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Save now or pay later

We all know that considerable saving commitment is required for life&#39s longest holiday.

But very few individuals in occupational pension schemes make full use of the 15 per cent annual limit on pension contributions. Most occupational pension schemes will deduct 5-6 per cent gross salary as a basic contribution, leaving many individuals with significant scope to make pension top-ups.

Company scheme members have three main options for making voluntary contributions. Some final-salary schemes allow the member to buy extra years of service within the main scheme.

If this is not an option, then a scheme member can pay in to an in-house additional voluntary contribution arrangement run alongside the main scheme or they can taking out a free-standing AVC contract, which is run by an insurance company, pension provider and investment management company and is totally separate from the employer&#39s main scheme.

Current changes to the pension landscape are (and increasingly will be) having a significant impact on pension investment decisions. Mintel expects employers to call time on generous final-salary pension schemes and replace them with moneypurchase arrangements. Run in a similar way to most AVCs and FSAVCs, such schemes offer no guarantees of a particular income in retirement.

Those who invest in a personal pension scheme are allowed to take up to one-quarter of the accumulated pension fund as a tax-free lump sum. Members of money-purchase occupational schemes can take some of their benefits in the form of tax-free cash but the maximum amount is limited by reference to an employee&#39s length of service and final earnings. AVCs and FSAVCs do not, however, share this benefit.

However, like money-purchase pensions, with money-purchase AVCs and FSAVCs there is an obligation to buy a pension annuity (although this can be deferred until the age of 75) which will pay a fixed income for the rest of the pensionholder&#39s life.

At the moment, annuity rates are low and are forecast to stay low for the foreseeable future, meaning the annuitant is looking at a low return, with no possibility of improvement. Furthermore, like all other forms of pension payments, annuity income is taxed.

Poor annuity rates have prompted suggestions that investment in products such as Isas which invest in stockmarkets might be a better option for retirement saving and more so for pension topping than perhaps an AVC or FSAVC.

Like pensions, Isas are tax-efficient but work in the opposite way. Isa investments are made out of taxed income but any investment growth is free of income tax and capital gains tax.

Also, through to April 2004, Peps and Isas have an added attraction of a 10 per cent tax credit on dividends. Mintel believes that, in a low annuity rates environment, investors will increasingly look for diversity in their retirement investments.

From April 2001, employees earning less than £163;30,000 will be able to contribute into a stakeholder pension and, at the same time, belong to their employer&#39s defined-benefit scheme. Currently, occupational scheme investors who want to make extra pension contributions have to use the AVC scheme that their employers offer or an FSAVC scheme run by a pension or investment company. Accordingly, rules regarding concurrency will most likely lead to a radical shake-up of the AVC and FSAVC industry.

For many, the stakeholder pension will be a better pension top-up option. By making pension top-ups into a stakeholder scheme, investors will be able to take a tax-free cash lump sum from the pension on retirement, an option that is not open to AVC and FSAVC investors.

A pension lump sum will be particularly attractive to investors especially at a time when annuities are at an all-time low. In contrast with AVC and FSAVC plans, investors will not have to wait until they are allowed to draw a pension from their company scheme to cash in their stakeholder pensions.

Under the stakeholder proposal, investors will be able to draw an income at any age from 50 onwards.

Also, under the stakeholder proposal, providers will have to cap their annual management fee to no more than 1 per cent. This is likely to be better value than almost all AVC and FSAVC schemes. There are widespread fears that the stakeholder pension could have an impact on the uptake of occupational arrangements. Providers of company schemes fear that the publicity will remove interest in traditional occupational arrangements and, worse still, prompt companies and members to move from occupational schemes to stakeholder pensions.

Accordingly, a move by employers to money pur chasestyle stakeholder pensions would curtail demand for AVCs and FSAVCs since pension top-ups could simply be made within the stakeholder scheme. Some 47 per cent of company sch eme members make AVCs or FSAVCs. AVCs are the most common method of topping up occupational pension provision. In total, about 34 per cent of occupational pension scheme members claim to be making in-house AVCs.

AVCs are often seen as a better option for pension provision since schemes usually have much lower charges – around 1 per cent or less – and often the employer will bear all the costs of running the scheme. Unlike AVCs, free-standing arrangements often attract higher charges to cover set-up costs, commissions for advisers, advertising costs and management fees.

Despite these typically higher costs, about 13 per cent of occupational pension scheme members make FSAVCs.

FSAVCs provide the investor with a wider choice of pension investment than AVCs and are fully portable, meaning they can be kept running or can be converted into a personal pension if the employee changes job.

The most realistic targets for pension top-ups are, of course, those who delay starting to make a pension savings until late on in life and/or those who have gaps in their current provision. Only around one-quarter of adults start making their pension contributions before the age of 25.

About 71 per cent of these consumers claim they have always made regular pension contributions.

Those who start a pension later are more likely to have no gaps in their retirement provision. However, they will often need to make pension top-ups to compensate for years of pension underfunding.

It is widely acknowledged that many consumers reach 45 unaware of what sort of final pension they can expect. Many of those who do obtain a forecast from employers, pension providers and the Department of Social Security are shocked to find their funds fall well below their expectations.

Almost half of working adults believe their current retirement provision is adequate to provide them with a comfortable retirement, a further third believe their savings are insufficient and the remainder simply do not know. The Government&#39s decision to provide all working adults with pension forecasts is likely to prompt many into topping up their existing pension provision.

Based on the combined factors of age at which a pension was started and the regularity and sufficiency of pension contributions, only around 28 per cent of working adults are financially prepared for their retirement. A further 33 per cent pf working adults are making (or have made) pension contributions but need to top up their funds to make up for gaps, late starting or insufficient contributions and a further 39 per cent have yet to start saving for retirement.

The pensionless and those who are underfunding their existing pension will be the key targets for pension providers. But, despite the fact that many working adults would consider making additional pension contributions, the reality is that many have little money with which they would actually be able to save.

In total, about 47 per cent claim they could not afford to make any further pension savings and a further 23 per cent say they could save no more than £163;50 in addition to their existing pension provision (if any). That makes for frightening reading.

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