Investing For Your Retirement
Pension scheme contributions
With current tax relief, for those on a marginal tax rate of 22%, a contribution of £ 100 only costs £ 78 (and for those on 40% only £ 60) and then earns income and capital gains free of tax (except that tax deducted from dividends can no longer be recovered). So pensions are a very tax efficient investment.
When a pension is drawn, it is taxed as income but in most cases some 25% of the pension fund can be withdrawn as a tax free lump sum.
Contributions to the state pension schemes and occupational schemes are made from income. Personal and stakeholder pension contributions are also usually in the form of regular monthly payments but need not be.
For self employed people with irregular income, contributions in the form of a lump sum once a year, when you know how much is available, might be more appropriate. Furthermore, charges tend to be lower when contributions are made that way.
Individual pension accounts
With all forms of pension scheme apart from occupational final salary schemes, including stakeholder pensions for which they are specifically designed, contributions can be paid into an individual pension account (IPA), which is a wrapper like an ISA.
The money can be invested in gilts, unit trust and shares in pooled investment funds and the advantage is that you have control over how the money is invested and can value your scheme at any time by looking up the value of the investments.
If IPA holders change jobs and wish to join their new employer's scheme, they can either transfer the IPA into the new scheme or leave it where it is, stopping contributions to it as appropriate.
AVCs
These additional voluntary contributions on top of an occupational scheme can also be made in the form of a lump sum and at present it is possible to go back to earlier years if there is space within the Inland Revenue limits on contributions.
There is some debate about whether AVCs are better value than ISAs. With AVCs the contribution is tax free but the benefit is taxable, whereas ISAs are the other way around.
In both cases money in the scheme is free of tax on income and capital gains but ISAs have the advantage that tax deducted from dividends can be recovered until 2004. Charges may be higher for pension schemes than for 1SAs.
Most experts favor AVCs because the tax gain comes at the beginning and so funds accumulate tax free at a higher level. The main advantage of ISAs is complete freedom of action you can get your hands on the money at any time. However, some people prefer the discipline of not being able to access the funds before retirement.
Cash lump sum on retirement
Most pension schemes include an option to take a cash lump sum on retirement. It is a pleasant decision to make, but it may not be easy. Remember you can choose to take as much as you like up to the scheme limit, but you lose pension in proportion.
If a pension is fully inflated proofed, then it might be better to keep it intact. If not, then it might be possible to buy an annuity with the cash, which pays more after tax than the pension foregone, depending on annuity rates at the time.
You do not have to buy an annuity; you may choose to invest the money differently. You may in any case want to use some cash to pay off some at least of your mortgage.
But think carefully before using it for a holiday or a new car!
Pension annuities
With money purchase occupational schemes, personal pensions and the new holderholder pensions, the fund at retirement must be utilized to buy an annuity (this can be deferred in some cases beyond retirement). This is called a compulsory purchase annuity, and all the receipts are taxable.