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Choosing the Right Pension Investment Vehicle

Richard Beardsworth Pension Expert

By Richard Beardsworth.

Independent Financial Advisor

More Reading on Personal Pensions...

As a worker preparing to invest in a pension, you have many decisions to make. You have to choose what kind of pension you want to put your money into as well as the right investment vehicles within your chosen pension. The choices you make ultimately determine how much retirement income you will have.

It is important that you take the time to educate yourself and make a point of sitting down with a financial advisor to create a suitable retirement plan. However, do not panic over having to make pension investment choices. With some rare exceptions, you can always make changes down the road if the decisions you make today do not offer the results you are hoping for. The key is to stay on top of things at all times so that you can make modifications when needed.

Choose the Kind of Pension First

Your first pension investment decision relates to determining the kind of pension you intend to invest in. If you are like most people, you will invest in only one pension at a time. You can elect to have several pension funds going simultaneously if you have sufficient income to contribute. The three most common pensions for UK workers are:

  • Occupational Pensions – Also known as a workplace pension, the occupational pension is a scheme offered through your employer. Most occupational pensions these days are defined contribution schemes arranged through specialist pension providers, banks, or insurance companies. Government employers also offer occupational pensions that may be either defined contribution or defined benefit schemes.
  • Stakeholder Pensions – The stakeholder pension is one that is arranged by the investor in partnership with a bank, insurance company, or specialist provider. Sometimes companies offer stakeholder pensions alongside their occupational pensions in order to give workers another choice.
  • Self-Invested Personal Pension (SIPP) – This pension is one arranged by the investor with a specialist pension provider. Although an employer can contribute to a SIPP, the scheme itself is entirely separate from the workplace. A SIPP contract is established without deference to the employer.

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A fourth kind of pension, known as a qualifying recognised overseas pension (QROPS), is not one you would invest in directly in the same way you would one of the other three. Rather, it is an overseas pension scheme into which you would transfer your existing pension fund for the purposes of retiring abroad. QROPS are regulated to prevent investors from using them as loopholes to get around pension rules.

Investing Your Pension Monies

Once you choose a pension and begin contributing, what happens to your money? As Money Saving Expert founder Martin Lewis explains, pensions are a risk-based investments rather than guaranteed investments. Allow us to explain the difference.

A guaranteed investment is one in which the investor is guaranteed to not lose principal under any circumstances. Savings accounts and bonds are good examples. No matter how much money you put into a savings account or bond, you will always get that amount back at maturity. You usually get a small amount of interest as well.

A risk-based investment is one that comes with no guarantees. What you put into it is subject to gain or loss depending on how well your chosen investments perform. Stocks and shares are good examples of risk-based investments. Because pensions are typically invested in these kinds of vehicles, they are considered risk-based investments as well.

With that in mind, you will be able to choose from various types of investments when setting up a pension. Note that your pension provider may limit your choices to some degree. Typical choices include:

  • Stocks and Shares – You may be able to choose direct investment in stocks and shares or indirect investment by putting your money into funds that pool it with the contributions of others before investing in stocks and shares.
  • Government Securities – A government security is a bond or note guaranteed by the government. By investing in government securities, you are giving the government access to your funds for the purposes of financing its needs. You are essentially loaning to the government.
  • Insurance Company Funds – Insurance companies make money by investing. When you put your money into an insurance company fund, you are supplying the capital they need to finance their own investments.
  • Endowment Policies – Endowment policies are essentially life insurance contracts. Investing in such policies provides an insurance company with the money they need to make lump sum payments. In exchange for providing the financing, the insurance company generates a return on your money.
  • Property and Property Funds – Some pension schemes allow members to invest in commercial property or property funds. Investing in a property fund is an indirect way to enjoy the benefits of property investing without actually purchasing property as the sole owner.

There are plenty of other options we have not listed here. Those above simply represent the most common options found in UK pension schemes. What's important for you to note is that each option carries with it a level of risk and return. Weighing risk versus return is an important part of making the right pension investment decisions.

Be Sure to Get Advice

The average occupational pension is not going to expose you to an excessively high level of risk. Occupational pension providers are not in the business of allowing their members to wind up broke at retirement. Most of your options with an occupational pension are going to be low to moderate risk.

As for stakeholder pensions and SIPPs, these are a different matter entirely. Both kinds of pensions offer a wider range of investment vehicles from which to choose. Some of those vehicles offer low risk and low reward while others offer higher reward in exchange for higher risk. It should be clear that you need to get good advice in order to account for your level of risk aversion.

Changing Your Investment Options

You will eventually decide on your pension investment options after getting all the information and seeking out the proper amount of advice. Once those decisions are made, it is time to let your pension start doing its thing. Monitor the performance of your investment choices over 10 to 12 months’ time. Prior to the annual renewal, you should get a pension statement from your provider detailing how well you have done in the past year.

With that information, you can determine whether changes need to be made. For example, let us say one of the mutual funds you invested in returned only 0.5% compared to a secondary fund that returned twice that amount. If that secondary fund is forecast to do equally well in the coming year, you might want to take your money out of the first fund and transfer to the second.

Additionally, you may be convinced to use some higher risk investment vehicles in order to encourage better growth. However, if the return after 12 months does not justify the risk involved, you might want to transfer some of your money into something less risky. The point to understand is that you can always shift your money around from among the pension investment options your provider offers.

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One final option is to transfer out of your current pension and into an entirely new scheme that improves your financial position. Such a move is not right for everyone, especially since there are fees and charges involved, but it can be the best move if there is enough disparity between what you are currently earning and what you could earn in a better scheme.

Your pension investment decisions will determine your future income. Do not make them likely. Take advantage of all the free guidance and the advice of a certified financial advisor to make the most of your money.

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