In the past decade, pensions have evolved at a fast pace in terms of the rules that apply to them and the plans that are available in the market place.
Many of the issues that have plagued the reputation of pensions have now been resolved but, as these issues are not so well publicised, many myths have developed and continue to be used as a reason to not invest in a pension.
1. Your pension is lost when you die
This is true of most annuities (which many choose to purchase with their pension funds at retirement) and final salary schemes (e.g. the public sector schemes) – particularly when there is no surviving spouse to receive a continuing income.
In practice, however, it is not necessary to purchase an annuity and fewer workers are now being enrolled in final salary schemes. Indeed, pension funds actually represent one of the most efficient methods of passing funds to the next generation as they can, in certain circumstances, be passed on without any tax deduction (including Inheritance Tax). This is particularly impressive given that tax relief can be obtained on the contributions in the first instance.
2. Pension plans have high charges
It is the case that there are many pension plans with fairly high charges, which will reduce the investment returns.
It is, therefore, very important to assess the charges but it is wrong to assume that all plans have high charges. Indeed, over the last twelve months alone, the typical charges on pension plans have been reduced significantly and it is now often the case that it costs no more to invest in a pension plan than it does to invest using any other sort of arrangement (e.g. a Stocks & Shares ISA). It is also quite feasible to transfer existing pension funds to a cheaper arrangement in many instances.
3. You need to live to a very old age to get your money back
If you buy an annuity with your pension fund now, you will typically obtain half as much income from it as could have been obtained in the early 1990s. Although life expectancy may have increased since then, this still represents a huge fall and many now believe that annuities provide poor value for money.
The fact is, however, that you do not need to buy an annuity with your pension pot and this has been the case for several years now.
A pension plan is effectively a tax-efficient vehicle for investing for your later years and to say that you will not get your money back from a pension is like saying that there is no point investing for your retirement. In short, criticise annuities if you wish – but do not paint pension plans with the same brush.
4. They keep changing the rules so you never know what you will get back
It is true that pension rules have been changed a lot in recent years and they will probably continue changing in the future. This is, therefore, a risk that needs to be balanced against the tax reliefs available.
It should, however, be noted that most of the changes have been carefully designed to ensure that there is no retrospective effect. So, whilst changes may prevent some individuals from putting more money into a pension, they have had little effect on their accrued pension funds in most circumstances.
In addition, most of the changes affect only those with large pension pots or with high earnings.
5. Your money is tied up with a pension
There is plenty of truth in this, as the Government wants us to hold on to our pension funds for our later years, rather than spending it all when we are young.
But pensions are more flexible than many expect, with the ability to draw ad-hoc sums from 55 onwards (regardless of whether you continue working).
The changes expected to take effect from April 2015 will enable individuals to cash in their entire pension pot, if so desired.
6. Pension plans have poor levels of investment growth
Most pension plans are invested in stock market funds and, as stock market investors have experienced volatile times in recent years, these trends have been used to describe pension plans in general.
Such volatility would have been experienced in, say, a Stocks & Shares ISA as well and so some distinction should be made between a pension plan as a vehicle for investing and the investments used within that vehicle.
7. If your pension provider goes bust, you will lose everything
Between the Maxwell scandal and the fall of Equitable Life, many continue to have a lack of trust in the security of pension funds.
Since these events, there has been significant change and development in the UK regulatory system, including strict capital requirements for regulated firms and increases to the UK Financial Services Compensation Scheme. It is, therefore, the case that pension investors have more protection now than they did back then.
Richard Johnston is a Chartered Financial Planner at Murray Asset Management