Six ways to boost your pension
Friday 18th June, 2021
"How can I increase my pension in the run up to retirement?"
This is a question that many of us ask, as retirement looms, quite often no more than three or four years away. This is because our pensions, despite their crucial role in funding potentially a third of our life's expenditure requirements, are often our most neglected assets. They simply sit forgotten in the background, unattended for thirty or forty years, until we suddenly become acutely aware of their importance and how insufficient our provision up to this point has been.
Now, there are no quick fixes. Building a pension pot sufficient to provide for your retirement is a long term activity, and you cannot make up for a 30 years of underfunding in 3 years or less.
However, there are a few things you can do to improve your position. In the guide below, I explain six of these options that can help to increase your pension pot and retirement income, and ensure that your pension is best positioned to meet your needs.
There are a few unfortunate realities in life. Some we are very familiar with, like death and taxes. Others we don’t really talk about. Things like saving for your pension and whether you will be able to afford to retire. These are topics that we tend to avoid like the plague.
Often the clients I work with have what I call fragmented finances. Like many people, they have had a number of jobs throughout their lives and have built up a number of pensions, many of which they have lost track of. They are often very successful and good at their jobs. This self-same success has resulted in their finances being in a parlous state. Their success has left them without time to plan for the future. Occasionally, they have had the time to start planning when they are between contracts or jobs, as they make their way up the corporate ladder. However, career and life quickly swamp them again and the plans fall by the wayside, once again. They end up with a patchwork quilt of investments and pensions.
As they start to approach retirement, it suddenly dawns on them that they are not sure whether they can afford it. They look at the financial detritus they have accrued randomly during their lives and they are not sure where to begin pulling it all together into a coherent plan. Some opt to perform a manoeuvre I call the Ostrich.
However, this doesn’t help anybody. The thing most people need is a place to start. Therefore, I have pulled together a list of 6 positive things you can do to improve your pensions and start getting thing in order.
Review your pension portfolios
I would say that most people I meet do not know what their pensions are invested in. They were put into some sort of generic fund at the start and have never given it a thought since. Alternatively, they fancied themselves as Gordon Gekko at the outset, and then lost interest. Either way, with the passing of time they have lost track of what their pension holdings are.
Despite this, some have done quite well. Purely by chance, they have held a focussed portfolio of largely emerging market and technology funds with almost 100% exposure to equities and over time, these have provided really substantial returns for them. Not the worst position to be in, you might say. However, as they approach retirement, the last thing they want is for their pension funds to hit a rough patch and burrow down like a homesick mole. It therefore makes sense to diversify their asset allocation to reduce volatility and the downside risk. This won’t guarantee a smooth ride into retirement, but it will reduce the size of some of the bumps.
For others, they may be invested in horrendous with profit funds (or something equally atrocious and generic) that have been paying out a paltry bonus of 0.5% to 1% for the last 10 years. In many of these situations, they would have been better off in cash. While it is not possible to make up for the lost years of poor investment, it is possible to ensure that it doesn’t continue. A few small changes can help to give the portfolio far more chance to generate reasonable returns.
In many cases I come across clients who have been invested in perfectly reasonable life-styling funds. These are funds that gradually reduce their exposure to shares and move into less volatile holdings like bonds and cash, the closer you get to retirement. Many of these funds have performed credibly during their lifetime. However, as they approach the member’s selected retirement age, they become less and less suitable, unless the member is intending on buying an annuity to fund their retirement.
Following the introduction of pension freedoms, the majority of people seem quite keen to steer away from annuities, even if they are likely to be the most suitable option given their personal approach to investing. The purchase of annuities has fallen off a cliff due to low annuity rates and the likely loss of some or all of the principle used to purchase the annuity, upon death. A large proportion of retirees are looking at using Flexi-Access Drawdown to fund at least the initial part of their retirement. If you are adopting this approach, you will probably need a reasonably high level of exposure to shares in order to sustain the drawdown of income from the pension without completely eroding the pension value before you die.
Furthermore, there is now evidence that the biggest risk to your pension in drawdown is sequencing risk. This refers to the risk created by the particular sequence in which portfolio returns are generated (i.e. weak or strong years for performance) and in which withdrawals are made from the portfolio. Dr Wade Pfau describes sequencing risk like this:
“Sequence of returns risk relates to the heightened vulnerability individuals face regarding the realized investment portfolio returns in the years around their retirement date. Though this risk is related to general investment risk and market volatility, it differs from general investment risk. The average market return over a 30-year period could be quite generous. But if negative returns are experienced when someone has just started to spend from their portfolio, it creates a subsequent hurdle that cannot be overcome even if the market offers higher returns later in retirement.” (The Hidden Peril in Sequence of Returns Risk-Dr Wade Pfau – 10/03/2015)
In other words, if you get poor returns in the beginning of your retirement (i.e. when you first start drawing down on your pension), then you may irreparably damage the prospects of your pension surviving for the whole of your retirement.
