Here’s the bad news: working out the value of a pension isn’t straightforward! It depends on the type(s) of pensions you have and when you want to retire, among many other things.
In this article, we’ll talk about the types of pension you could have, how their values are calculated, how you can get a projection of your pension fund’s future value and what to do after that.
Defined Contribution pensions
A Defined Contribution (DC) pension is a pension fund that you (and if you’re in a workplace scheme, your employer pays into) and the total pot can be used to buy an annuity or take un-crystalised pension lump sums, as your income needs require it.
It’s possible to find out what your DC pension could be worth when you retire by contacting your pension provider or using other free services, like moneyhelper.org.uk. The projection will factor in investment growth (5 per cent is typical) and inflation-linked growth in your earnings when giving you a projected figure.In some ways, this is the easy bit – the true value of the fund is in how much income it can provide you in retirement. This is determined by several factors.If you want to buy an annuity when you retire (trading your fund for a guaranteed payment for the rest of your life) then the insurance company will assess how long you’re likely to live for based on your health and life expectancy and the current value of your fund. If someone is in good health at 65, the insurance company might expect them to live for another 20 years, so the calculation would be (roughly) total fund value / 20 = annual payment.
Payments stop when the pension holder dies, most of the time. There are ways to ensure payment continues for a spouse for example, but the insurance company will factor this in and the overall annual amount they will offer you is likely to be less.
The most common method at the moment is to flexibly withdraw from a pension fund, so the rest of the fund remains invested and has the opportunity to continue growing in the stock market.
For example, you might have a pension pot of £200,000 and you withdraw £20,000 to live on. That means £180,000 will still be invested. If it grows by 5% after charges, you will have a pot of £189,000 to draw down on next year. Of course, there’s a risk that the pension may lose value in the market and this method makes it trickier to gauge the value of the pension because it will be subject to market conditions and the amount you withdraw. This method also allows you to pass on whatever is left in the pension fund when you die.
So, the value of the fund comes down to the decisions you make at retirement. Are you attracted to the certainty of an income, even though it might be substantially less than what you could have through flexible drawdown? Or would you prefer to take the risk of keeping your fund invested?
Defined Benefit pensions
To find out the value of a Defined Benefit (DB) pension, you should contact your scheme administrator as these pensions are subject to terms and conditions set by the scheme administrator.
They were designed to offer a guaranteed payment for life to the holder, upon their retirement and that is still their primary purpose.
Some people have ‘transferred out’ of their final salary scheme and have obtained a cash equivalent transfer value (CETV), which is the cash amount your scheme will give you upon transferring out. This is a calculation of the cash required now to generate the equivalent monetary amount guaranteed by the DB pension in retirement, again, assuming investment growth. However, in the majority of cases, this is not likely to be suitable as the DB pension is usually the best outcome.
The State Pension
Don’t forget, you may be entitled to State Pension provision in retirement, according to your level of National Insurance contributions (35 qualifying years to get the full new State Pension. You’ll get a proportion of the new State Pension if you have between 10 and 35 qualifying years).Asking a simple question like ‘how much is my pension worth?’ can throw up many more questions. To ensure you’re making the decisions that are most suitable for you, please speak to an independent financial adviser.
If you’re a long way off retirement you have a long time to get your strategy right so agreeing that now can give you peace of mind for the long haul.
If you’re very close to retirement, a tweak here and there and the right mix of retirement income products could make a big difference to your income in retirement.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Pension income could also be affected by interest rates at the time benefits are taken.
The tax treatment of pensions in general and tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future.
Accessing pension benefits early is not suitable for everyone early and may impact on levels of retirement income and your entitlement to certain means tested benefits.
You should seek advice to understand your options at retirement.