plonkee money an english-er's thoughts on personal finance

May 28, 2009

pensions are investments

Filed under: retirement — Tags: , , , — plonkee @ 7:23 pm

You shouldn’t take financial advice from a Baptist minister.

I was listening to Radio 4’s Thought for the Day earlier on, where a Baptist minister was talking about the sensible, risk averse people having to bail out the more foolish, risk takers. Bail outs are not universally popular, but one thing in particular that he said stuck out to me. He said that he has his whole fortune safely in a building society.

are building societies safe?

Of course, you’ll all be aware that building societies are not intrinsically safe. Your money is only as safe as either the institution you’ve put the money in, or if that fails, the extent to which it’s guaranteed by a government scheme such as the Financial Services Compensation Scheme.

When you hold money in a building society, you hold it in cash, and cash has its own risks. There’s the risk of inflation eating away at your money, and the opportunity cost – the chance that you could have done better with your money elsewhere.

do you have money elsewhere that you forget about?

I suspect that the Baptist minister in question doesn’t have his whole fortune safely in a building society. I can’t be certain but it’s likely that he expects to enjoy a ministers’ pension when he retires, he’s probably contributing to one right now.

what do pensions have to do with anything?

Well, work and personal pensions are part of your fortune. Especially if you are planning on retiring one day on more than the state pension. Final salary pensions are much sought after, because they offer great benefits to retirees. But those benefits need to be paid for.

You might think that if you have a final salary pension, it comes with some sort of cast iron guarantee. But it doesn’t. There’s only one place that the money that you pay in can grow into enough to pay out, and that’s in investments. Regardless of the type of pension that you have, there’s no secret money cupboard.

If you have a final salary pension, then the trustees and the scheme actuaries decide where how the money should be invested – usually in stocks, bonds, cash and property – and try to ensure that there will be enough money to cover everyone’s pension. That’s why a lot of schemes are asking members to contribute more, for the same or lower pension when they retire. If they don’t, there isn’t going to be enough money to pay everyone’s pension, because money doesn’t grow on trees.

If you work in the public sector, the taxpayer could be forced to pick up the tab if there’s a shortfall, but don’t count on everyone else voting for that.

If you have a money purchase or defined contribution pension, then you can directly control your investments. You should take the opportunity to learn about risk and investing, but there’s probably a default set-up that is at least vaguely appropriate.

maybe I shouldn’t invest?

There is always the risk that your pension might not be worth as much as you hope, but it’llĀ  be better than nothing, and it’s very likely to be better than just sticking the money in a building society, as there are tax breaks, (and often employer contributions) for using a pension wrapper.

Nearly everyone is invested in risky things and it’ll probably turn out ok. In the long run. Don’t use the current economic climate as an excuse for delaying your investing.

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