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Pension Funds Print E-mail

Jeremiah 29:10 For thus says the Lord: "After seventy years are completed at Babylon, I will visit you and perform My good word toward you, and cause you to return to this place. For I know the thoughts that I think towards you, says the Lord, thoughts of peace and not of evil, to give you a future and a hope."

Pension funds are a growing concern as highlighted by government and media alike.  The fundamental problem is that, on average, people are getting older, referred to as an ageing population. Pension fund managers are finding it increasingly difficult to pay good pensions in an economic climate that is complex and unstable.

When investing in pension funds, one needs to be very careful, because it is often the only source of income for up to 40 years, from the age of 65 to 105.  In 1966, when a person of the age of 105 today would have retired, a loaf of bread cost around 6p , which is a lot less than today. Whilst a particular portfolio of retirement funds may have seemed valuable in 1966, it could very well be worthless today.  Quite often, your pension income will not increase at the same rate as general prices of goods, which means you will become progressively poorer during retirement. The worst thing that you can do, is to keep cash or leave lumps of money in a bank account for a long period of time, as the value will simply disintegrate. Interest rates often track just above inflation rates and well below lending rates. This means if you are spending the interest on your savings to fund living costs, the capital will steadily decrease in value.

[FSA's pension calculator]


This is the grim view, but it does not necessarily have to be the case.  If your money is wisely invested it can grow at the same or a better rate than inflation and you can live on the income without touching your capital.

How is this done?

By choosing investments that grow faster than the average prices of goods. Unfortunately, investments grow at different rates all the time.  They tend to have growth spurts that can last from short to very long periods of time.  They can also decline sharply without warning. The key to planning for retirement, is to watch how your money is performing all the time and to keep abreast of developments in markets.  Beware of sales representatives earning commissions on investments that they sell and do not trust everything advisers tell you.  Excellent advisers do exist, but if you are not informed, it can be difficult to tell the good apart from the greedy.  Ensure that they are registered with a regulatory body such as the Financial Services Authority in the UK, and review their profile on the Internet to ensure there are not a string of complaints against them. Follow the example of successful people who increase their own wealth.

This document can form the basis of pension education, explaining the basics you need to know about pension funds and how they work.  Pension funds may not be enough to keep you afloat in retirement.  Therefore, retirement planning should include a good mix of safe investments such as pension funds, and more risky but faster growing investments such as stocks and shares.

[Free investment advice from TD Bell Enterprises]

Why bother with a pension fund?

Pension funds provide a way for your employer and the government to contribute towards your overall retirement fund.  Your employer will make a direct contribution, but you need to confirm with your employer how much they are prepared to contribute.

The Government will contribute by offering a tax saving to you and your employer for contributions up to a maximum limit set by the Inland Revenue. You will also get a basic state pension to top up your pension, but a basic state pension is not enough to survive on. It is paid out of your National Insurance contributions, so it is important to pay enough NI for a long enough period, currently ten years minimum, or you may loose out when you retire. More guidance is available on government websites and the rules change from time to time, usually annually around April. The state pension may also increase annually providing essential growth in income lacking from other forms of retirement funding.

If you own a business, a company contribution to a personal pension fund is a great tax saver. There is no PAYE or National Insurance to pay on the contribution. The contribution is a tax deductible company expense, saving tax at the marginal rate of corporation tax for that particular company. HMRC will contribute the basic rate of tax (such as 20%) of the value of the contribution directly to the fund. Lastly, if you are a higher rate taxpayer, you can claim a further 20% rebate on taxed earnings for the contribution in your annual personal tax return.

If you don’t bother with pension, you are simply throwing money in the water.

When do I start planning for retirement?

The sooner you start, the better your chances are of saving enough to live comfortably in retirement.  You can start on the very first day of your very first job.  If you think about it, you only have 45 working years from the age of about 20 to 65 to save for the next 30 to 40 years from the age of 65 to 95 or 105.  With the advances in medical science today, this may be even longer.

The key is to remember that the last 30 years of your life will be the most expensive years, because:

  • the general prices of goods would have risen

  • you will have no salary, increases or bonuses

  • your medical bills may be high

  • you will need hobbies to keep you mentally and physically active

What do pension fund managers do with your money?

