Just what has Spider-Man got to do with planning for your retirement? It’s a good question. I’ll spare you the photos of me in my Spider-Man get-up as a kid, but as a fan of the franchise, I can quote the odd line. When it comes to pensions, the quotation I have in mind is from Uncle Ben, when he cautions Peter Parker (a.k.a Spider-Man), and says “with great power comes great responsibility”
A little Googling puts the origin of this quotation much further back in ‘real’ history but as a Spider-Man fan, I’ll stick with the Uncle Ben origin story.
But back to its relevance to retirement planning. Before I explain let’s take a step back and explore some changes you may have seen or experienced in the pensions world.
From Defined Benefits to Defined Contributions
When you think of retirement planning, Defined Benefit (DB) schemes may come to mind. You may have heard these referred to as final salary schemes.
These schemes, which are funded by the sponsoring employer, are commonly referred to as “gold-plated” pensions, as they promise to provide members with an index-linked income for life. The amount of income you receive as a pension simply depends on how much you earn and your length of service.
DB schemes are expensive to run however, and so we’ve seen their decline in recent years, with very few schemes now accepting new members. In their place, Defined Contribution (DC) arrangements have emerged. The more comic book minded of you may think I’m sneaking in a DC Comics reference in here. I’m not – it’s just a happy coincidence that they share the same acronym.
DC arrangements, such as personal pensions, differ greatly from their DB counterparts. There is no specific level of income guaranteed. Instead, they are essentially investment pots. The member pays into the pot and the value is determined by the level of contributions and the performance of the underlying investments. Today, most workplace pensions are DC arrangements with the employer contributing alongside the employee each month.
With DC arrangements, the responsibility rests with you to ensure there is enough going into the pot and that it’s invested appropriately to provide you with the money you need when work comes to an end. This is the key difference from DB schemes, where the responsibility lies solely with the employer.
That’s where the power and responsibility comes in. You have more power over your DC arrangement, and that brings with it far greater responsibility.
It is vital that you ensure you are paying enough into the pot, whilst also ensuring the underlying investments are structured appropriately to deliver for you. Failure to do so could impact your ability to live the life you want, later on.
Taking the benefits from your arrangement
When it comes to taking benefits from a DC arrangement, legislative changes in recent years mean that you now have a high degree of choice as to when and how you go about doing so. By contrast, DB schemes are much less flexible in this regard.
Having the power to tailor your retirement income strategy to your needs is a great thing. It does however leave you with the responsibility of solving what Nobel laureate, William Sharpe, refers to as the “nastiest, hardest problem in finance”. That is the challenge of balancing your desire to spend today with the need to ensure that you have enough for the remainder of your life.
To solve this problem effectively requires a clear understanding of your wider financial position along with the application of a cohesive investment strategy across your assets. All the components of your financial life need to be pulling in the same direction, dictated by an understanding of what it is that you hope to achieve in the future.
Wealth planning across generations
Pensions and DC arrangements can provide the ability to efficiently transfer wealth to the next generation and so this too is an area where your decisions will have consequences – hopefully of a positive nature – for years to come.
We work with our clients to ensure together that they remain on track throughout their lives. If you aren’t working with a Financial Planner, let’s have a chat to see if we can help.