no guarantees.)
Historical performance suggests that shares produce a real return (that is, after inflation) of around 6% a year, which has easily beaten cash savings. That said I can't be certain this will continue in the future.
And third, now could actually be a very good time to start investing in a pension. While the stock market is down, Moresweety will have the opportunity to buy more shares while they're cheap. Then when the stock market recovers, those cheap shares will be poised to grow in value.
Are ISAs better?
From an investment and tax perspective pensions and ISAs are broadly similar, but some people prefer ISAs as a way of saving for retirement. Money can be withdrawn from an ISA at any time. You don't even need to wait until you retire. And you can take as much cash out as you like, when you like.
But with pensions there's no access until you reach 55 at the earliest. And even then there are pretty strict rules on taking benefits from your pension pot. Read Pensions Versus ISAs to find out more.
That said, by choosing an ISA over the pension, Moresweety will miss out on the valuable employer contributions. I think that makes the case for this pension pretty compelling.
If Moresweety chooses the staff pension scheme, 9% of salary will be invested in the pension fund. While that's a pretty good start, it's sensible to increase that amount as time goes by. Moresweety could consider taking out an ISA for these extra savings, rather than using the same pension. This will help to spread risk and provide some access.
Look out for Question of the Week #3 next Friday.
Editor's Note: This article should not be seen as individual advice for Moresweety. We don't know Moresweety's financial circumstances so we can't say for sure whether saving in a pension is appropriate now or in the future.