I've been thinking about pensions provision recently, seeing as I now have enough income to make it worth considering. A few thoughts occurred to me, though, about how to approach the subject.
- Obviously, government rules and market conditions covering the various financial instruments discussed below are highly mutable. Since, as I say, any financial instrument is subject to these risks, I discount them entirely. No use worrying about pensions tax perks being removed when, for instance, the tax-exemption on ISAs could also be revoked. We have to assume that rules and conditions will stay roughly constant.
- Pensions provision is achieved through stakeholder pensions, which are managed by providers. These providers are allowed to charge me for the service they provide, but these charges are capped at 1.5% for the first ten years, and 1% thereafter. The best deal I found on the market (after an admittedly short search) was 0.7% for starting a pension.
- Charges erode the value of investments. Therefore, all else being equal, lower charges are to be preferred. This is a key point, and worth reflecting on. There are sound arguments advanced in favour of the position that actively managed funds are not, nor can they be, worth the management charge paid for them, in comparison with trackers and other mechanical funds.
- Therefore, on performance grounds, a pensions fund is a worse buy than a tracker fund held outside, since the present market for trackers has minimum total expense ratios of the order of 0.3% to 0.5%. But it gets better!
- The tax perks on pensions are well-known; Her Majesty's Robbers and Crooks will give you 28% of your invested funds, on the grounds that they'll steal it back eventually, when you use the pension fund to buy your annuity. That's true whether you're a tax-payer or no.
- Therefore, you might think "you get 28% back, which you can make work for you; what a deal!" That's what Her Majesty's Thieves want you to think, but think about it this way. Assume for the minute that you can achieve the same returns inside a pension as out. What does it matter which order you do things in? It's as broad as it is long whether you get your 28% at the beginning or at the end, because your return is a rate of return. So if I double my investment and then get 28% relief, that's as good as getting an initial 28% relief on my investment, which then doubles.
- Since I've already argued that funds inside a pension can be expected to do worse, you're better off keeping your funds outside a pension until the latest possible time. That means having a plan for getting all that capital into the pension scheme before you retire, so that you can take advantage of the tax relief. That's quite important, because the tax relief is not negligible, especially if your annual income from the pension pot worked out as attracting a rate of taxation considerably below 22%.
- If your employer makes matching contributions, however, then that is worth real money to you. You should think very carefully about refusing what amounts to free money; under those circumstances, I would be inclined to put up to my limit in the scheme, claiming the full matching contribution. The sums would need to be done quite carefully, but I would be inclined to think that getting an extra pound for every pound invested outweighed the management charge differential. Consequently, you should claw every penny you can from your luckless employer, and then if you want to make further investment, do so outside your pension scheme.
- Annuities are probably iniquitous. The rules are presently in flux, but Her Majesty's Goons may yet demand religious principles against annuities in order to permit me not to have one. I think I can provide a few. They offend my religious principle of "making the best return on my money that I possibly can", how's that? They also offend my religious principle of "not relying on government payouts when I'm perfectly capable of providing for myself". That's somewhat amusing, because they share that one, but still insist people base their private pensions on products which derive their value entirely from gilts, which are government bonds. If I were married and had sproglings, I'd be inclined to add my religious principle of "leaving something for the kids" to the list. If we're talking pensions more generally, I think I'd like to mention my religious principle of "not paying someone who earns more than me to look after my money". And yes, I think that, with a little creativity, I could probably argue that each of those was genuinely a religious principle. Whoever said theology was worthless?
- There are a few "neverthelesses", though. Firstly, pension pots are Untouchable. That means that, short of a dire emergency, you can't (or shouldn't) get the funds out. But therefore, neither can the Goons make you use up your pension should you become jobless. Also, iniquities—sorry, I mean annuities—are secure to a fault. So they're not all bad; just that you can do a bit better outside, if you're willing to work at it a little.
In sum, it may not be that all is rotten in the State of Denmark, but it's certainly getting squishy around the edges.