I recently read a brilliantly crafted blog complaining bitterly about pension charges and how these charges had eaten up any growth in the plan. When I started reading this I assumed we were talking about an old style plan but to my dismay this was a plan started in 2009.
As I read this article, it made me realise that actually the problem was not necessarily in the charges but in the decision that the person had made in making the investment. For me this highlighted the dangers of going direct.
Painting a picture
We have a couple in their fifties who, in 2009, after taking early retirement decided to save money in a personal pension (they already had some pension benefits which I assume were funding their early retirement).
The reason they decided to invest in a personal pension was due to to the 20% tax relief. The argument seems to make sense; £2,880 is grossed up to £3,600 (so £720 put in the pension for free).
The aim was to save in the pension for three years and then access the money I assume as an annuity (income) and receive the 25% tax free cash. Their investment strategy was to invest in a low cost cash fund.
Returns on cash funds over the last few years have been poor and actually as this couple discovered the charges were higher than the returns……..
The argument of the blog is that the fault lies in the pension system and there should be some sort of free pension system. There is also an argument that if the money had been put in a cash ISA they would have got more money.
Reading this blog, although I have sympathy for this couple, I think it highlights the dangers of going direct.
Firstly this is all about what is the financial plan. The assumption here is that two years contributions into a pension will provide them with a pension in three years’ time. However, my first starting point would be this – what income do you want in three years’ time? Once you know what income you want then how will you achieve that?
A pension may be a route – interestingly one point the blogger doesn’t make is that actually even with the charges they received £1,440 in free money which they wouldn’t have got from the ISA. Effectively this is a massive amount of ”interest” - if this is what they want to call it.
The pension gives a 20% uplift but on the downside the income will be taxed (assuming they are a tax payer) and in reality a pension fund of £8,000 is going to provide a tiny pension income after tax. Even with the uplift was it right to invest in a pension or were they always going to be disappointed with the outcome because there was no financial plan in place.
Secondly my concern is about understanding how you are investing. So the assumption is that possible because of their age and their time to retirement the only option is to select a cash fund. A cash fund is not the same as ISA cash account. Often they invest in the markets so the returns will be less than a standard cash account. Understanding your investment is crucial, I have recently done research around low cost investments like bonds and cash and to be honest it frightens me more than equities.
Also it also highlights the dangers of past performance; cash prior to 2009 was probably producing good returns. Post 2009 well…….
So here we have someone who appears to have no real financial plan, has made a decision based on the tax relief (which might be right) and then chooses a fund which at best will provide minimal returns.
So they then complain about the pension when compared to the ISA, the two are not the same. To start with – with the ISA they would have had £5,760 invested. With the pension, after tax relief, £7,200 was invested; an uplift of £1,440. To get that from the ISA over 3 years would have had to have seen amazing interest rates………
The other thing to consider is that with the ISA although there is no tax relief any income is tax free. Interestingly in the article the person talks about a 3.2% instant access account for her cash. Again I am not challenging this but these accounts are incredible hard to find and normally come with restrictive conditions.
I have seen too many people have a go at charges on pensions and my conclusion is that too many people are stepping into the unknown. Ultimately you must have a plan, you must know what you want and ultimately you must know what vehicle is best to deliver on that plan and how you invest to achieve that.
The blog I read highlights the danger of DIY investments, saving money is great but get it wrong and it will cost you significantly more in the long run.