Advice for first time pension planner

jdobrowski

Hi everyone,

I've recently been thinking that it's about time I started some proper retirement planning, and could use some advice on pensions.

I'm 25 at the moment with a salary in the 40% tax bracket. I've been maxing out a cash ISA for the past two years, and aim to do so up until retirement age (although I do plan to use the savings in my ISA for a house deposit within the next couple of years).

To compliment my ISA I'm now looking to set up a penison. I work for a very small company that doesn't offer a contributory pension at the moment, and so I'll have to go down the private pension route. On top of my ISA, I can save around £400 per month with my current salary and outgoings.

At the moment I'm leaning towards a private or stakeholder pension. I do have a reasonable understanding of investment basics, but no real-world practice at the moment, and so feel that a SIPP is likely over my head (though I would be happy to put the time into improving my financial knowledge and monitoring funds so long as charges work out).

My current plan is to compare the historical performance and charges of some of the big providers (e.g. Standard Life, Scottish Widows, etc.) and pick the one that seemed to tick boxes in both cases.

Does this seem like a good approach, or would it be worth me taking another look at SIPPs again? I did have a brief look at the SIPP charges at Hargreaves Lansdown, but the fund charges appeared higher than those of stakeholder pensions at Scottish Widows, for example. This combined with my current lack of investment experience is what initially put me off.

Any further advice based on my situation would be most welcome.

Cheers,
James

jem16

jdobrowski wrote: »

At the moment I'm leaning towards a private or stakeholder pension.

A personal pension at your age and amount of contribution is probably going to be best as you can go with a multi-charged pension which is likely to be cheaper than a stakeholder as well as giving you access to better quality funds.

I do have a reasonable understanding of investment basics, but no real-world practice at the moment, and so feel that a SIPP is likely over my head (though I would be happy to put the time into improving my financial knowledge and monitoring funds so long as charges work out).

A SIPP really is for an experienced investor who is looking to invest in areas that a SIPP allows but a personal pension does not. If only using funds a SIPP can be dearer.

My current plan is to compare the historical performance and charges of some of the big providers (e.g. Standard Life, Scottish Widows, etc.) and pick the one that seemed to tick boxes in both cases.

It's not the provider that makes the performance but the investments that lie within the tax wrapper ( pension).

You really should be looking at where you want to invest and what provider will give you access to the funds that will meet your requirements.

If you are not sure what you are doing perhaps seeing an IFA would be a good move.

jdobrowski

Many thanks for the response Jem, your advice is very much appreciated.

A multi-charged pension isn't something I'd heard of before (the ones I've been looking at appear to charge a single annual percentage), so I'll do a little more research into that one tonight.

Seeing an IFA may be a good option. With the large number of funds out there I'm not entirely certain where to begin. I was looking at the Aviva stakeholder pension earlier today, and even with just 39 funds on offer it seemed plenty to chose from! :undecided

sterlingstash

Mickflynn, I'm not sure you are comparing like with like, as you appear to be quoting real returns for pensions (1-2%) and nominal for mortgage interest (the real interest rate on 4% mortgages being about 0 at the moment).

However, having always been a strong proponent of the value of pensions, I have just reviewed my 8 years worth of pension contributions to find that the fund value is only a little higher than the total amount put in over that 8 years (my employer and my contributions) which has left me rather disillusioned. I calculate that growth has been less than 3% (nominal) rather than the usual 7% quoted. No longer having employer contributions (having moved jobs), I am now seriously questioning the value of continuing my contributions rather than saving outside of a pension. Of course, this just mirrors the fund performances although the funds I am invested in have tended to perform quite well compared to their respective benchmarks. For the lack of flexibility in the pension, I am wondering whether the loss of tax efficiency is a price worth paying...

Lokolo

sterlingstash wrote: »

Mickflynn, I'm not sure you are comparing like with like, as you appear to be quoting real returns for pensions (1-2%) and nominal for mortgage interest (the real interest rate on 4% mortgages being about 0 at the moment).

