Alternatives to Pensions
If you’re thinking about protecting your finances in retirement, the idea of paying into a private or employment pension might seem like the obvious choice. However, a pension doesn’t always represent the best option for everyone. So, if a pension’s not right for you, what are the other options?
Here, we’ll cover some pros and cons of pensions – and explore which alternatives might work for you.
Pensions – an overview
Both private and employee pensions have, for a long time, been the go-to financial choices for people looking toward old age. They’re both products that you can use to save money for retirement. The money you receive at the end depends on how much you’ve paid in – and how the pension company’s investments have performed.
As with most other financial products, there are pros and cons involved with pensions.
Pros of pensions
When you have a workplace pension, your employer will, up to a certain level, match your contributions. In effect, this doubles the amount of money you’re investing, often significantly boosting your final pension value.
When you reach pension age, you’ve got some options around how you use your pension ‘pot’. You could choose to take it as one lump sum, taking out amounts as required – or even use the funds to buy an ‘annuity’ – a product which will give you a guaranteed income for the rest of your retired life.
Pension providers invest and reinvest your funds over the course of your working life – so, rather than simply watching a small amount of interest add up, they’ll continually be investing, then reinvesting an increasingly large amount of money – often significantly adding to the final value.
You’ll usually benefit from tax relief if you pay into a pension – with a workplace pension, your contribution is taken off your gross (pre-tax) earnings, effectively reducing the amount of taxable income you make. With a private pension, you can often claim tax back, since the amount you pay is from your net (after-tax) earnings.
Cons of pensions
While repeated investments with your pension fund can lead to increasingly large returns, investments are never a sure-thing, so, there’s a chance your pension could decrease in value. The chance of this happening is low, as investments are carefully considered, but you could lose money in the short term.
If you choose to opt for a guaranteed income from your pension fund, you’ll need to buy an annuity – and the cost will usually take up all of your pension pot. This cost reflects the fact that you might live longer than your fund allows for, especially if you include a loved one on your policy.
Your pension pot remains inaccessible until you’re at least 55 – which means a pension is effectively savings – but savings that can’t be touched; even in a financial emergency.
Inflation vs. return
Your pension will return a large sum of money – but that large sum might not be worth as much in the future as it is today. If inflation drives the value of your money down, you might not be looking at as much comfort as you expected in older age.
Why are people considering alternatives?
Part of the reason people are considering alternatives to private pensions relates to changes in State Pensions. In 2019, State Pension age will begin to increase for men and women. By October 2020, you will have to be 66 to start claiming your State Pension – and this increase in age is likely to be reflected in private pensions too.
Currently, you can access your private pension at 55 – but this relies on the ‘pension freedoms age’ – a government agreed figure that sets out the age at which you can access pension funds. There’s some uncertainty around whether or not this age will increase in the future – and uncertainty around finances is always likely to drive people toward considering options that they feel more in control of.
So, what are some of those options?
Although it’s not a very large amount of money, a State Pension will provide you with a modest income after retirement. It’s vital that you pay into the State Pension pot through your national insurance contributions, so you should make sure this is the case, even if you’ve had periods of unemployment or living overseas during your earlier years.
Some people choose to buy property rather than paying into a pension of saving money for retirement. How people choose to invest in property varies; some people choose to buy larger houses while they’re working, before ‘downsizing’ in older age, freeing up equity.
For other people, buying rental properties which you can either sell – or continue to rent out mortgage free – in later life is a more attractive option. While there’s some effort required to continue managing a property portfolio, it’s often significantly less than would be needed in post-retirement employment.
Of course, it’s hard to predict property and rental markets into the future, so property isn’t a guaranteed income, but people will always need somewhere to live, even if pension investments aren’t performing.
In some ways, an ISA comes with some of the perks you’d expect from a pension – especially around tax relief. You can save up to £20,000 each year in an ISA – and it’s tax free. This tax-relief allows for a substantial amount of money to be saved before retirement.
Although access to an ISA isn’t quite as simple as drawing from a savings account – it’s much more accessible than a pension pot, so, if you ever ran into financial issues pre-retirement, you’ve got your savings to fall back on.
The accessibility of an ISA could mean that it’s tempting to access the funds for non-essentials before retirement, but, if you keep the money in your ISA, you benefit from a range of investment options, giving you some options around projected future returns.
While an ISA won’t pay out money in the way a pension annuity might, you could access the money post-retirement as needed, and, unlike an annuity; after death, any remaining funds become part of your estate.
Continuing in work
In many cases, retiring from work altogether just isn’t an option. In these cases, people often choose to continue working, although perhaps opt for a job that represents less pressure, or reduced hours – especially if your income is supplemented by State Pension payments.