Whether you are employed and have been offered a company pension scheme, or you are self-employed and setting up your own pension, you will need to make some choices, which you might not be prepared for. For example:
1) The pension provider
2) The type of pension plan
With workplace pensions that you are auto-enrolled in, it is likely that the pension provider has been chosen by your employer. SMART Pensions, NEST, NOW: Pensions and The People’s Pension are among some of the biggest names in providing workplace schemes for employees.
Most of these providers will automatically enrol people in the default fund (sometimes given an alternative name, such as “balanced”). Most people will not change this – in fact 92 per cent of employees are enrolled in the default fund. However, it is possible to change it at any time if you want to.
Beyond the “default” option
Why would you want to? Well, there are significant disparities in performance, even between default funds with different providers, with returns over a year ranging from 6.3 per cent to 12.5 per cent even within this category, according to research from JLT Employee Benefits.
The research suggests that an employee contributing to the worst-performing default fund on the market could be £300,000 worse off after saving throughout their working life than someone on the same salary, saving for the same time period, in the best-performing default fund.
So, before you decide you are happy with the default option and consign your pension choice to the back of your mind, it might be worth a 10-minute glance at the other options.
Don’t forget that even if you have already been paying into a default fund for some time, you might be able to move it elsewhere if you decide it’s not for you. If you are transferring a pension pot worth more than £30,000, you legally need to seek financial advice on whether to move it.
Returns versus risk
When choosing a fund, consider the returns you would like your pension to make for you, as well as how much risk you are willing to take and whether you have any other top priorities, such as only wanting to invest in ethical companies, or having a Sharia-compliant fund.
If returns are key for you (and don’t forget a few % can make a big difference over decades) it might be a good idea to look at the historical performance of the fund choices on offer (you can do this by clicking on a link to the “fund factsheet”). While past performance is not an indicator of the returns you will get in the future, it can give you an idea of what to expect and of the approach the fund takes.
If you choose to explore options other than the default fund, the next way to choose will be according to how much risk you are willing to take. Providers have different names for them, but there are often three options here: low risk, medium risk and higher risk.
Naturally, most of us will veer towards low risk, but might think twice about this after considering the returns prospects for each: lower risk funds are unlikely to produce as high returns as the higher risk funds. However the higher risk funds also have the chance of bigger losses.
Why age matters
Generally speaking, it is more appropriate to take a higher risk approach if you are younger, with many years of pension saving ahead of you (and therefore more time to ride out lows as well as highs).
However, if you are older, with more savings under your belt that could be at risk of losses if, for example, there was a stock market correction, lower risk funds are usually considered a safer place for your life savings.
.. And so do your values
There is more demand for ethical investments than ever before and many pension providers now offer an ethical option - but you might have to search around the website to find it. Generally, returns are on a par with mainstream funds. This is also true for Sharia-compliant pensions.
If you are self-employed or just don’t have a workplace pension, you might want to have your own. Most of the big auto-enrolment platforms are also open to private pension savers, but you can start a pension of your own on most of the big investment platforms, including Hargreaves Lansdown, Charles Stanley Direct and Selftrade, as well as some of the newer platforms including Nutmeg and PensionBee.
Some of these offer regular private pensions, with similar options to choose from as workplace pensions. Although with investment platforms, you usually also have the option to self-select from a range of funds, meaning you can customise your pension portfolio.
For even greater customisation, there are what’s known as Self-Invested Personal Pensions (SIPPs), which have a wide selection of investment options, including some esoteric ones. However, some of these options can be extremely risky and there have been a number of cases of mis-selling of investments within SIPPs, so take care.
NB. FSCS cover can apply to pensions if the pension provider goes into administration, but how much is protected depends on what type of product the pension is. If it is an investment product, cover can go up to £50,000. However, if the product is classified as a long-term insurance contract, the cover can be 100% of the claim, with no upper limit.
Don’t forget fees
Another thing to look at is the Annual Management Charge of the various funds, plus any other charges (there’s a full breakdown on the Pensions Advisory Service, here). These are usually quoted as a %. There can be big differences in the charges that different providers levy and like the annual return example, these can add up to big differences in the pot you end up with. But to complicate matters, funds that are actively managed, and therefore – in theory – likely to produce higher returns, come with higher charges.
It is then up to you or your adviser to decide whether you think the greater returns are likely to outweigh the higher charges over time.
A word of warning
The Pensions Regulator has published details of pension scams, where victims were told that if they transferred their pension pots to the schemes they would receive a tax-free payment commonly described as a “commission rebate” from investments made by the pension scheme – a form of pension scam. If you have been cold-called and offered pensions investments, here’s what to do:
- Contact your pension provider first to see if you can stop the transfer taking place.
- Then contact Pensions Wise to discuss your options.
- Then contact Action Fraud to report the scam.
If you are cold called, then hang up. Beware of investment deals that just seem too good to be true, make sure your adviser is regulated by the FCA and don’t take recommendations from a friend – check everything yourself.