However, having always been a strong proponent of the value of pensions, I have just reviewed my 8 years worth of pension contributions to find that the fund value is only a little higher than the total amount put in over that 8 years (my employer and my contributions) which has left me rather disillusioned. I calculate that growth has been less than 3% (nominal) rather than the usual 7% quoted. No longer having employer contributions (having moved jobs), I am now seriously questioning the value of continuing my contributions rather than saving outside of a pension. Of course, this just mirrors the fund performances although the funds I am invested in have tended to perform quite well compared to their respective benchmarks. For the lack of flexibility in the pension, I am wondering whether the loss of tax efficiency is a price worth paying...

This doesn't make sense.

Your employer is giving you X free money.
You are getting X tax relief.

Have you taken this into consideration when calculating returns?

You have said you have only got 3% returns - but what if you consider the amount you have put in yourself?

e.g.

I contribute 5%, my employer contributes 10%
3% growth.

So say my income is £1000.

I put £50 in, my employer puts in £100, I also get 20% tax relief on my contribution. After 1 year I get 3% growth so my fund value is £167.38.

Of that I have put in £50.....

How is it worth using that £50 to pay a 4% mortgage overpay instead?

sterlingstash

Hi Lokolo, thanks
I wasn't perhaps clear enough. My new employer does not contribute. My pension has been well worth it to date, due to my old employers contributions, such that my fund value is double the amount I have contributed from my net income. BUT, investment performance has been poor (due to fund performance and of course management fees Mickflynn ) Going forward, the poor average returns compared the 'industry standard' forecasts are a big worry. Given that this has been over nearly a decade (perhaps 1/4 of my working life), even small under-performance in funds has a sizable impact on final pension pot, so despite starting early and following all the guidelines about contribution sizes, I can see my pension being a bit disappointing when I finally get there, if this performance continues.

Anyway - not wanting to hijack the OP. Just a recommendation to the OP to review past pension fund performance after fees, and to everyone to actively review how your pension is performing compared to forecasts. Of course, free money from employer will almost always make company scheme far better than other investment options. I just don't think that should be an excuse to overlook the poor real returns that the fairly typical pension funds (like balanced managed, global growth etc) are providing (after fees)
The OP states that he has no employer contributions which as I have found makes fund performance compared to other investments more pertinent, although as a higher rate taxpayer his pension contributions have greater tax efficiency than for many.

Judwin

sterlingstash wrote: »

Hi Lokolo, thanks
I wasn't perhaps clear enough. My new employer does not contribute. My pension has been well worth it to date, due to my old employers contributions, such that my fund value is double the amount I have contributed from my net income. BUT, investment performance has been poor (due to fund performance and of course management fees Mickflynn ) Going forward, the poor average returns compared the 'industry standard' forecasts are a big worry. Given that this has been over nearly a decade (perhaps 1/4 of my working life), even small under-performance in funds has a sizable impact on final pension pot, so despite starting early and following all the guidelines about contribution sizes, I can see my pension being a bit disappointing when I finally get there, if this performance continues.

Anyway - not wanting to hijack the OP. Just a recommendation to the OP to review past pension fund performance after fees, and to everyone to actively review how your pension is performing compared to forecasts. Of course, free money from employer will almost always make company scheme far better than other investment options. I just don't think that should be an excuse to overlook the poor real returns that the fairly typical pension funds (like balanced managed, global growth etc) are providing (after fees)
The OP states that he has no employer contributions which as I have found makes fund performance compared to other investments more pertinent, although as a higher rate taxpayer his pension contributions have greater tax efficiency than for many.

But....If you recognise/believe that your chosen fund/funds are performing poorly, why not switch into something thats performing better? There are plenty of funds returning 10%+ p/a over a 5 year period.

The current yeild on the FTSE All share is (apparantly) 3.3%, so even without any growth in the value of the index, that needs to be included in the calculations. And I seem to remember reading on here that there's an HSBC FTSE tracker fund with something like 0.3% annual charges.

I have a bog standard lazy investor Pru With Profits pension at the moment - averaged 9-10% p/a over the past 5 years. I also have an SS ISA with H-L, and that's doing much better, but is quite volatile.

mickflynn39

Judwin wrote: »

But....If you recognise/believe that your chosen fund/funds are performing poorly, why not switch into something thats performing better? There are plenty of funds returning 10%+ p/a over a 5 year period.