The best demonstration of this risk I have seen comes from research carried out by Brooks MacDonald. They compared the performance of a £100,000 portfolio over an extended period, where £5,000 is being withdrawn each year. The difference between poor and strong performance in the initial years is starkly demonstrated in the graph below:
It is not the easiest to read, but the blue line demonstrates the performance of a portfolio with a strong performance at the outset, while the pink line demonstrates the impact of poor performance at the outset.
Therefore, the lifestyle fund’s move into less volatile asset classes with a focus on capital preservation rather than growth, actually jeopardises the sustainability of your retirement if this holding is retained into the period where you are actually drawing down from the portfolio. There are many views on the best strategy for withdrawing funds from pensions in a sustainable manner, but the majority of them agree the need for a sizeable exposure to shares.
Increase your contributions
This seems obvious, but many people miss this completely.
For many people approaching retirement, they have paid off their mortgage, the children have finally flown the coop (hopefully not boomeranging) and their expenditure has consequently fallen dramatically, while income remains fairly high.
This leaves open the option to make considerably larger pension contributions. The opportunity to take full advantage of employers who are willing to match employee pension contributions is huge, particularly if you work for one of the larger financial institutions where pension provisions from employers are very generous. It is like claiming free money. Either way, if you have an amenable employer, it is really worth discussing having as much of your salary as you can afford paid directly into your pension from your pre-tax income.
This is incredibly tax efficient, as you are paying the contribution out of pre-tax income, but you also do not have to pay National Insurance on the pension contributions.
The years prior to retirement are also a time where many employees are made redundant, getting the proverbial tap on the shoulder and the golden goodbye. Many of the redundancy packages can be very generous. There is the additional benefit that the first £30,000 of redundancy payment is tax free. Unfortunately, the rest is taxable and often at very high rates, depending on your own income and the time of payment.
If you are already a higher rate or additional rate tax payer, it is worth seeing if you can arrange for your redundancy to be paid out at the beginning of a tax year, so your tax status is as beneficial as possible.
Secondly, it is worth asking your employer to pay up to your available annual allowance (plus unused allowance from the previous three years) into your pension. This can once again save a substantial amount in tax and National Insurance and certainly beats losing up to 47% of your redundancy payment in taxes and National Insurance.
Defer taking your state pension and final salary pensions
The Basic State pension is a very useful benefit. It is much maligned by many, but if you looked at purchasing a similar income on the open market, I think you would be surprised by how much it would cost. It is reliable and the government carries all the risk of paying it. Furthermore, it has an element of inflation protection built in.
I also think that questions over its long-term availability over the generations are greatly exaggerated. This is not because I deny how much it costs to provide or that I am blind to the shrinking workforce and growing retiree population. Rather, I am aware that the State Pension is engrained into the British cultural psyche and is regarded by many as a crucial and inalienable right as they move officially into retirement. I therefore cannot see any government risking power by taking steps to reduce it or get rid of it. It is important to remember where the balance of voting power lies in the UK. The silver vote (as it is euphemistically called) carries a big stick and is not afraid to use it.
The new Basic State Pension provides £179.60 per week (£9,339.20 per year) provided you have built up 35 years of National Insurance contributions. For a couple that amounts to £18,678.40 per year, which isn’t a bad start. (This is based on 2021 figures and is only an example.)
However, if you delay taking your state pension, it will increase every week you defer, as long as you defer for at least 9 weeks.
Your State Pension increases by the equivalent of 1% for every 9 weeks you defer. This works out as just under 5.8% for every 52 weeks. The extra amount is paid with your regular State Pension payment.
By deferring for a year (52 weeks) you will increase your pension by £10.42 a week or £541.84 per year.
Similarly, many defined benefit (final salary) pensions, have an option which allows the pension to increase for each year that you defer taking the pension. For some this increase is simply in line with inflation, subject to a cap. However, for others the increase can be a fixed percentage which is often unexpectedly generous. It is therefore worth chatting to the administrator of your pension to find out what the rules are.
Make up any shortfalls in National Insurance provisions
As highlighted above, the new State Pension is quite a welcome (if under-rated) addition to your pension provisions. However, for many people they are not entitled to the full State Pension, as they do not have 35 years’ worth of National Insurance contributions.
This is often due to extended career breaks to look after children or care for an elderly or ill loved one, enforced unemployment or periods working overseas. It is often possible to obtain credits to make up the shortfall, but in some cases this option is not available.
Whatever the reason, it is possible to make up at least some of the shortfall in your contributions by paying voluntary National Insurance contributions. These generally have to be made within 6 years of the year you are paying for, however, the time limit has been extended in certain circumstances, as a result of the introduction of the New Basic State Pension.
The amount you will have to pay depends on the year/s you are looking to make the contribution for.
It is possible to go online to check your National Insurance record via your Government Gateway account at Check your National Insurance record - GOV.UK (www.gov.uk).
You can also complete an application form (BR19) and send it to the Future Pension Centre to get a state pension forecast. Application forms can be downloaded from GOV.UK.
