Pension Investment Funds: Choosing The Right Option For You

Pension funds are long-term, tax-efficient savings plans that allow you to put aside a portion of your income for retirement. They are typically made up of a portfolio of assets, including stocks and shares, bonds, cash, and commercial property. There are several types of pension funds, including workplace pensions, personal pensions, and self-invested pension plans (SIPPs). When choosing a pension fund, it is important to consider your financial goals, risk tolerance, and investment style. Pension funds usually offer a range of investment options, from low-risk to higher-risk funds, and provide a consistent stream of funding upon retirement.

Workplace pension funds

There are two main types of workplace pension funds: defined benefit pensions and defined contribution pensions. Defined benefit pensions are based on your salary and how long you've been a member of the scheme, while defined contribution pensions are a more common way of saving for retirement, allowing you to build up a pot of money to give yourself an income when you retire.

With a defined contribution pension, you will usually be given the option to choose your own investments. If you don't, your money will be invested in a 'default' fund, which is designed to suit a broad range of people. These funds tend to be lower-risk and are sometimes referred to as 'lifestyle' or 'target date' funds, as they move your money into lower-risk investments as you approach retirement.

If you are invested in the default fund, you can also choose to move your money to different funds offered by the scheme, allowing you to tailor your investments to suit your needs and preferences.

With a defined benefit pension, you are not responsible for the investment decisions. Instead, your employer makes the investment decisions and chooses the risks needed to reach the promised retirement income target.

Personal pension funds

There are three main types of personal pension funds: standard personal pensions, stakeholder pensions, and self-invested personal pensions (SIPPs). Standard personal pensions are offered by most large pension providers and typically offer a range of investment choices. Stakeholder pensions allow for low minimum contributions and provide the flexibility to stop and start payments or transfer out at no cost. SIPPs offer a wider and more sophisticated range of investment options but require hands-on management and often come with higher charges.

When choosing a personal pension fund, it is important to consider your investment style and comfort level with risk. You may opt for a cautious approach with lower-risk assets, an aggressive strategy with higher-risk assets, or a balanced mix of both. It is generally recommended to diversify your investments across different assets, sectors, or geographic regions to manage risk effectively.

Before selecting a personal pension fund, be sure to compare the charges and investment options offered by different providers. Typical charges include annual management fees and switching charges. Understanding these fees is crucial in making an informed decision about which personal pension fund is right for you.

Self-invested pension plans (SIPPs)

A self-invested personal pension (SIPP) is a type of pension scheme that allows individuals to make their own investment decisions from a wide range of investments approved by Her Majesty's Revenue and Customs (HMRC), the UK government department responsible for tax collection. SIPPs are "tax wrappers", allowing tax rebates on contributions in exchange for limits on accessibility.

SIPPs are tax-efficient investment vehicles as they allow investors to receive income tax relief on their contributions at their highest marginal tax rate. For instance, an individual who pays the basic rate of 20% and contributes £8,000 to their SIPP account is eligible to reclaim £2,000 from the HMRC, which will then be deposited into their SIPP account. There is no tax relief for pension contributions exceeding £60,000 a year.

SIPPs give individuals the freedom to allocate their assets in a wide range of investments, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs). This is in contrast to company-sponsored pensions, where the company chooses a shortlist of investment options.

SIPP participants can defer a portion of pre-tax income, investing in stocks, bonds, and ETFs, among other approved assets in a tax-advantaged manner. They can start withdrawing funds at age 55, even if they are still employed. Typically, individuals can take up to 25% of their funds tax-free, with the rest taxed as income.

There are different types of SIPPs, including:

• Deferred: Most or all of the pension assets are generally held in insured pension funds, with self-investment or income withdrawal activity deferred until an indeterminate date.
• Hybrid: Some of the assets must be held in conventional insured pension funds, with the rest allowed to be 'self-invested'.
• Pure or full: Schemes offer unrestricted access to many allowable investment asset classes.
• SIPP Lite or Single Investment: Schemes that feature much lower fees for investments that are typically placed in only one asset.

SIPPs are generally more suitable for those who understand financial markets and are prepared to actively manage their investments or pay a financial adviser to do so. It is important to seek independent financial advice when choosing a pension fund.

Defined contribution pension plans

In a defined contribution plan, there is no guarantee of a specific amount of benefits upon retirement. The value of the account will fluctuate due to changes in the value of the investments. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.

One of the advantages of defined contribution plans is that they offer a tax-advantaged way to save for retirement. For example, in a 401(k) plan, contributions are made with pre-tax dollars, and any earnings are tax-deferred until withdrawal. Additionally, employer-sponsored plans may receive matching contributions, providing an incentive for employees to contribute.

However, defined contribution plans also have limitations. They require employees to invest and manage their own money, which can be challenging for those without financial expertise. Unlike defined benefit plans, defined contribution plans do not guarantee a certain amount of retirement income, and some individuals may not save enough to last through retirement.

Overall, defined contribution pension plans offer employees a way to save for retirement with tax advantages and the potential for employer matching contributions. However, it is important for employees to carefully manage their investments and ensure they are saving enough to meet their retirement goals.

Defined benefit pension plans

In a defined benefit plan, the employer is responsible for managing the plan's investments and risks. They typically hire an outside investment manager to oversee the plan and make investment decisions. The employer funds the plan by contributing a regular amount, often a percentage of the employee's pay, into a tax-deferred account. Employees may also be required to make contributions.

Upon retirement, employees become eligible to receive their benefit as a fixed monthly payment (annuity) or, in some cases, as a lump sum at an age defined by the plan's rules. The specific benefit amount or payout is guaranteed upon retirement. If the employee passes away, their surviving spouse typically receives the benefits.

One disadvantage of defined benefit plans is that if the stock market performs well, employees may not benefit as much as they would with defined-contribution plans, where payouts are directly linked to investment returns. Additionally, employees cannot simply withdraw funds from a defined benefit plan as they might with a 401(k) plan.

Defined benefit plans are less common nowadays but are still widely used in the public sector.

Frequently asked questions