Taking a Structured Approach to Managing Your Pension Assets

The recent cost of living crisis has highlighted the importance of retirement planning and building/protecting pension assets. While the objectives of your pension plan may be simple, there are many moving parts which need to be appreciated. Changes in regulations, finances and risk profiles can have a significant impact on your long-term aspirations.

Against this backdrop, I thought it would be interesting to publish an article breaking down the individual topics surrounding pension assets.

Retirement goals

Before we look at the funding and management of pension assets, you first need to identify your retirement goals. In a similar scenario to a car journey, if you don't know where you are going how do you know when you get there?

The Pensions and Lifetime Savings Association have created a handy website that identifies broad later-life costs for those looking at a minimum, moderate or comfortable retirement. While indicative, as every scenario is unique, it does give you an idea of the costs to consider. It's also essential to recognise the value of your state pension and its place in your long-term income.

Once you have identified an estimate of your future cost of living, it is possible to calculate the required funding and retirement contributions needed to reach that level. Many people continue to contribute to their pension scheme, unaware or ignoring estimates of the future value and are often shocked to find out how much is available in retirement. Planning is the key.

Understanding the different types of pensions

There are two main types of workplace pension:-

Defined benefit (also known as a final salary scheme)

This type of scheme, where the pension is based on your final salary and years of service, is relatively rare in the modern era. Regulatory and tax changes have made them more expensive for employers, with many now switching to a defined contribution scheme.

Defined contribution (also known as a money purchase scheme)

The most common type of scheme today, pension contributions are invested, and the value of your pension fund in retirement will depend on investment performance. Upon retirement, options include taking an element of tax-free cash, a regular pension, buying an annuity and other alternatives.

Recently, there has been a significant increase in the popularity of personal pension schemes detached from your place of employment. While some employers will contribute to a personal pension, there is no legal obligation, and the scheme tends to be funded by individual contributions.?

Tax implications

There are several attractive tax implications when it comes to pension investment:-

• Contributions are tax-free, paid gross or net, with taxation reclaimed from the government.
• Income and capital gains are free of tax, which can have a significant cumulative impact on your long-term investment returns.

In the tax year 2023/24, pension contributions are limited to either 100% of your salary or ￡60,000, whichever is the lower. Where you need to reclaim tax on contributions, this will be paid at your appropriate income tax rate. In most scenarios, you can backdate pension contributions up to 3 years to utilise previously unused allowances.

Managing your pension assets

As the vast majority of schemes today are defined contributions, with your pension fund value is dependent on investment performance, it is crucial to address the issue of asset management. There are two main options:-

• Self-managed
• Discretionary management

It all comes down to your experience and confidence in managing your pension assets, where actions taken or not taken today can considerably impact your funds available for retirement. This is where you need to identify your risk profile and objectives for retirement.

When it comes to pension asset management, in the early days, investment tends to be focused on growth (bearing in mind someone starting a pension in their 20s may be contributing for 40 years), switching to a balanced approach in your 40s and more asset protection/income-based as you approach retirement. These approaches are not set in stone; timings and changes can vary, but they give you an idea of the stereotypical movement in strategy.

Regulatory issues

Over the years, we have seen several changes regarding pension regulations, the majority of which have been well received, while others have caused confusion and sometimes been detrimental to long-term returns.?

As a professional financial adviser, I am all too aware of the changing regulatory landscape, advising my clients where adjustments are required. It is vital to ensure that your funds are managed within the scope of the regulations, maximising the benefits while minimising long-term liabilities. Consequently, your pension assets must be reviewed regularly, at least annually, to consider the performance and address potential changes.

Pension fund performance

This brings us neatly to the subject of pension fund performance, an area which is often dismissed by those with personal pension funds. Similarly to everyday insurance, many people simply set up their pension plans and arrange contributions, often failing to compare and contrast performance against peers.?

Whether a third party manages your funds or you take a more hands-on approach, it's essential to regularly review the performance of individual investments and your broader pension scheme. There may be minor tweaks you can make to enhance long-term returns; perhaps some of your investments are underperforming while others are more attractive. It is still possible to maintain a long-term investment strategy while addressing any short-term challenges and potential changes.

Pension assets and inflation

The key to long-term pension fund management is maintaining or enhancing your relative investment power and increasing your pension assets. While not always possible, increasing your pension contributions in line with inflation is advisable, thereby maintaining relative investment power. For example, if the cost of living increases by 10% (investment performance aside), unless your funds increase by 10%, your relative spending power is falling.

Periods of underperformance due to not increasing pension fund contributions in line with inflation have prompted some people to seek higher returns, which often attract higher risk. There lies the danger, the potential downside.

As a side note, it is also vital to revisit your long-term pension fund goals as the estimated cost of living further down the line may have increased more than forecast. Again, these issues can be addressed by regular reviews of your overall finances, including pension assets.

Beneficiaries and expressions of wish

Most pension schemes will allow you to complete what is known as an "expression of wish" form, which identifies those you wish to inherit your pension assets on death. Legally, your pension trustees are not obliged to follow your instructions, but it is relatively rare, and they must have an excellent reason to consider alternatives.

While pension assets will not usually form part of your estate, if you die under 75, they are traditionally passed on tax-free to the beneficiaries. Conversely, if you die over 75, the beneficiaries will likely be liable to income tax on funds received. There are other ways in which you can save in a tax-efficient manner that can help reduce any tax liabilities for your beneficiaries.

Taking professional advice

I have attempted to cover the main topics regarding pension funds, regulations, management and taxation, but each scenario is unique to each person. We also have the constantly changing regulatory structure, providing a more open approach to pension assets, but not always straightforward. Unfortunately, due to the long-term nature of retirement planning and pension investment, actions taken or not taken today can significantly impact your standard of living years or even decades down the line.

Summary

There are areas of pension management where individuals are obliged to take professional advice, such as pension transfers, but this can be a complex topic aside from transfers. It's essential to maximise your pension assets while also introducing a degree of protection, a balance which can be challenging to find. Something as simple as failing to increase your pension contributions in line with inflation can have a significant knock-on effect further down the line.

If you would like a no-cost, no-obligation chat about your pension assets or wider finances, don't hesitate to contact me, and we can book a date in the diary.