Ultimately the way you invest your contributions is a personal matter and will depend on your individual circumstances. It's likely that your choices will change over time as you progress through your working life. Some particular issues you may be faced with at different stages of your career are:
Aberdeen Asset Management Life & Pensions Limited does not provide advice on the suitability or otherwise of specific investment transactions. You should contact an independent financial adviser to determine an investment strategy which is most appropriate to your specific circumstances.
Balancing risk and return over the longer term
A longer term view is critical in the context of retirement planning. If you have many years to go before retirement you have time to let your investment recover from any short-term falls. Above all you need to make sure your savings are protected against inflation.
Overall, one effective way to guard against the risk of inflation eating into your savings is to invest in assets that are likely to increase in value more rapidly than inflation over the longer term. For a lot of investors this means investing primarily in equities for the majority of their working lives, in order to maximise the value of their funds at retirement.
Protecting against market fluctuations closer to retirement
As you get closer to retirement, your investment horizon shortens. Remaining invested totally or primarily in equities becomes a more and more risky strategy, as there may not be enough time to build your savings up again should the equity markets suffer a sudden fall.
A common question from pension scheme investors is "How long is the longer term?" There is no single point when your longer-term horizon becomes short-term. Your individual needs and circumstances will be very different from those of your colleagues. But, at some stage in the years before you retire you will generally need to think about stabilising your investments, and protecting them against market fluctuations.
At this stage it may be sensible to consider diversifying by switching more of your investments into less volatile assets than equities. A greater proportionate investment in an asset class such as bonds may be desirable at this stage.
Converting your retirement savings into retirement benefits
Upon retirement you will need to convert your retirement savings and draw an income. Under current pensions legislation you will normally have to use your savings to provide a pension to live on in retirement. Usually this would be in the form of an annuity, which is a pension bought from an insurance company.
Annuity prices vary with a number of factors, including your age and sex, and the options you choose (eg pension increases). Importantly, annuity prices at any one time are likely to depend on the price of long dated conventional and index linked bonds. This is because the annuity provider will usually invest the amount of your savings that you use to buy the annuity in bonds – so that they can use the income generated from bonds to pass on to you as your pension. So, the price that the provider has to pay to invest in those bonds will normally be reflected in the price it will charge you for your annuity.
This is an important point, because bond prices will fluctuate from time to time, depending on prevailing interest rates. Generally, the lower the interest rate, the more expensive bonds – and by implication annuities – will be, and the less income your retirement savings will buy.
There is a risk that bond and annuity prices may rise sharply (because interest rates fall) shortly before you retire. Consequently you may receive less pension income than expected. To try and reduce this risk you may want to move your savings into long dated fixed interest or index linked bonds as you approach retirement. This will help protect your savings against any sudden movements in annuity prices. By buying bonds at different prices over the final years just before you retire you can invest in bonds at prices averaged over that period. So, if annuity prices are increasing when you come to buy your annuity, the value of your savings which are invested in bonds should also be increasing.
One final point is that, under current legislation, you are likely to be able to take part of your retirement benefits as a cash lump sum. The actual amount of this sum can only be determined at the point of retirement, but you might want to consider protecting the capital value of part of your savings by investing some money in a cash fund over the final years before you retire.
Tax concessions are not guaranteed and may change at any time; their value will depend on your individual circumstances. You should be aware that taxation legislation is liable to change in the future. References to taxation are based on Aberdeen Asset Management's assessment of the current Inland Revenue legislation as at the date of this release.
Your pension scheme and "lifestyle"
As well as offering you different single funds in which to invest, your pension scheme may also provide a further option – called "lifestyle" or sometimes "lifeplan".
A lifestyle option works by managing the risks to which your investment is exposed throughout your working life. The trustees of the scheme, normally with the help of their investment advisers would decide the actual structure of the lifestyle option, but typically it would start off with your contributions being invested totally or primarily in equities. Then, as you get closer to retirement, your funds would be switched, automatically and over a specified period, into bond and cash funds.
Your Scheme Booklet should give you details of any lifestyle option available in your scheme.
You should remember that a lifestyle option does not come with a promise of guaranteeing you the best possible return – no investment can do that. And remember too that it may not be the most appropriate option for you in terms of the funds used and the period over which the switching between them takes place. So, if you do have a lifestyle option, make sure you understand exactly how it works and you are comfortable that it meets your own particular requirements. If you are in any doubt, speak to an independent financial adviser.