3 excellent reasons why it’s critical to review your pension

March 19, 2015

Finally. Your first pay slip from your new job. You tear open the edges, divert your eyes immediately to the bottom right, mentally note the amount, do a cartoon-style double take, then feel your rage increasing as you realise that you’ve been paid less than you were hoping for. What’s happened?! Who has stolen your hard earned cash?!

Well, as well as the government taking their share in the form of income tax and national insurance, the answer to that question is ‘You have’. Well, future you, anyway. Because hopefully, it means you’re now paying into your company pension.

For some people, that will be the extent of the action they take with regards to a pension. They’ll sit back, not really noticing that the money is going to some mystical future-pot, and get on with their lives. Annual statements will be immediately sent to the recycling. Any box ticking requirements will be dealt with by ‘ticking the middle one’, and the amount of money actually amassing in the pension pot will remain a mystery until pension time. If they’re lucky, bingo! But if they’re not…well, there could be a serious problem.

If that sounds like you, then stop right now. We need to talk.

Imagine you’re buying a car. You go into the showroom, see a blue car and buy it. Hey! You own a car! Awesome! But there’s no way you’d buy a car like that, is there? You’d establish what you need out of a car, do your research, then go about finding the best deal possible.

How much will the insurance cost? Will it carry the kids in the back comfortably? Is there enough room for the buggy or golf clubs in the boot? How much will the servicing cost? How many miles per gallon are you going to get? Which showroom has the best offers?

Well, the same applies to your pension. And if you’ve just been letting your pension do its thing while you have no idea what it’s doing, why, and how much it’s costing you, then it’s time for a review.

Here are three good reasons why you should look through your pension paperwork to see what’s going on.

Minimise the fees to maximise your pot

A pension is an investment. Investing costs money. But ‘how much money?’ is the key question. The critical point here is that you need to know what you’re paying in fees. Just like the price of the same beer will differ depending on where you buy it (the supermarket versus the pub versus the sports arena), the price of pension funds differ depending on a variety of factors. And while you might think that the difference between 1% and 3% isn’t that much, over the lifetime of your pension it really adds up.

Let’s say you invest £100,000 in the stock market when you’re 30 (ambitious, but stick with us), with the idea in mind that you’re going to retire at 60. Now, imagine that your £100,000 pot grows at a decent 5%, and that you’re being charged 3%. When you come to retire at 60, you have £180,000 in your pot. Not bad, considering you haven’t added another penny to that pot for 30 years – compound interest has taken its course!

But wait. Because if your money had grown at 5% and you were only charged 2% in fees, you would have ended up with a £240,000 pension pot. Ouch. That 1% cost you £60,000!

And if your money had grown at 5% and been subject to just 1% fees, then you would have retired on £322,000 – not far off double what you got when your fees were at 3%.

See what we mean? Fees matter. Big time.

The good news for your workplace pension is that a new fee cap is about to come into play. After an independent enquiry found that some pension schemes were charging way over the odds, the City regulator has capped fees for managing workplace pension pots at 0.75% from April 2015.

But, that still means you’ve got work to do on any other pension that you might have. Find out how much you’re really paying, and if it’s too much, it’s time for a more serious review.

Take advantage of free money

While fees are clearly one of the biggest risks to the growth potential of your pension pot, you may also be missing out on more money going into it in the first place.

There are a few ways that this can happen. Firstly, via tax relief. If you pay into a pension yourself, or if your employer takes it from your monthly pay packet, you automatically get 20% tax back from the Government. So, if you put £80 into a pension, £100 actually goes in.

If you’re a higher rate tax payer, you can claim an additional 20%, and if you’re a top-rate taxpayer that goes up to and extra 25%. So a higher rate tax payer would only need to put £60 in to receive £100.

However, if you don’t reclaim this tax, it won’t be paid! So, it’s a good idea to check to see what tax bracket you’re in, and whether or not you are missing out on the tax relief boost. If you are, it’s time to claim. And fast! The GOV.UK website is a good place to start if you think this might apply to you.

Another way to boost your workplace pension is through a company match. For example, your company might automatically put a percentage of your salary into a company pension pot for you via a salary sacrifice scheme. Pretty cool, as it’s free money. But, if you do a bit of research at work, you may find that if you add another few per cent, they will match it. For example, if your company puts in 10%, and then matches a further 2% that you put in, you may be able to put 14% of your salary into a pension for the price of 2% of your salary. Every employer is different, but it’s worth a quick chat with your HR department.

Adjust your risk profile

Many pensions were, and still are, based on ‘lifestyle’ funds. Essentially, this means that with 40 years until retirement, your fund would be invested in more aggressive, risky funds, which would hopefully deliver higher returns. Then, as you got closer to retirement, your fund would automatically start to sell its riskier components and buy ‘safer’ funds, with less exposure to the ups and downs of the stock market. If you’re currently invested in a lifestyle fund, it’s not necessarily a bad thing – the switch to safety will be taken care of, and you’ll have less to worry about.

It’s worth remembering though that if you retire earlier than the original retirement date under the plan, you may have too much exposure to markets and your value could dip before taking benefits. Conversely if you plan to retire later, you may miss out on growth by phasing into cash and bonds too early. Another reason to review your plan.

Now that the income drawdown rules have changed, perhaps you don’t need your pension pot just yet, and would like it to continue to grow at a steady rate. In which case, having all of your money in cash and bonds won’t do it for you. You might need to be a little more aggressive. Or, perhaps you’re thinking of using some of your money to buy an annuity, and you’d like to invest the rest so it will grow. Again, you need to think carefully about the funds that your money is invested in, because they might not match your appetite for risk.

Or perhaps you have the opposite problem? You’re reaching retirement age and are far more exposed to the stock market than you thought you were. You’d much prefer to have a really cautious, safe portfolio – you’ve built up your pot of money, now you want to protect it.

No matter the scenario, unless you know what your pension is currently invested in, you won’t be able to make an assessment about whether or not it fits your risk appetite, goals, and current situation.

Time for a pension review?

If you’ve never paid attention to your pension before, now’s the time. Check the fees. Look for opportunities to add more money where possible, and take a moment to think about what you want out of your pension so you can adjust how you invest. A simple review will put you ahead of most people who aren’t aware of what they’re saving or why, and as we’ve shown, a little attention could mean a much bigger pension pot when you decide to put your feet up.

You may even be able to buy a nice blue car…

 

This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.

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