By Naomi Caine, 07/11/2008 00:00

Are pensions pointless?

Picture this: You've worked hard all your life and dutifully saved into a pension. You are now in your late 50s and looking forward to retirement. But then you receive a letter from the managers of your pension fund - and your dreams are shattered.

Your fund has plummeted in value along with the stock market. Worse, there might not be enough time to make up the losses before you retire. It's a nightmare scenario, but it is a reality being played out in many homes across the country.

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Millions affected
About four million people are members of so-called defined contribution or money purchase pensions run by their employer. The schemes offer no guarantees. Instead, they invest in a range of assets, primarily shares. How much you get at retirement depends on the performance of those investments.

But the value of defined contribution assets plunged by nearly 30% to £395 billion between October 2007 and October 2008, according to research by Aon Consulting. In other words, if you are a member of a company money purchase pension, your fund has lost a third of its value.

Let's say you had built up a pension pot of £30,000. It could now be worth as little as £20,000. If you are due to retire in five years, the loss could blow a hole in your retirement plans.

Your pension in the crunch

Annuities reduced
Most people buy an annuity with the bulk of their pension fund when they retire, which pays a guaranteed income for the rest of their lives. A pension of £30,000 could buy an annual income of about £2,100. If you have only £20,000 to spend, you could expect an annual income in retirement of just £1,400.

"It may appear a double blow to workers that not only are they facing more of a struggle to make ends meet, but the economic turmoil is also seemingly eating into the money they have been putting aside for retirement," said Helen Dowsey of Aon Consulting.

Exposed to market jitters
Personal pensions, like company money purchase plans, invest heavily in the shares. So they too are exposed to the falls in the stock market.

Even final salary schemes are not immune from the global downturn. Final salary schemes, sometimes known as defined benefit plans, are guaranteed by the employer. The amount you get is typically based on the number of years of service and your salary at retirement. But Aon has warned that the UK's 8,000 final salary pension schemes lost an estimated £226 billion in the last year. Of the 200 biggest schemes, 64% are now in deficit.

Final salary schemes threatened
These deficits threaten the future of final salary plans. Many firms have already closed their schemes to new employees in an effort to contain costs. A total of four out of every five final salary plans is now shut to new workers. Companies are also watering down the plans.

A common tactic is to close a scheme to future accruals. In other words, your future years of service will not count towards your pension. Aon estimates that half of employers in the UK with final salary schemes could be closed to future accruals by as early as 2011.

What happened to our pensions?
How did we get into this mess? Surely we pay our pension managers to, well, manage our pensions. Did they not foresee the fall in share prices? Could they not have moved our money into safer assets, such as cash or bonds?

Laith Khalaf of Hargreaves Lansdown, an independent financial adviser, said: "Some company schemes include a lifestyling option and gradually shift your money out of equities in the run up to retirement. But too many people understand too little about their pensions. You should find out where your fund is invested and if there are any alternatives."

Are pensions pointless?
Or how about pull out of the scheme altogether. Surely pensions are pointless if they are not going to provide a decent income in retirement? Why not spend the contributions throughout your working life and fall back on the state scheme in your old age?

It's tempting to call time on pension savings, but it might not be altogether wise. If you are a member of a final salary plan it makes little sense to give up. Your pension is still the gold standard and the only real worry is if your employer goes bust and the scheme is in deficit.

For future retirement, there are big benefits
Even if you are a member of a money purchase plan, your employer most likely contributes to your retirement fund. If you refuse to join the plan, you therefore miss out on the contributions. It's a bit like turning down a pay rise.

Then there's the tax relief, which applies to all pensions, company and personal. If you are a basic rate taxpayer, the government makes up to £1 every contribution of 80p. Higher rate taxpayers can claim the extra 20p through their tax return.

Anyone thinking of throwing themselves at the mercy of the state should also find out their likely entitlement. The basic state pension is just £90.70 a week, which is hardly going to fund a round the world cruise.

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Bad news for soon-to-be pensioners
Of course, these are just meaningless numbers if you are staring a pension loss in the face. If you are due to retire with a depleted fund, you are confronted with some stark choices.

You can either take the loss on the chin, delay retirement, or buy an annuity with some of your fund and leave the remainder invested in the hope of future profits.

Tough choices
The rest of us must also make some choices. Pensions might not be pointless but the recent stock market downturn has served as a harsh reminder that they are not failsafe either.

Members of company pension plans should start to take an active interest in their scheme - and fast. Find out where the money is invested and if you can switch to a different fund. Also ask about lifestyling. The government-funded Pensions Advisory Service recently warned that workers who paid into pension schemes might not be aware of the risks of investing in shares. So get risk aware!

If you have a personal pension, how good is your manager? It might be a bit unfair to judge the fund on very recent performance, but you should check the track record. If it isn't up to scratch, find out about any penalties and then consider switching. In the world of pensions, loyalty doesn't necessarily pay.

You might even want to set up a self-invested personal pension (Sipp) which gives you total control over your pension investments so you don't have to rely on a manager.

It's also worth remembering the old adage that you shouldn't put all your eggs into one basket. Yes, there are advantages to pensions but there are also advantages to a savings account, bonds, gilts, gold - even property. If you depend only a pension, you could be disappointed.

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