As financial products go, pensions may not have a great image and for a whole variety of reasons.
But if you’re putting together a retirement savings plan, can you really do any better with alternative, non-pension investments?
Alternative investments that might form the basis of a ‘DIY pension’ could include your own basket of cash, property, investment funds, shares or bonds and in just about any combination.
Indeed, with property prices on the rise once again, it is hardly surprising that many people will be tempted to opt for bricks and mortar to help fund their retirement.
Andrew Fahy, head of tax and financial planning at Investec, said: “I think many people are making mistakes in this area. They’re avoiding pensions and going down other roads and that might be something as simple as having an investment property as your pension as opposed to more structured investments.”
It’s likely, he says, that savers are simply overlooking the tax advantages of pension-structured investments and, more importantly, finding ways to get the most out of them.
“With an investment property, an apartment or house, the first thing is that you are buying the property with after-tax income, so someone is using their net funds from their back pocket to buy. If you’re borrowing a portion of it you’re not getting the full reduction on your interest because the interest is not fully deductable, and along the way you’re being hit for income tax on the full amount, and then there’s going to be the capital gains tax.”
Poorly informed
It’s often assumed that the relief on contributions provides the biggest single tax-saving benefit to pensions, but it’s actually the capital gains exemption on the investment growth, which has a powerful compounding effect over a very long period of time. ‘That’s the magic of it, the tax rate compounding.’
Alastair Byrne, senior defined contribution investment strategist at State Street Global Advisors, says that those who believe they can beat pensions as a vehicle for their retirement fund, may well be poorly informed.
“These individuals could risk giving up the potential advantages of some institutional funds, such as better governance and lower fees, in order to place their savings in more costly investments. In addition, a misplaced belief in your capacity to find a better place for pension savings raises the risk of exposure to losses, for example, with property.”
But any comparison really comes down to how they are taxed.
“Most of what you would call alternative investments you could buy through a pension,” said Fahy.
“Really what you’re looking at is the pension structure versus a non-pension structure. If somebody wants to buy equities, if somebody wants to buy property, you can do it tax inefficiently or you can do it tax efficiently through your pension.”
Indeed, while the differences in the way they are taxed are clear, perhaps comparing alternative investments with pension investments is missing the point. Experts say the only reason why you should consider alternatives to pension investments is to have greater flexibility to access cash during your lifetime.
“The big advantage of non-pension investments is accessibility. It’s there and you can get it at any age,” said Fahy. “You’re just giving up the tax-saving benefits.”
The value of independent advice will likely come into its own if you are unsure about how to weigh your investment portfolio between your pension fund and lifestyle investments that you can access at any time.
When it comes to pensions there will be issues to navigate around pension fund thresholds, tax rules and contribution rules, but also what your financial circumstances are. If you may need to demand access to cash it may not be wise to put all your savings into your pension.
Are annuities dead?
One strong trend that is emerging in the pensions sector, thanks to persistently low interest rates, is the fast declining popularity of annuities.
“People are moving away from annuities because of low interest rates, but the other side of it is the ability to keep your pension and add your wealth to your family’s balance sheet,” said Andrew Fahy, head of tax and financial planning at Investec.
He concedes that for folks who take out approved retirement funds (ARFs), which allow you to continue investing a portion of your pension pot after retirement, it will be a balance between the mortality risk of an annuity (which die with the owner) and the investment risk of the ARF, but he says this is a trade off that more people are willing to take because they view their pension as belonging to the whole family.
Alastair Byrne, senior defined contribution investment strategist at State Street Global Advisors, says there is still a place for annuities as part of retirement planning and they continue to have some appeal.
“Our research shows that once retired, the most likely action for 20 per cent of Irish respondents is to put all of their DC balance into an annuity, with an additional 44 per cent indicating they would put a portion into an annuity. While they may be expensive right now, the guaranteed income feature can still be an attractive option for some members.
“Annuities can also work well at a later stage in concert with an ARF, when moves in bonds yields and the shorter period the life assurer will be covering might make them cheaper.”
In addition, some investors will choose to try and get an indexed rather than a level annuity to help buffer them against inflation.
But another trend is in underwritten annuities, whereby if you are suffering ill-health at the point of retirement you may be able to get a much better annuity rate because you may not live as long as someone who is healthy.
The advantage is that it will still continue to pay you an income for how long you live, however long that may be.