Here’s a question for you:
Who is responsible for your pension?
Now, if you answered “errr, don’t know” or “my financial adviser” or “I think its an insurance company”, then that’s pretty normal. But its the wrong answer.
The correct answer is that YOU are responsible for your pension!
I’ve noticed that even people who think of themselves as savvy savers and obsess about their other investments somehow neglect their workplace pension.
Like a puppy, a pension is for life. Its not something you ignore after they send you the paperwork in the first week of your new job. Neglect is abuse. And that’s bad. 😦
Who else is gonna look after your puppy for you? You may be thinking that your employer has an obligation to look after your best interests and steer you in the right direction pension wise. Wrong.
You may be thinking that the government will make this all happen for you. Wrong.
You may be thinking that your financial adviser has your back on this. Wrong, wrong, wrong.
This is on you. Your workplace pension should eventually be one of your biggest assets. It could easily end up worth more than your house. Do you know where your house is and what goes on in there?
Errrr….hopefully you do. So why not your workplace pension?
You need to know what’s going on in your pension. So its time for you to turn detective and figure this stuff out…
1: Get the facts
You need to get the facts.
This means either getting the paperwork or getting access to your pension platform online. For example, do you have the factsheet for the fund(s) your pension is currently being invested in?
If you haven’t got this, get it. If in doubt, ask your HR manager how / where you can get this information.
Don’t be fobbed off. Does Sherlock Holmes stop solving mysteries just because the HR Manager is out of office on another diversity awareness course?
No, he does not.
2: What’s the deal?
OK, now read the basic information. Do you understand it? What are the key elements of the deal? Could you explain it to a 10 year old child?
Most pensions now are defined contribution schemes. In other words, you (should) know what goes in and gets invested, you just don’t know how much it will be worth in the end.
If you’re in a defined benefit scheme (where you know you’ll get a pension of £X per year), you can skip down to section 7. For everyone else, here’s what you need to know:
- how much is your employer contributing?
- how much are you contributing?
- what fund(s) are you investing in?
- what fees are you paying?
Look for any element of match funding (i.e. the employer matches your contributions) as its crazy not to get the maximum contribution from them that you can. Do you just walk past free money lying on the pavement?
(hint: the correct answer here is no)
Not putting enough in to get the full employer match funding is like walking past £50 notes lying on the floor without bothering to pick them up.
And then there are the tax benefits. Pensions are the most tax-efficient investment vehicles there are. They’re even more tax efficient than an ISA. Generally, there are no guarantees and no free lunches in life…but pensions do give you free money.
If you’re a 40% taxpayer, everytime you put in £6,000 the government tops this up to £10,000. That’s £4,000 of free money right there. Where else can you get a return of 67% per year guaranteed by HM Government?
This £4,000 of free money comes in 2 parts:
i) your platform / administrator claims cash for your pension scheme from the government (no paperwork required from you) and
ii) a reduction in your tax bill at the end of the year (for which you need to complete a tax return).
You should be saving something into a pension. Even if you intend to retire at 40 and don’t like that you can’t get your hands on the money until you’re 57. Even if you’re worried the government might move the goalposts. So yes, you are allowed to pay down debt and / or fill your ISA first…but after that, if you can save more, you should be saving something into a pension.
3: Choose an asset allocation
If you ignore that form from HR, your hard earned money will get chucked into a default option. They’ll probably put you into a “balanced” fund that contains lots of expensive bonds that yield next to nothing because that’s the “safe” option.
Safe for them, perhaps. After all, its not their money. Safe for long term investors saving for retirement? Not so much.
Let’s be optimistic. No, really, you should be….everything is fucking marvellous and you’re probably going to live to 85+. So you’ll be investing for long term returns and ignoring short term volatility. If you’ve been following this FI stuff for a while, you’ll know you wanna be either 100% or mainly in shares.