Find lost pensions
As I mentioned earlier, one of the biggest problems that many retirees will face is locating all their pensions. This is due to the fact that the jobs market and careers have become so fluid these days. It is unusual for someone to work for the same company for the whole of their career. For many people, it is not unusual to undergo a complete change of career later in life. I can think of an acquaintance who retrained as an optician, after years of working as an account manager. In fact, people are likely to work for an average of 11 employers throughout their lifetimes (Telegraph 13/04/2021)
And if you think this is really an isolated problem, it is not. There is apparently £19.4bn in lost pensions waiting to be claimed in the UK. (Association of British Insurers, May 2020)
The question therefore arises, if you have lost pensions, how do you locate them?
Firstly, you can approach any old employers with your National Insurance number and details of your employment and they might be able to put you in touch with the pension provider or administrator.
If you are struggling to find pension details, you can always try contacting the free government pension tracing service by phoning 0800 731 0193. By doing this, you can find contact details for your old workplace or personal pension scheme. Once again, you will need to provide certain details of your employment in order to assist them in finding your pension details.
Lastly, if you were contracted out of the old State Earnings-Related Pension Scheme (SERPS) at anytime between 1978 and 2002, you may have built up pension benefits in a contracted out personal pension scheme. If you feel you may have had such a pension and have lost track of it, you can write to HMRC with your National Insurance number and your personal details and they will be able to let you know the details of any pension providers that they paid pension contributions into on your behalf, as a result of you opting out of SERPS.
Take financial advice
Lastly, taking pension advice can make a huge difference to how you use your pension assets in retirement. A good financial adviser can provide you with a clear withdrawal strategy, which will help you have the greatest probability of making your pension benefits last throughout your retirement.
An adviser will utilise sensible investment strategies, cash flow analysis, a safe withdrawal rate and a variety of responses to different market and personal circumstances to provide you with a roadmap through retirement, but also a realistic assessment of your circumstances.
You may baulk at this due to the possibility of extra costs or a feeling that you don’t have enough money or complexity to warrant financial advice.
With regards the extra cost, this is absolutely true. However, there are options that allow you to pay these fees out of your pension, so you don’t necessarily have to fund the advice out of your personal account.
The question then arises as to whether the advice is worth the cost. Research carried out by Numis Securities (Daniela Esnerova, Value of advice put at 2% as SJP returns top Hargreaves, FT Adviser, 24/09/2020) demonstrates that taking financial advice added on average 2% to an advised portfolio after costs, compared to a DIY investor portfolio. The most important thing to note about this analysis, is that it took into consideration both portfolio returns and costs. The Numis report is not a standalone piece research and is supported by numerous studies that show the benefit of taking advice on investor wellbeing and overall returns.
The International Longevity Centre published a report “The Value of Financial Advice” which found the following:
- Receiving professional financial advice between 2001 and 2006 resulted in a total boost to wealth (in pensions and financial assets) of £47,706 in 2014/16.
- The benefits of financial advice are potentially greater for those we term “just getting by” than for those we consider “affluent”: the former would have seen a 24% boost to their pension wealth compared to 11% for more affluent groups (those most likely to be advised).
- Evidence also suggests that fostering an ongoing relationship with a financial adviser leads to better financial outcomes. Those who reported receiving advice at both time points in their analysis had nearly 50% higher average pension wealth than those only advised at the start.
When considering the possibility that you don’t have enough money, financial advice comes in a number of different shapes and sizes and deals with clients of all different levels of wealth: whether they are just starting out or they have already built-up high levels of wealth.
Some advisers charge a fixed percentage of the assets under management, which is particularly beneficial for those just starting out, while others charge fixed fees, which may be more beneficial for wealthier clients with more wealth already built up, where charging a percentage of the assets would be potentially exorbitant. Advisers are able to adapt their fees according to your needs and to give you the best start possible.
In relation to complexity, you don’t know how much complexity you have, until you actually sit down with the financial adviser. You might be surprised by the number of things that get taken into consideration and avenues available to you. Once again, if you have a low level of complexity, then the adviser can adapt their service accordingly.
You may argue that you are able to handle your planning yourself and don’t need to pay for the service. You are absolutely correct. However, if you haven’t been doing it up until now, why are you suddenly going to start doing it in the future?
There are a number of things you can do yourself, but don’t. Many people can clean their houses themselves, but rather pay £200 per month to have someone come in and take care of the cleaning for them. The advantage of this is that it buys them time and a better quality of life and it is likely that the cleaner will do a better job.
Once again, you could probably sort out your own accounts, but the time and knowledge required and implications of getting things wrong, means that you leave it in the hands of a professional accountant. I have been paying £240 per month for my accountant, simply to free me up to focus on other matters. I am chartered and fully capable of doing this myself, but my accountant’s long experience and qualifications means that they should get things right and will spot opportunities and errors that I may well miss. The extra time and security means that I value this service and do not begrudge the fee. It should be the same with financial advice.
The list of options above for potentially improving your pension situation is not intended to be exhaustive. These are a few ideas to provide you with a starting point.
The key thing to all of this is to pool together all of your available resources, ensure that they are held as tax efficiently and cost effectively as possible in a suitable investment portfolio.
When everything has been marshalled together, and you have clarity on what you have and are likely to receive, you can then also calculate what you will need and whether there is a shortfall. By establishing resources relative to need, you can then start putting in place a plan to make up any shortfall or adjust to make provision for it.