Where should i look to use my pension contributions?
Q: The company I work for is ending its defined benefit pension scheme.
I've been in the scheme since 1983 and have accrued 27/40th of my full salary. This pension will be maintained separately from a new defined contribution pension that the company is now offering in its place. I also make extra contributions through an additional voluntary contribution scheme.
I am 55 years old and want to know if, at my age, I should put all my future pension contributions into cash funds for security? Alternatively, should I invest some in equity and property and maybe only half in cash, on the proviso that when I turn 60 I will transfer all of the pension into cash?
A: Philip Pearson is a partner at P&P Invest in Southampton.
A defined benefits pension scheme is theoretically guaranteed. If the scheme has received adequate funding over the years, then this pension is available to you, without investment risk, from the scheme's retirement age.
You can therefore afford to take some degree of risk with the new pension, as the benefits from this are likely to be only modest, given the limited period in which you'll be investing.
Watch Moneywise TV: Get more money from your pension
You need to decide when you wish to retire, as this will determine the most appropriate strategy to maximise the investment over the remaining period.
Although a cash fund would be low-risk in the short term, the returns are poor and insufficient to combat the effects of inflation, which is currently around 4.5% as measured by the retail prices index.
Some equity exposure should be considered if your investment term is between five and 10 years, because the chances of losing money from investing in the stockmarket are dramatically reduced as your investment will have time to recoup any potential losses.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
Defined benefit pension
Often referred to as a “final salary” pension, benefits paid in retirement are known in advance and are “defined” when the employee joins the scheme. Benefits are based on the employee’s salary history and length of service rather than on investment returns. The risk is with the employer because, as long as the employee contributes a fixed percentage of salary every month, all costs of meeting the defined benefits are the responsibility of the employer. (See also Final Salary).