At this point someone usually pipes up about something about having your age in bonds etc etc. I prefer Jim Collins rule of thumb about asset allocation: people working towards financial independence have 100% of their portfolio in shares (plus an emergency fund of cash). Later, once you’ve quit working, you include a 25% bond / cash allocation to act as a portfolio stabiliser.
Shares (or equities) are slices of ownership in companies. And, thanks to the magic of capitalism, every year companies get better at making products, services and profits. This is why shares have historically delivered the best returns.
But what if something disastrous happens to the UK economy? Well, that’s why you need broad geographical diversification.
4: Choose a fund
You probably have a range of funds to choose from. One key choice is active versus passively managed index funds. Active means expensive. Passive index trackers consistently outperform active funds after the impact of fees. Most active fund management reminds me of the parable of The Emperors New Clothes.
Why not keep things simple with a single low cost global equity index tracker? Something like the Vanguard All World ETF (VWRL). Vanguard is the only large fund management group that is owned by, and run for, the customers. That means low fees. VWRL costs 0.25% per year. Why pay more?
If Vanguard are not available on your pension “menu”, then you can look for a similar low cost, global equities index tracker. Or maybe you can transfer out (see below).
5: How much to contribute?
Some schemes set the contributions (e.g. employer 10% of salary, employee 5% of salary).
If you have more flexibility to vary your contributions then you can contribute an amount up to the lower of £40,000 or your earnings each year…in general you should invest as much as you can, subject to the constraint that it will then be locked up until 57 (55 if you’re 47+). For money that you need to access before then, you can invest £20,000 per year tax free into a shares ISA.
The beauty of monthly contributions to a pension from salary is £ / $ / € cost averaging, meaning that your investment is “dripped in” over time and over different market conditions.
6: Consider a SIPP
Will your employer pay their contributions into a self invested pension plan (SIPP)? These can be significantly cheaper (in terms of lower fees) and provide better choices versus a corporate scheme.
However if your employer won’t pay its contributions into a SIPP (and will only pay into the corporate scheme) then you should stay in the corporate scheme. Never leave free money on the table.
Having a SIPP in addition to a corporate scheme is also an option. You can then use the SIPP for squirrelling away any annual bonuses etc.
You can use this handy Monevator table to help you choose a SIPP provider.
7. Advanced options
When I was working, I was able to move my pension pot from my employer’s scheme to a SIPP which allowed me to halve the fees I was paying.
Even if you need to stay in your workplace scheme to keep getting employer contributions, its worth checking whether you can make partial transfers out to a SIPP, thereby gaining control and cutting fees on the bulk of your portfolio. You can see a helpful post on this from RIT here.
A SIPP also allows you to consolidate pension pots from prior jobs. This is often a smart move because 1) the fees on those schemes may be ridiculously high 2) you regain control over investment choices and 3) having everything in one place reduces admin and simplifies planning.
One of the things that really helped me gain comfort that I knew what was going on with my pensions, was to consolidate them all in a single SIPP where I could see what I was invested in and what I was being charged in fees.
Its easy to transfer defined contribution schemes into a SIPP. You just instruct your SIPP provider and they handle all the paperwork and do the chasing. If your old provider messes you around and drags their feet, you can call in an airstrike via a complaint to the Financial Ombudsman.
Those of you with private sector (not government employer) defined benefit schemes need to know that its possible to transfer out. You could cash in and transfer to a SIPP and manage your money yourself. Get a transfer value (free) from your pension administrator that will tell you how big the cash amount would be. It’s not for everyone (you’re bearing more risk). But this worked well for me. You can read a helpful post about this here.
Are you joking? The difference between a shitty, high cost pension and one that’s low cost and invested right is enormous. Fees can add up to huge amounts of money over time. And when it comes to fund management and platform fees, you get what you don’t pay for.
Investing an hour or two getting this shit sorted out is one of the best investments of time you’ll ever make.
Don’t neglect your pension.
Please note that this is provided for information and is not regulated investment advice. You are free to leave comments but for regulatory and practical reasons I can’t answer questions on what you should do…The Escape Artist has boundaries 🙂