It emerged this week that only 45% of pensioners will be entitled to the full, new, flat-rate state pension during the first five years of the system. The new system means that a single, flat-rate payment of 150 per week will be made from April next year and, with the number of people paying into a company pension scheme hitting a 60 year low of just 35%, the future for retirees seems rather bleak.
Of course, many people believe that the house price growth of recent years will enable them to sell up and downsize when they retire. However, this may not be the case, since house price growth is likely to moderate somewhat over the medium to long term (due to a combination of rising interest rates and a lack of affordability), while downsizing also does not offer the same benefits as a pension does.
As such, contributing to a pension seems to make sense because it offers diversification benefits, tax advantages and is relatively straightforward to organise and manage.
Defined Contribution Schemes
For most people, a defined benefit pension scheme is no longer available, so a defined contribution scheme is the next best thing. This involves the individual making regular payments into a scheme and can take various forms. The simplest is a company scheme thatis offered by your employer, but a Self Invested Personal Pension (SIPP) is also available, which gives you more control over the types of investment held and how it is managed. For example, while a company pension plan may offer you the choice of a handful of funds to invest in, with a SIPP you can invest in shares, commercial property, various other assets, and can even leverage your portfolio, too.
The main benefit of a defined contribution pension is that all the amounts paid into it are tax free. This means that for every 80p you invest, the government will also invest 20p and, in the long run, this tax advantage can have a major impact upon your level of returns. As such, defined contribution pensions are generally more efficient than simply investing your own after-tax money in the stock market.
Another option available is an Individual Savings Account (ISA). They are different than SIPPs because the capital you invest in them is not tax-free and therefore is unlikely to grow as quickly as it would in a SIPP. However, withdrawals from ISAs are tax free whereas from SIPPs they are not, and you can withdraw as much or as little cash from ISAs whenever you like, which offers more flexibility than for SIPPs where there are restrictions on when and how much can be withdrawn. As such, ISAs are becoming more popular especially since the limit on how much you can invest in them was raised to 15,000 during the current parliament.
Although investing in a pension may not seem hugely exciting to most people, one way that could make it more interesting is by thinking of it as a business. In other words, your pension is essentially a holding company that invests in other businesses and, in doing so, makes a return that allows you to stop working at an earlier age and enjoy a richer retirement.
Clearly, the earlier you start, the longer you will have to reach the amount you need to live comfortably in older age. However, even for those people who havent yet started to think about retirement, its never too late and, with everything being available online these days, kick-starting your pension has never been easier.
Of course, once you have a pension in place, finding the best shares to buy is your next priority. And, to that end, the analysts at The Motley Fool have chosen 5 Shares That You Can Retire On.
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