Pension funds are the goldmines for post-retirement life as they offer the much-needed financial security for leading a comfortable life after retirement. They are affected by many factors varying from personal contribution amount, fees and charges, investments made by the retirement fund and returns on investments, and withdrawal options.
Growth Your Fund Achieves:
The income from a pension account is directly related to the fund’s performance. The fund’s performance has a massive impact on how much your retirement amount will be, especially in the case of defined contributions schemes. The retirement amount is defined benefits schemes is almost fixed; however, for defined contributions pension schemes, the growth and returns generated by the pension fund make a huge difference.
Therefore, you must keep an eye on your retirement investment portfolio and keep balancing it from occasionally to generate high returns. The income from the funds in a pension that earns a return of 8% per year is about 50% more than the income from a fund returning 6% a year.
Contributions You or Your Employers Make:
The aggregated pension pot is a total of the contributions that the employers and employees make towards the pension fund. A retirement contribution fund is practically as big as the money you put into it. Thus, the income from pension funds is directly proportional to the contributions made.
It becomes more relevant for the defined contribution pension schemes wherein employees make a fixed contribution per month to their pension fund. The employers can match these contributions by the amount they choose. As a result, the total amount of pension pot and income from it will vary with the percentage of salary employees defer for being contributed to their retirement fund.
On the contrary, defined benefits pension schemes are mostly funded by the employers who contribute towards the employees’ pension funds based on their salaries and years of service. The contributions, in this case, remain more or less fixed, and the same applies to the benefit amount received after the retirement.
Charges:
The fees and charges charged by the pension providers play a crucial role in determining the final value of your retirement account. They may not appear to be significant compared to the total pension fund amount; however, they make a big difference.
Let us assume one pension provider charges £10 per month as the management fee, another firm charges 5% of monthly contributions, and the third one charges 1% of the annual contribution. All the charges will reduce the income generated, with the hardest hit done by the annual management charge of 1%. Thus, the fees charged by the pension providers reduce the amount in your retirement pension account and impact the overall income.
Retirement Age:
The age at which you start investing and at which you retire also contributes to the total income from the pension fund. Both the starting age and retirement age impact the duration of investment and, therefore, the returns and income.
Pension funds work on the magical power of compound interest and a matter of few years affects the retirement income drastically. You may use a pension calculator to get a clear picture of how much your pension pot is meant to be depending on your current age, monthly contributions, and retirement age. The small contributions over the years compound into a significant amount. Therefore, later retirement age and earlier age you start investing increase the number of years you contributed and the duration for compound interest, beefing up your pension pot.
Inflation:
Inflation decreases the purchasing power of money. As a result, it has the capability of swallowing your retirement income. Inflation not only increases the price of goods and services but also signals the government to increase the contribution limits to the retirement schemes.
All in all, high inflation can have a severe negative impact on your retirement income. The money you accumulate over the years may not remain worth the value if the growth and returns do not surpass the inflation rate. According to research, a 1% inflation can eat into thousands of pounds of retirement income. Additionally, if the inflation rate rose to 3%, the loss would be in hundreds of pounds.
Annuity Rates and Annuity Options:
Retirees have an option to withdraw 25% of the pension pot tax-free, while the remaining 75% can be used to buy an annuity. The annuity generates a fixed income for the rest of life. The pension funds and income from them are also significantly affected by the annuity rates at the time and annuity options.
The type of annuity plays a key role in determining its impact on income. While level annuity pays a fixed amount of income every year, escalating or inflation-indexed annuity options increase the payment amount every year to counter the effect of inflation. Moreover, other annuity options can be investment-linked that make payments depending on the performance of the stock market.
Tax Benefits:
Just like fees charged by the pension providers, taxes incurred and paid on the retirement fund also affect the retirement income to a large extent. The increment in income is not only restricted to post-retirement but also the contributions made towards pension funds earn tax relief for the contributors. Thus, you can save on tax while putting the money in and also while taking it out. The percentage of tax benefits impact the total retirement income.
Thus, the pension funds and income from them is affected by several individual, economic, and social factors. You must consider all the parameters to ensure that you grow your pension pot to its maximum potential. You must start contributing to the pension fund as early as possible to increase inflow duration and consider funds will lower fees and charges. Additionally, it is also advisable to keep track of the portfolio performance to ensure that your pension pot grows well and does not suffer due to the poor performance of some assets. The inflation rate and other rates must also be kept in mind to get the best out of your pension fund.
