Cash alternatives sound like a great idea to me. Does this mean we can go out and spend the money straight away on whatever we like?
This is something the experts are very worried about. They fear that everyone’s going to go for the cash option and use the money for short-term financial needs rather than for saving for retirement.
”People tend to be over-optimistic about how well off they might be in retirement, so if they are offered the money then they are likely to take it and spend it on other things,” says Jonathan Watts-Lay, head of UK marketing at JP Morgan Fleming. “The problem is that people are not saving enough for their retirement at the moment, so giving them the option to delay that pension saving could just make things worse. “If you can access the funds before retirement, there is a good chance that you will do so. This may solve some immediate need, but it leaves the retirement problem unsolved.”
But I’m only 25 and I want to spend the money now. Surely I don’t need to start paying into a pension yet.
Francis Klonowski at financial planning consultants Klonowski Co says: “I think being of a young age could be used just as well for an argument in favour of using the money for pension contributions. I remember a phrase from an old-fashioned life assurance type salesperson many years ago: ‘The first pound makes the most money’. With the sums needed to fund a decent retirement, there probably isn’t such a thing as starting too early.”
But what about spending the extra funds on more important things like a house? First-time buyers need all their money to get a foot on the property ladder.
OK, but while that might solve your house buying problem it doesn’t solve the problem of retirement income. Experts make the point that by the end of a full working lifetime most people will have amassed two substantial assets: a house and a pension. “The best way to fund both is to do so regularly over as long a period as possible, starting as young as possible,” says Steve Bee, head of pensions strategy at Scottish Life. “Concentrating on just the house as a lifetime purchase could leave you with insufficient means in retirement and would be likely to put you in a position where releasing equity from your property is your only realistic option to provide income, other than working until you drop, of course.”
So you’ve convinced me that saving for my retirement is important, but what choices do I have if I choose to take the cash but still want to pay into a pension?
There is a range of options for retirement planning and what you choose will depend on your circumstances. Options include an alternative money purchase scheme, a personal pension, a self-invested personal pension (Sipp) and a stakeholder pension.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “The stakeholder plan is probably the best choice for people who don’t really know what they are doing. If you want more choice, you should invest in a personal pension. The next level up from that is a Sipp, which would offer you more flexibility to choose the investments within your pension fund.”
He says the most sensible option would be to have your employer pay the contributions directly into your pension scheme. This could be an existing scheme that you may have already with a previous employer. If you have the money directed straight into another pension scheme, it will be treated in the same way as it is for your employee pension scheme and you won’t be taxed on that money.
Will my choice be affected by the type of scheme I am already in?
Of course. If you are in a money purchase scheme it will matter much less if you decide to start paying into another plan.
If you are in a final salary scheme, it is unlikely that you will want to take the cash alternative, particularly if you are older. The older you are the more the employer has to pay into the scheme so the more you would need to negotiate in cash as an alternative to make it worthwhile.
So there seem to be quite a few options, but the real question is: “Should I take the cash alternative or not?”
Advisers tend to be against taking the cash, with one even saying: “I can’t see it working, and if you’re offered it, you should refuse.”
This is because, if the cash is not used to invest in a pension plan, you will not be benefiting from the attractive tax advantages. “The cash option, however, could cost an employer more because it would need to pay national insurance (NI) on the cash payment whereas employer contributions to a pension plan are free of NI,” says Jerry McLoughlin, director of private clients at Punter Southall Financial Management.
However, other experts believe employers will pass the tax on to employees. “A typical pension contribution of £100 is likely to only be £87 in cash because the employer will have to pay NI contributions on it and is unlikely to pay that on top of the cash,” says John Turton, director at Bestinvest.
It’s starting to sound like a bad idea. Are there no advantages to taking the cash?
Don’t get me wrong. It would be the sensible option for high net worth individuals approaching retirement.
”High earners who are close to the £1.5m pension cap should take the cash alternative because there is no point in them continuing to have money paid in pension contributions if they have already reached the limit,” says Turton.
