Planning for Retirement with Superannuation
Few terms within the arena of retirement planning are as confusing as 'superannuation'. Much of the confusion lies in the different definitions of the term found in the UK and other countries like Australia and New Zealand. The different definitions not only make it difficult for pension investors to get a handle on what they are doing, but they may also lead to financial problems among UK expatriates who decide to retire to a country offering superannuation schemes that do not comply with UK rules.
Under the strictest definition of the term, superannuation is defined by Investopedia as follows:
“An organisational pension program created by a company for the benefit of its employees; also referred to as a company pension plan.”
In order to draw a distinction between the UK definition and the one utilised in Australia and New Zealand, we prefer to describe superannuation as a process of saving for retirement rather than an actual scheme in and of itself. Understanding this distinction makes it clear how things work here as opposed to other countries.
The Process of Superannuation
Referring back to the Investopedia definition of superannuation reveals a link between the process and what we commonly refer to as company pension plans. In this regard, superannuation is relatively simple.
An employer establishes a workplace pension and then offers it to all qualifying employees. By the way, auto-enrolment rules ensure that nearly every employee will be offered such as pension by the end of 2018. Once that pension is established, the employer provides qualified workers with the necessary information to determine whether they want to participate or opt out. Those who choose to participate must agree to the management policies of the pension fund.
These policies will include minimum contributions as well is a timetable for when those contributions are made. In almost every case, the employer deducts the appropriate amount of money from a worker's salary and diverts it directly into the pension fund. This is usually done during every pay period. The automatic nature of this process is what qualifies it as superannuation.
In essence, a superannuation scheme in the UK is a workplace pension in which contributions and deductions happen automatically. Pension members have no say in the matter once they sign the documents necessary to begin participating. From that point forward, everything is handled by the employer and the pension provider.
Advantages and Disadvantages of Superannuation
- Automatic Savings – Having money set aside automatically is a big benefit to people who have trouble budgeting for savings. Some have even likened superannuation to 'investing in yourself'. A superannuation scheme makes it easy to set up a savings plan and then forget about it.
- Future Benefits – Obviously, setting aside money in a superannuation pension scheme provides future benefits by way of eventual retirement income. The principle of little bits here and there adding up to something big certainly applies with superannuation.
- Low Risk – Superannuation pension schemes are comparatively low-risk investments. They are designed as such in order to provide the maximum possible protection to all members. You may not become independently wealthy through superannuation, but you are unlikely to lose your shirt either.
As beneficial as superannuation schemes are, they also have their drawbacks. Two of the disadvantages are:
- Lack of Flexibility – The superannuation scheme is very rigid in terms of contributions and investment options. That means you get very little flexibility with superannuation. Investors who want more flexibility usually prefer to put their money into stakeholder pensions or SIPPs.
- Limited Earnings – The low-risk nature of superannuation limits your earnings as a result. For this reason, some investors put a modest amount of money into a superannuation scheme but then take extra income and use it to invest in more profitable opportunities.
There is no right or wrong where superannuation is concerned. Just like any other kind of investment, how superannuation can be utilised in your circumstances requires looking at your overall goals, how much money you have to invest, and how you intend to make your goals reality.
Superannuation as Part of Your Plan
Every worker in the UK should make the effort to establish some sort of retirement plan as soon as possible. There is very little chance of having enough income once you stop working if retirement planning is not something you have purposely pursued. And unfortunately, we in the UK have a bad habit of failing to plan. If you have not yet started working on a retirement plan, remember this old adage: failing to plan is planning to fail.
Superannuation is a good place to start your retirement planning because it is so easy to do. Under new auto-enrolment rules, almost every worker in the UK will have the opportunity to participate in a workplace pension scheme under one of the following three conditions:
- Auto-Enrolment – Workers who are over the age of 21 and earn a minimum amount are eligible to be automatically enrolled in their company pension plan.
- Opting In – Workers who meet the age requirements for auto-enrolment but do not earn enough money to qualify, will still qualify for opting in. This means they can choose to participate in a workplace pension with full expectation that the employer will contribute.
- Voluntary Participation – Even workers who do not qualify under auto-enrolment or opting in can access workplace pensions through voluntary participation. They can enrol in a company pension even though their employers are not legally obligated to contribute.
You could make the case that new auto-enrolment rules were one of the best things to happen to superannuation in a long time. As such, superannuation could be the place to start your retirement planning.
We say 'start' because your retirement goals may require more income than your workplace pension can offer. For example, let us assume that your employer offers a NEST pension that will require 5% contributions from you beginning in 2018. A 5% contribution on a salary of £25,000 would amount to £1,250 annually. Over a 40 year working career you would manage to put away roughly £50,000. Even with an annual return of 10%, that amount of money isn't going to go very far in providing your retirement income. If you want more, you will have to consider other ways of investing.
The stark reality of superannuation is one of the reasons financial advisors are continually urging people to begin planning as early in their working careers as possible. The worker who has 40+ years to save for retirement is in a far better position than one who waits until age 50 to think about it. A younger worker can put money into a superannuation scheme as part of a long-term, low-risk strategy, but he or she can also put additional income into more aggressive investment options to more effectively grow his or her retirement income.
There is no single financial plan that works well for every person. Therefore, we urge you not to just do what everyone else is doing. Make the effort to work with a financial advisor who can help you identify your goals, assess your current situation, and develop a strategic plan that will make your retirement goals reality. If superannuation is part of that plan, great. If not, that's okay too. Do whatever it takes to provide the retirement income you will need.
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