The truth is that retiring comfortably on a pension is not a dream if you start saving early enough and you employ a few common sense strategies. Pensions are very good instruments for retirement saving. They are more than capable of providing enough income that you will not have to worry about running out of money or being stuck with an insufficient state pension.
Three Pension Basics
Before we get into talking about how you can comfortably retire with pension income, there are three basic things you need to know. First is the fundamental truth that there are two kinds of pension models, the first being what we call 'defined benefits'. A defined benefits pension guarantees a certain level of benefits at retirement regardless of how the pension scheme performs. A defined contribution pension is just the opposite. Its eventual payout to members is wholly dependent on how well the scheme performs in its own investments.
The second basic principle you need to know is that the government instituted auto-enrolment in 2012. Under auto-enrolment, every eligible employee in the UK must be enrolled in an employer-sponsored pension scheme unless a conscious choice to opt out is exercised.
Third, consumers do not have to rely on employer-based pension plans alone. They can invest in private plans including SIPPs and stakeholder pensions. It's not uncommon to actually invest in both. You might put some money into a workplace pension and a similar amount into a SIPP.
How to Succeed with Pension Investing
With the basics of pensions out of the way, you may be wondering how it's possible to succeed with pension investing. Actually, doing so is part science and part intuition. Nearly every pension saver will be better off getting advice from a financial adviser or pension expert in making the decisions necessary to invest.
Having said that, the first step in successful pension investing is to start saving as soon as you possibly can. Pensions do best for savers over extended periods of time. If you start saving at 25, for example, you are likely to have a lot more pension income at retirement than someone who waits until 55 to start saving.
When you do start saving, keep in mind the following:
- Diversification – Don't make the mistake of putting your money into a single kind of investment. Spread your money across different options with varying levels of risk. The higher the risk, the higher the potential reward and vice versa.
- Be Active – Don't make the secondary mistake of enrolling in a workplace pension and then forgetting about it. Be an active part of your pension by paying attention to performance and moving your money around as necessary to maximise returns.
- Pay Attention to Rates – Both interest and bond rates play a significant role in pension performance. Keep an eye on them. When interest rates fall, bond yields follow suit. That means any of your investments that are tied to bonds are not going to perform as well.
- Beware of Scams – Every pension saver is likely to receive at least one unsolicited invitation to transfer before retiring. Be very, very careful of such offers. There are a lot of scams out there. Before you agree to any transfer, thoroughly vet the company you're thinking of transferring with.
- State Pension Forecast – It is a very good idea to get a state pension forecast every five years or so prior to the age of 55. After that, you should get a forecast every year. The state pension forecast lets you know how much you are likely to receive from the state pension system so that you can make necessary adjustments to your private investments.
When It's Time to Retire
Saving for retirement is only half the equation for successful pension investing. The other half involves how you actually access what you have saved when it comes time to retire.
It used to be that the annuity was the default option nearly every pension saver exercised. Thanks to pension freedoms, we now have significantly more choices. Within six months of retirement, you should sit down with a financial adviser capable of helping you figure out what you are going to do once you stop working.
An annuity still may be your best bet, but you need to look at your other options as well. You may be better off:
- establishing a drawdown contract
- taking your pension as a lump sum
- using your pension account like a bank account
- investing your pension savings in more lucrative opportunities
- transferring your pension to an overseas plan.
It is possible to live a very comfortable life in retirement strictly from pension income alone. But you have to prepare correctly. The best advice anyone can give you is to encourage you to start saving as soon as possible and work with a financial adviser who can help you establish, and stick to, a solid retirement plan.