Different Ways of Saving for Retirement
Pensions are generally the best method of retirement saving. They have big tax benefits. And it’s said that if they didn’t exist we’d all be clamouring to invent them.
However they’re not the only way to save up for your old age. Here are some alternatives.
ISA’s. (Individual Savings Accounts).
They are special types of investments provided by ISA managers (basically the usual
pension providers and many other investment companies) which are free of income tax on dividends and interest. They are also exempt from
capital gains tax.
Think of them as a “tax free wrapper” in which you can invest your savings.
You can have an ISA and any form of pension at the same time.
There are two types of ISA – a Cash ISA for savings in the bank and an investment ISA for stock market based investments. You have an annual allowance of £10,200 and can invest up to half in cash. The balance (or all of it) can go into an investment ISA. Investment ISAs have the potential of a greater reward than cash – but could also lose you some or all of your money.
Your ISA could be invested in a wide range of shares and bonds including unit and investment trusts. You can put your money in just about anything, anywhere in the world.
The main difference with a pension is that you make your payments into an ISA from your
net income ie income that you’ve already been taxed on. However, after this, ISAs are exempt from income tax and
capital gains tax.
If, on retirement, you convert the ISA to an
annuity you would pay less tax on the income from it than a pension fund annuity.
Anyone over 18 can have an ISA providing they are UK residents.
Advantages of ISA’s over Personal Pensions
One of the problems with a personal pension is that if you have no earnings, you’re probably not getting a
tax break although non-earners can claim basic tax relief on contributions of up to £3,600 a year. You only have to put in £2,880 to get this amount of pension contribution.
But you have your annual ISA limit whatever you contribute to a pension and whether you work or not.
The other main advantage of ISAs over pensions is flexibility particularly your ability to get to your money at any time. Unlike a pension pot which has to be turned into an annuity, you can take your ISA when and how you like. So you can spend it before you die – or tomorrow if you want!
But some see this freedom as dangerous. They fear you will take out money which you should be putting away for retirement. Are you disciplined enough?
Generally, forget these. As anyone whose mortgage endowment will fail to pay off their loan knows, endowments have been a disaster (except for the folk flogging them!).
In case you are curious, an endowment is where you pay a regular sum into an investment policy operated by an insurance/pension company for a fixed period of at least ten years. You also get life insurance included.
This used to be the traditional way to organise regular savings and became a popular method of mortgage repayment. The downside is high charges, disappointing performances and poor surrender values. They’re not flexible so don’t get involved with them unless an
IFA recommends one for a very good reason. And that’s very unlikely.
Endowments are now spectacularly out of favour thanks to very bad publicity following warnings from many household name providers about poor performance – meaning people have had to increase their mortgage payments to ensure they pay off their loan. Otherwise, they could well be dealing with their mortgage well into retirement. And that’s not good.
Investing in your own property
The idea here is you keep moving up into a bigger house during your career and on retirement “trade down” to a smaller house. You’re left with no rent to pay and profit which you live off.
The positive aspect is you are forced to make your mortgage payments during your career – unless you want to be evicted – unlike say a flexible pension where you may find it hard to choose between those cream cakes and increasing your pension contribution.
Also, property is seen as a generally safe foundation although it doesn’t tend to appreciate in value as much as other investments can.
The down side is that expenses during your working life will be higher due to being in a larger house e.g. heating, insurance payments etc. And of course, there are periods when prices fall.
If and when you sell your house at retirement you then have a problem of converting the capital sum (ie your profit) into a regular income.
Or if you are renting the property out (having bought a smaller second home) who will manage this as you get older and at what cost.
Buying to Let
As confidence in traditional pensions continues to decline there’s an increasing trend in looking to property as a way of saving in a more enterprising way than simply investing in your own home.
A typical example would be “buy to let” – ie where you buy a property with the aim of letting it out to tenants. Ideally this covers the mortgage and you end up being able to eventually sell the property.
You end up with an asset that is yours. It avoids all the hassles of pensions such as being forced to turn your investment into an annuity. You can leave the properties in your will – you can’t do that with a pension.
If you’re interested in this and want to read specifically about renting to students in a university town or commuters in suburbia, the Council of Mortgage Lenders has two leaflets ‘Buying to Let‘ and ‘Thinking of Buying a Residential Property to Let‘ You can order them by phone on 020 7440 2255.
There’s an argument that investing your pension in shares (ie equities) has historically been more profitable than property. However this is based on the strong share performance of the last 50 years. Now that things aren’t looking so great for shares a lot of people are looking to invest in property instead.
Gold, jewellery, old records, beer mats, jazz records, antique furniture could all be worth a lot of money if you collect them for selling.
But frankly they are all far too speculative for basing your comfortable retirement on.
You would need to be insured to cover all eventualities. And while they may increase in value they don’t benefit from the magic of compound interest.
Under the floorboards/ Cash in the mattress
This used to be how many people saved. We put this in because we’ve heard of a couple of people talking about it seriously in the sense that they don’t trust the banks any more.
Sorry to state the obvious but this is a nonsense strategy in this day and age. Besides losing the power of compound interest that investments can have, there’s no insurance against fire, theft and so on.
Alternatively you could work during your retirement. The idea is you learn a new skill to plan a part-time retirement business.
Recently there’s been a lot of media coverage of the idea that we’re all going to have to work into our seventies anyway. And then there’s the growing acceptance that early retirement is a sure way to an early grave and that if you want to live a longer and healthy life you should keep active, ideally doing something you enjoy.
Have a look at a few articles about this click here