Pensions are the most tax efficient way of investing for your future
When you are younger the word pension might in itself be a turn off for you. And if you’re anything like me, you couldn’t imagine being in your 50s when you’re just starting your adult life in your 20s. Pensions at that age can feel irrelevant. It’s typically not something that most people think about until we’re in our 40s or older.
But the fact of the matter is that pensions provide us with the most tax efficient way for investing for our future no matter how old or young you are. And your pension will be where most of your income come from for your financial independence.
Now that the gold plated defined benefit pensions have all but disappeared in the private sector, the onus is on you to take control of investing for your future.
You may think this is bad news, but it’s not – it’s a positive because we now have more control over our future instead of when and how much we retire on being entirely under the control of our employer.
At the very least, you have the freedom to move around jobs instead of feeling that you are obliged to stay in the job you hate purely for the guaranteed pay out you’ll get eventually one day.
BUT and this is a big BUT, we have the control and freedom without the knowledge. We are not taught even the very basics about how money and pensions work in our education. I’ve been on a big learning journey myself including passing IFA qualifications, which is why I want to ensure others benefit from this knowledge without having to take the exams that I did.
I am convinced that everyone – including you reading this right now can build up the knowledge and confidence to feel in control of your money today and have the future you dream of.
Let’s dig into exactly how you’re highly likely if not certain to have your pension investment wrong.
How Defined Contribution Pension Funds Are Set Up
Pension platform providers know that most people – the vast majority in fact – have no clue about how to manage their pension investments.
This is true for people of all ages but particularly true for those of us who started our careers in the private sector on a defined benefit pension (DB) and were switched over to defined contribution (DC) later in life.
We have paid no attention whatsoever to how our pension platform provider is investing our DC fund.
Your employer will be using a pension platform provider such as
- Legal and General
- Standard Life
- Aviva
Each provider will have a different choice investment options available and these will vary by provider.
But unless you actively choose a specific investment option, the provider will place you in their default, which is the Lifestyle or sometimes called Lifecycle option
Lifestyling is an investment strategy that provides automatic switching of your pension savings into another fund, or funds which generally have a lower risk profile or aligns your pension savings more closely to your plans for using these, as you get closer to your planned retirement age.
What this means in practice is a gradual movement from higher risk equities – company stocks to bonds which typically have lower risk and lower volatility.
Why could lifestyling be wrong for you?
Because pension providers know that most people do not actively choose their investments and simply allow the platform provider to decide, the lifestyle option is their best guess on what is right for you.
But the trouble is that their best guess is based on the average investor. And most people like you are not the average investor. We all have completely different circumstances and plans for our future financial independence.
Lifestyling assumes that you want to reduce your risk when as you get closer to retirement. so the fund will automatically reduce the percentage of equities increase the percentage of bonds as you get closer to retirement
The reason for this is because lifestyling default assumes that when you are far away from retirement you are in your growth phase on your investing and that you want to maximise the growth of your fund as much as possible.
And it also assumes that as you get closer to retirement, you want to reduce the risk and decrease the volatility in your fund which in turn results in a lower growth over time. The rationale is that you are happy with lower growth during retirement because you also want to reduce the losses
Taking the lower risk drawdown lifecycle fund from my provider as an example, the protection against volatility starts a whopping 40 years out from your retirement date. Yes, this reduces volatility but think very carefully on why you would want to do this so far out from from retirement and as a result miss out on potential growth that you would get from a higher risk fund.
Why wouldn’t you reduce risk closer to retirement?
Perhaps the right thing for you is to gradually reduce the volatility of your investments and have a low risk portfolio when you are retired. That could be exactly right for you and you don’t want to have to think at all about how your pension is invested.
On the other hand, perhaps you can tolerate more risk and as a result greater long term growth during retirement.
Maybe you have other sources of income. Perhaps you have a property that you rent out and receive income from, or perhaps you have other investment funds such as stocks and shares ISAs
I could go on. I hope you get the point.
The point is that your personal circumstances and goals for your retirement are unique to you so make sure that you are aware of the funds that your provider or providers are investing your pension in make a conscious choice as to where they are invested.
Do it right now!