Judwin, you mean well but 'past performance is no guarantee of future success'. If anything all the evidence points to the fact that funds that have performed well for a while are the ones more likely to start to perform badly. That added with the dealing costs, management charges etc. would mean he would probably be worse off than just staying put. He would certainly be worse off in the short term. Fund managers love nothing better than switching funds as it gives them a golden opportunity to get their hands on more of our money. I'd also check that 0.3% 'deal' before diving in as I would be amazed if there aren't any 'hidden' costs they are keeping quiet about.

jem16

mickflynn39 wrote: »

I'm only advising people who are considering pensions where they are responsible for all the contributions and costs to ensure they pay their debts off first as long as the interest rate on the debt is higher than 1-2 per cent.

Anyone paying 40% tax and will only pay 20% tax or less in retirment should also pay into a pension. Nothing else will come close to that.

mickflynn39 wrote: »

Judwin, you mean well but 'past performance is no guarantee of future success'. If anything all the evidence points to the fact that funds that have performed well for a while are the ones more likely to start to perform badly.

That's where regular yearly rebalancing comes into play. You don't just stay in the same funds year after year.

I'd also check that 0.3% 'deal' before diving in as I would be amazed if there aren't any 'hidden' costs they are keeping quiet about.

The HSBC trackers all have a TER of less than 0.3% - there are no hidden extras.

http://www.h-l.co.uk/funds/fund-discounts,-prices--and--factsheets/search-results/h/hsbc-ftse-all-share-index-inst-accumulation

hugheskevi

If you have £10k in savings you could get about £300 a year in a long-term bank deposit account, £400 a year in your pension

So this would be a 4% return in a pension (£400/£10,000).

All my figures in my previous post are based on long term trends.

What is the source for this? 4% looks low. 5% would seem closer to the mark for an equity portfolio long term looking at long-run (over the last 100 years) return.

The key point that most people miss is that after allowing for inflation and charges most pensions funds generate a return of between 1-2 per cent.

So charges reduce growth from 4% gross to about 1-2% net. Consistent with a TER of about 2-3%, is that right?

The real long term figure is 5.6 per cent.

How does this relate to the 4% above (£400 return on £10,000)?

If we're paying one and a half or two per cent or even three per cent a year in charges, that will wipe out a large part if not all of our potential earnings from putting our money in a possibly risky investment rather than in a bank account.

It certainly would put a big hole in profits, but why would I have such a high charging pension? Across all of my own and my partner's ISA and pension investments, I can't think of any with a total cost of more than 1%, even taking into account dealing costs and buy-sell spreads.

From all these numbers, shouldn't the conclusion be that the real long-run return on equities is about 5%, a typical pension charge would be 1% TER, so I could therefore expect a long-run return of about 4% real? Admittedly you may argue that the long-run return has been fundamentally lowered in some way, as the last 20 years have been strange times. Even so, I doubt you'd reduce the expected return to much below 4% real (pre charges)?

mickflynn39

jem16 wrote: »

Anyone paying 40% tax and will only pay 20% tax or less in retirment should also pay into a pension. Nothing else will come close to that.
That's a lot to predict when you are 25. Are you always going to be paying 40%? How do you know whether you will be paying 25%? I disagree that nothing else comes close. Gambling on the horses (if you are disciplined and know what you are doing) provides me with more than enough to live off and has done for the last 3 years when I retired at 50 without a pension. Also my buy to let property has increased greatly in value and also provides me with a steady monthly income.


That's where regular yearly rebalancing comes into play. You don't just stay in the same funds year after year.

And no doubt you get a management charge for the privelige which eats into your fund.


The HSBC trackers all have a TER of less than 0.3% - there are no hidden extras.

http://www.h-l.co.uk/funds/fund-discounts,-prices--and--factsheets/search-results/h/hsbc-ftse-all-share-index-inst-accumulation

The TER probably covers an annual management fee but what about other charges like share dealing(covering brokers' commissions, price effects and bid/offer spreads on shares and bonds bought). Then when you take into account the initial cost of purchasing units, which is usually 5 per cent, you would be paying well over 0.3%.