Employees, HMRC and employers contribute to the fund.  The money is pooled and invested in large lumps.  A mix of investments are chosen to achieve growth and to try to ensure that the money contributed is safe.  Trustees are appointed to make decisions about how to invest the funds, and to watch how they grow and perform.

Pension funds make major contributions to company shares on the stock markets.  As majority shareholders in many companies, they have a lot of power over the management decisions that companies make.  The performance of most pension funds is largely based on the performance of the companies in which the fund managers make investments.  That is why there is a risk that the funds can run out of money.  There are also salaries and overheads to pay so that the funds can be managed.  These costs can eat away at the value of the funds.

The Financial Services Authority oversees these funds in the UK.  Similar authorities exist in most countries. Pension fund managers are required to complete returns to the FSA on a regular basis.  The returns are a statement by the fund manager of how much money is available in the fund versus how much money the fund is due to pay out to the pension beneficiaries and contributors.  The FSA has set rules that force funds to have enough money to cover all its obligations, by making sure that a ratio of fund value to fund obligations is maintained at all times.  The returns are audited by accountants and the FSA relies on the audit opinion of the accountants to make sure that the returns are accurately completed.  The FSA also receives complaints from the public and investigates funds based on complaints if they feel it is necessary.

The risk attached to pension funds is therefore that the pension fund value is dependent on stocks, shares and other investments.  That is why pensions suffer when the stock market crashes or performs lower than expected.  Stock market performance is in turn affected by individual company sales, costs, share prices, interest rates, currency values and global economic factors such as the price of oil and gold. Share prices are relative to global performance conditions and calculated with reference to the earnings a company is expected to produce.

A portfolio is valued by an actuary every three years to ensure that the pension fund can meet its obligations to pension fund holders. The calculations are complex and performed by specialists. These valuations can have a significant effect on company balance sheet values of the pension fund and the company who contributes to it.  Valuations are therefore sensitive to manipulation by company managers, especially if their remuneration is dependent on performance targets. The figures are published in the audited accounts and updated annually. Audited accounts are available to the public from Companies House, and can be purchased for £1 per set.

Once the valuation has been performed, the actuary will produce a report that calculates the value of contributions required from companies and employees to cover the obligations of pensions payable to pensioners. The contributions are thus adjusted and split amongst companies and employees.

There is a lot of information to consider when deciding on a pension fund, and that is why it is important to spread investment risk and not place all your hopes and dreams in one egg basket. The most valuable information can be obtained from the balance sheet and notes to company and pension fund accounts, to assess how a fund is performing year on year.

What do I get back from the pension fund?

The money you contribute today, will also go towards the pension payments of people who are currently retired.  When you retire, you should receive a lump sum and a monthly sum to live on, which will be funded from the money contributed by working people to the fund at the time of your retirement.  You can choose to have the monthly sum paid from your existing fund or another annuity provider, and may get more by switching annuities.  This allows you to lump together your pension with any other small annuities you may have.

It is very difficult to compare what you get out of the fund with what you put into the fund.  The time difference causes the biggest problem because £1 at the time of your retirement will not have the same value as £1 today, as you will be able to purchase different kinds of goods with the money.

It is also difficult to keep track of how much you have contributed to the fund, because the amounts keep changing and your employer and the government also make a contribution.  It may however be a useful exercise to calculate what you think has gone into the fund, and compare it with what the fund promises to pay to you in their initial quotation.  Before you participate in any fund, make sure you understand exactly what you are putting in, and what you are getting out.

Another difficulty is moving jobs before retirement.  Some types of funds are not as flexible as others when it comes to moving benefits from one employer to another, or paying out benefits early if you decide to stop working.  In these circumstances you can receive less back than you paid in due to administration costs.  These types of investments need time to grow, and are not a short-term fix.

Get as much information as you can about any offer, make sure you understand all the small print, and then make an informed decision.  Fund mangers are after all in it to make money for themselves too, or there will be no point in managing the funds.

For detailed information on types of pension plans see Wikipedia The Free Encyclopedia

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