Is it worth having a pension?

Question

I know this could be a duplicate of other questions here, but I think I have a different take on it which may be of interest to others in a similar frame of mind.

Some background

I'm self-employed and based in the UK, and every time I've looked at a pension I've balked at the idea of handing over a large sum of cash every month to a pension company. It seems that all they do is take their fee and invest the remainder into the stock market which is a fairly volatile investment vehicle. The UK government provides an additional contribution to boost my investment so my pension pot grows much more quickly than any other investment. But all this comes at a price...

At retirement I cash out and have to purchase an annuity. The price of this annuity is driven by market conditions and my health at the time. I may not necessarily get a good deal and a fair chunk of my investment will be lost. On the upside, I do get a regular income for life (or some determined length of time).

But this is the kicker for me: when I pop my clogs all that money I saved goes to the annuity company and is lost to my family as any kind of inheritance.

The question

So, would a better approach be to invest in a low-fee index tracker and wrap the whole lot up in a trust to provide protection against both tax and excessive spending by the beneficiaries? I should point out that I'm currently overpaying on my mortgage and that my house is the most significant asset I have.

Answer 1

Paying someone to look after your money always costs something - it doesn't matter whether you're inside a pension or not. Fees are highest for "actively managed" funds and lowest for passively managed funds or things where you choose the investments directly - but in the latter case you might pay out a lot in dealing fees. Typically pensions will have some small additional costs on top of that, but those are hugely outweighed by the tax advantages - payments into a pension are made from gross salary (subject to an annual limit), and growth inside the pension is tax free. You do pay income tax when you take the money out though - but by then your marginal tax rate may well have dropped.

If you want to control your own investments within a pension you can do this, subject to choosing the right provider - you don't have to be invested in the stockmarket at all (my own pension isn't at the moment). I wrote an answer to another question a while ago which briefly summarises the options

As far as an annuity goes, it's not as simple as the company taking the money you saved when you die. The point of an annuity is that you can't predict when you'll die. Simplifying massively, suppose the average life expectancy when you retire is 20 years and you have 100K saved, and ignore inflation and interest for now. Then on average you should have 5K/year available - but since you don't know when you'll die if you just spend your money at that rate you might run out after 20 years but still be alive needing money. Annuities provide a way of pooling that risk - in exchange for losing what's left if you die "early", you keep getting paid beyond what you put in if you die "late".

Your suggestion of taking the dividends from an index tracker fund - or indeed the income from any other investment - is fine, but the income will be substantially less than an annuity bought with the same money because you won't be using up any capital, whereas an annuity implicitly does that. Depending on the type of investment, it might also be substantially more risky.

Overall, you only need to secure the income you actually need/want to live on. Beyond that level, keeping your money outside the pension system makes some sense, though this might change with the new rules referred to in other answers that mean you don't have to buy an annuity if you have enough guaranteed income anyway. In any case, I strongly suggest you focus first on ensuring you have enough to live on in retirement before you worry about leaving an inheritance.

As far as setting up a trust goes, you might be able to do that, but it would be quite expensive and the government tends to view trusts as tax avoidance schemes so you may well fall foul of future changes in the rules.

Answer 2

It all depends on whether you can manage your money or not. Many people are incapable of doing so in a responsible way. Like any service, you get what you pay for -- active management costs money!

Answer 3

On the face of it, it doesn't look like a very good deal - neither pension not annuity company are in it for the fun of it, so they'll take their cut from your money, and then invest it anyway. The rest depends on what they promise you - if they just promise you market returns then I don't see much sense to do it, you can do it yourself. If they promise you some pre-defined average return not depending on market conditions (and hope to get ahead by actually getting better return and pocket the difference) then it might make sense, if you are not a very proficient investor. This will get you a known benefit you can count on (at least if you get a company with good rating/insurance/etc.) without worrying about markets volatility and having to keep the discipline and calm when markets jump around. It may be hard, especially for somebody of advanced age. Also, there's the part of government adding money - it depends on how much of it is added, is it enough to cover the extra fees?