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How to boost your pension
By Faith Glasgow
Most people's pension pots have been savaged by the market turmoil of the last 18 months.
Whether you're one of the 3.7 million workers paying into a stock market-based 'money-purchase' pension scheme offered through your employer (also called defined contribution or DC scheme, where both employers and employees contribute) or you have your own personal pension, the chances are your investment has lost up to a third of its value during the credit crunch.
Money-purchase schemes have seen the value of their pension assets collapse from £550 billion in September 2007 to £391 billion at the end of March this year, according to the Aon Consulting Defined Contribution Pension Tracker - a fall of almost 30%. And that's after the 6% recovery that funds enjoyed during March.
Personal pension funds have been hard hit too: Morningstar figures show, for instance, that the average UK pension fund is down 21% over 18 months to 31 March this year.
The big question now, particularly for those approaching retirement, is what to do about such a crippling shortfall. Your options will depend in part on the amount of time you have before you need your pension.
Are they worth it?
It's worth remembering at this point why pensions are such a good way to save for the long term. You get full tax relief on everything you pay into your pot - so if you're a basic-rate taxpayer, for every £100 going into the fund, you only pay in £80 and the Government will add the other £20. It's even better if you're a higher-rate taxpayer, as you only pay in £60 of every £100 and the rest comes from the taxman.
But don't forget that once you've put money in, you can't get it out again until you come to draw your pension. If you still have 10 or more years to go before retirement, it's a matter of sitting tight and waiting for markets - and the value of your fund - to recover.
Keep paying into it regularly meanwhile, because experts agree that stock markets are very cheap right now, which means your contributions will buy a lot of units of investment each month. This means people who are a long way from their retirement could actually benefit from the current market drop.
Indeed, it makes sense to increase contributions to your pension pot, if possible, so as to buy as much as you can while prices are low. Helen Dowsey, principal in the benefit solutions division of Aon Consulting, points out: "Although pension investment is sensible and tax-efficient, many people feel uneasy about continuing to pay money into volatile stock markets - but in the longer term equity markets remain the best bet for returns."
If you're coming up to retirement, then it's less straightforward. "Normally, we would advise people to take the 'lifestyle' approach and move gradually into fixed-income investments and cash as they get near retirement, because these are not so volatile," adds Dowsey.
"But the choices now are pretty stark: either they move into the relatively safe haven of cash and fixed income but take a hit on their pension fund, unless they can somehow find the money to make up the shortfall, or they leave their investments in the equity markets and wait for recovery, which may mean putting off retirement."
Finding additional money
First, says Jonathan Howard, head of the private client department at pension specialist Courtiers, bear in mind that (provided you earn less than £150,000, where contribution rules have changed) you can pay in up to 100% of your salary, so you may be able to increase monthly pension contributions from your earnings.
"There is no upper limit on contributions in the final year before you retire," he adds, "so it's worth putting through other savings and investments as pension contributions, so that you get the tax relief on them." For example, if you have investments worth £20,000 and you're a higher-rate taxpayer, by paying these into your pension you'll add £33,000 to your pot.
However, Dani Glover, director at Smith & Williamson, cautions: "It's not fun going into retirement without any savings you can access - if you've put everything, including individual savings accounts, into your pension, you risk having to start saving again from pension income for extras such as holidays."
ISAs
ISAs have a further tax benefit once you're retired, in that the money you take from them is completely tax-free. Glover points out: "ISAs can be a valuable source of extra untaxed income." Moreover, the Budget brought the announcement of a useful extension of ISA limits from £7,200 to £10,200, kicking in from 6 October for the over-50s (and from next April for everyone else).
But, says Mike Morrison, head of pension development at AXA Winterthur, your strategy really depends on how much money you have in the first place. If you need to maximise your pension to buy an annuity that will cover your basic living costs, it may be sensible to put most spare savings into your pension pot, at the expense of your rainy day and treats pot.
State pension
If you're retiring after that date, you may therefore find you qualify for a full pension, even though under the current rules you're short of contributions.
"The best thing is to contact the Department of Work and Pensions directly (NI Enquiry Helpline: 0845 915 5996) which will be able to tell you where you stand," says Howard. "If you will be short, it usually makes sense to top up: a small gap should cost just a few hundred pounds, but it will help increase your income for the rest of your life."
Another useful option, if you have a personal or company pension already or are continuing to work, is to defer your state pension. If you defer for a full year, you can claim an extra 10.4% of state pension. You can choose to take this as an extra weekly pension for the rest of your life or as a single lump sum.
Can you retire?
A survey by Standard Life found 30% of people aged 45 to 64 expect to continue in employment beyond retirement age. It may not be what you imagined you'd be up to at 65, but working on does mean that your pension fund can continue to grow.
The bottom line is that more older people from now on are likely to have to make difficult decisions about what's most important to them - leisure time or a decent income.
Annuities
So don't make the mistake of taking whatever annuity you're offered by your pension provider without comparing it with the wider market. Talk to a specialist financial adviser, or compare rates on websites such as annuity-bureau.co.uk.
You may be able to improve the rate you're offered if you have a medical condition such as obesity, or you're a smoker. A few insurance companies, including Norwich Union and Prudential (PRU), also offer 'postcode annuities' paying better rates in poorer areas.
Nigel Callaghan, pensions analyst at Hargreaves Lansdown, suggests 'mixing and matching' policies to try and balance income today with inflation and changing circumstances in the future. For example, you could buy a selection of annuity types.
"You could use a third of your fund for a level annuity, a third for an index-linked one which has a lower starting rate but will give some protection against inflation, and a third for an income drawdown contract that keeps your money in the markets with the potential to grow," he says.
If you plan to defer your retirement but want access to some of your pension, you could use an income drawdown scheme - where you leave your money invested and draw an income from it - for a few years.
This is suitable for pension pots of around £100,000-plus; it's a more flexible alternative to buying an annuity, and as your money remains invested in the markets, there's the chance of recovery. Better still, annuity rates rise as you get older.
But there are risks to income drawdown: stock markets could fall further, and annuity rates may also continue their long-term downward trend.
Is my pension safe?
Final salary schemes could be vulnerable if your company goes bust owing the pension fund money. This could mean your pension is reduced, but you may be able to get help from the Pension Protection Fund (PPF). If your company meets the PPF conditions and you've already reached the scheme's normal retirement age, you'll receive your full pension. If you haven't yet reached retirement age, you'll be entitled to 90% of your pension, capped at £27,000 a year, in due course.
In money-purchase schemes, where your cash is invested with a professional pension provider, the pension assets are ringfenced even if your company collapses. However, it's possible that the pension provider itself may get into difficulties, in which case you're protected by the Financial Services Compensation Scheme (FSCS). This pays 100% of the first £2,000 and 90% of the balance.
Lifetime annuity payments are fully guaranteed by the provider as long as it remains solvent. In the unlikely event that it goes under (which has never happened so far), you'll be protected by the FSCS.
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