For most people, a state pension is quite possibly the opposite of what they’ve experienced throughout most if not the whole of their working life, presupposing an employee and not running their own business. A pension is other people paying you. Anyone that spends money is likely to end up paying someone else but the difference with a state pension is that you get paid regardless.
Apart from having contributed to the national coffers, the only qualification needed to receive a state pension is old age. In the government’s mind, old age is symptomatic of having reached the end of your working life in readiness for the scrap-heap even though your healthy life expectancy might outlive the official retirement age.
It is possible to retire before the state retirement age and many people do. Occupational pensions see to that, so too do private pension arrangements. If you play your cards right then you could, as a friend has almost done, enjoy a longer period of retirement than the years worked. In the case of my friend, it’s about 48 years of retirement, with the bonus of an index-linked pension throughout.
The money for your state pension isn’t set aside each year in readiness: it is paid out of the money that the government of the time has at its disposal. The money for your private pension, however, comes out of whatever you’ve saved over the years so will vary not only on how much you’ve squirreled away but also what you invested in.
To help maintain a pension fund industry in the matter to which it is accustomed, living off the fat of the land, you are lured to hand over your hard-earned cash from an early age, with assurance the money won’t be squandered, in exchange for tax relief on the contribution. Tax relief is the government’s way of delegating some of the state’s responsibility onto the private sector. Relief varies with political tinkering. It used to be that you could only take 25% of your pension fund tax-free, the balance used to buy an annuity. The latest ruse is for people to be allowed to take however much they like out of their pension pot to do as they like with it. It is not all plain-sailing for the manufacturer of Lamborghini, there’ll be a tax-claw back and since the average pot is about £17,500, equivalent to 60 days on a world cruise, or not enough for a 10% deposit to buy much in the way of a property.
If you buy an annuity from a pension provider then the payment that you receive from the capital sum will be based on an actuarial estimate of your life-expectancy. How your pension payment is arrived at is a complicated mysterious calculation that bears a striking coincidence to the annuity provider drip-feeding you your own money back for as long as it can. To beat the system and end up better off than the amount you put in, you’d have to outlive their calculations.
With a self-invested personal pension (SIPP), the chances of your being paid regardless depends how canny you’ve been with your choice of investment(s). Contrary to popular belief, it’s not necessary to spread risk. To paraphrase Warren Buffett, nothing wrong with putting all your eggs in one basket: just watch the basket. Paradoxically, cash, arguably the most valuable asset in terms of liquidity and usefulness, is rarely seen as a positive investment even though derisory interest rates still result in an effortless hassle-free upward-only return every day. Savings on deposit, tax-free ISAs for example, tend to be dismissed as serious investments because pension providers cannot extract much in the way of costs from your pot. To deter you from the most obvious and transparent way of creating a pension fund for yourself, free of the restrictions imposed by tax legislation and political ideology, the pension fund providers invent carefully crafted alternative and costly products created by experts with probably no more clue than you about what the future has in store.
The main difference between how the big boys in the pension fund industry do it and the man-in-the-street is that the big boys invest in a combination of cash, equities, bonds and property mostly at wholesale prices, whereas the man-in the street invests in a combination of cash, equities, bonds and property mostly at retail prices. The difference between wholesale and retail may not be passed on to the pensioner so much as the promotion of the difference in performance between the risk in going it alone and how much better the experts could achieve based on how they did last year, even though past achievement might not have been that good, but there’s a plausible excuse. Unless you are into absolute returns, you’ll be into measuring percentage performance which can be very impressive long-term when the difference between wholesale and retail is overlooked.
Another factor that is often misunderstood is inflation. To keep pace with inflation requires index-linked investments of some sort, either literally or capable of matching changes in buying-power regardless. Inflation is something to work out for yourself based on your own life-style rather than on official figures. Constituents of the official indices might not be the same products and services that you buy or are likely to buy. Not many investments keep pace on their own: equities over the long-term have performed handsomely only with all dividends reinvested which implies you adding to the kitty every year; long-term depends upon selected start and end dates which may not equal your actual start and end dates; and companies have a habit of preferring to pay their directors and managers more rather than increasing dividends or worse reducing them for shareholders.
Property has a reputation as a long-term hedge against inflation but, as I’ve said elsewhere, you are buying a particular property, not the market as a whole. If you don’t have what it takes to pick winners on the stock market where trading activities are regulated then why do you imagine you’d do any better in an unregulated market of property where people with more money than sense are easy prey.
Life is designed to be simple, we complicate through the way we think, including letting the experts fool you into thinking it all very much depends.
The Rent Review Specialist