Pensions

Pension Prompt

I recently had a conversation with an older friend (he's 26) who told me that he didn't have a pension. This surprised me as naively I just assumed many working people put money each month into a pension. This conversation prompted me to do a quick poll of relatives and friends. I was quite surprised to discover how few people seemed to invest into a pension.

What is a Pension?

Firstly I think I should quickly outline what a pension is. A pension is a means by which you can invest tax-free income that comes out of your gross monthly salary. The pot grows over time as you add to it and gains capital growth. The (simple) end result is that once you have reached the age of 55 you are able to retire from work as you use the pot to buy an annuity which will provide you with an income for life. For more information on annuities, read my previous article on the subject.

Why you should invest into a Pension

There are several reasons to invest into a pension. The first is that the state pension is only £144 per week and you need to be 65 if you are a man or 62 if you are a woman to claim. This is not ideal for someone looking to retire early or to retire on a relatively large salary or both. This is one extremely good reason to invest in a pension.

A second reason to invest in a pension is that the Government encourages you to look after yourselves in retirement. As a result the Government tops up your contributions relative to the amount of tax you pay. If you are a basic rate tax payer and pay 20%, for every £80 you invest into a pension the Government will top up your contribution by £20, paid for out of your tax contribution. Likewise, if you are a higher rate tax payer and pay 40% on your marginal income, then for every £60 that you put into a pension the Government will contribute £40! Think of it as free money. It means that once you invest money into a pension it has already grown in size and that's before any capital gains!

A third excellent reason for investing in a pension is that if you work for a relatively large Company they may have a policy of matching your contribution up until a certain percentage of your gross salary. Just as before this is free money. Do not pass up the opportunity!

My personal pension story so far

I am no expert on pensions - I'm only 23! Most people my age cannot fathom thinking about something so far into the future. It is my goals to become a multimillionaire that drives me to consider these things. It is just one of a portfolio of investments that I intend to have throughout life.

I currently put aside 6% of my gross salary into a pension. That's about £135 per month. My employer generously matches up-to-a 6% contribution so that adds another £135 to my pension. The Government then tops up my contribution by £33.76. After excluding fees my total pension contribution is about £297 per month.

I am young. I have a lot of time ahead of me. I reasoned that I also had plenty of time to make a mistake when it came to the sort of investments that my pension should be allocated in. I've split my pension contribution between 3 different funds. 40% of my pension goes into a standard UK equities-bond split fund. Here, the fund manager divides the money in such a way: 60% into bluechip stocks and 40% into bonds. The other two funds that make up an even split of the remaining 60% of my pension contribution is split between an Emerging Markets equity fund and an Far East equities fund. This clearly makes my portfolio a risky one. I feel that I can mitigate this risk with time on my side and will reduce the amount of risk in about a decades time.

My pension results:

Thusfar, in the 5 months that I have been contributing towards a pension I have put in £675 into my pot from my own money. Through the various forms of topup this has resulted in a contribution of £1,483.9 which has grown in the last 5 months due to the investment vehicles by 4.6% into £1,552.6. It also means that for 6% contribution of my gross salary, I am virtually springboarding my contribution into a 14% gross salary contribution.

My intention is that by the time I am 60, assuming various levels of growth in salary and pension I intend to have a pension pot of about £825,000 in today's money. Assuming I take 25% of this out as a tax free lump sum this will leave me with a pension salary of about  £30,000 (a very rough estimation!) in today's money - not to be sniffed at in retirement. Of course, along side this I intend to have other investments with which to top up this salary.

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