Money: Pensions for latecomers

It's never too early to start saving for retirement. But can it be too late? In theory, by the time we are cruising up to the finish line at 65, we should have a pension reservoir almost ready for the taps to be turned on. But what about those unfortunates who find themselves with a few years to go, and have not - perhaps because they have been living abroad, or simply not earning for some reason - made any provision?

Even for relatively high earners, are five years of pension contributions going to be worthwhile, or would the money be better placed in other investments?

"It's never too late to start saving, as long as it is handled in the right way," says Derek Edmunds, a consultant with independent financial advisers Boylan & James. "The tax reliefs on personal pension contributions give a strong case for using that route, even for five years, although you may not be able to control when you're going to retire."

Maximum allowable contributions into personal pension plans increase on a sliding scale with age; people aged between 56 and 60 at the start of the tax year can pay in 35 per cent of their net relevant earnings, while for 61 to 65-year-olds the proportion is 40 per cent.

"In most cases, it's a cut and dried decision - put as much as you can into a personal pension first, then invest any balance into tax-free shelters," says Robert Guy, financial planning manager with independent financial advisers John Charcol.

"Say you put in pounds 10,000 into a pension plan in Year one. At the new 24 per cent basic rate of tax, from 5 April, that will cost you pounds 7,600. Even assuming that your contribution has no investment growth at all, at the age of 65 you have pounds 10,000 sitting there. You can then withdraw 25 per cent tax-free cash straightaway, so your outlay is pounds 7,600 minus pounds 2,500, or pounds 5,100. You still have pounds 7,500 left in your pension fund, and at current rates, this might buy you an annuity of say pounds 750. If that is your only income, you will not pay tax, so for pounds 5,100, you have earned a net return of 14.7 per cent. And for a higher rate taxpayer, the return is even better."

Building in reasonable assumptions of growth shows that even such a short- term investment is worth setting up. Legal & General estimates that a 60-year-old man earning pounds 60,000 and paying the maximum possible contribution into an L&G personal pension plan would, on a 6 per cent growth rate, receive around pounds 11,320 gross on retirement; at a 9 per cent growth rate, his annual income would be pounds 14,620, and at a 12 per cent rate, pounds 18,580 (taking into account charges).

"You would however do better if your company set up and paid for a company- sponsored plan," says Ron Spill, pensions consultant with Legal & General. "A company pension can be indexed, and build in a survivor pension where there's a spouse - with a personal pension, the initial amount would be cut back to accommodate these features." However, an occupational plan generally restricts contributions to income earned during the years remaining until retirement. And employee contributions are limited to 15 per cent of net relevant income.

With a personal plan, Inland Revenue carry-back provisions allowing the limits for the previous six years to be utilised (in addition to the current year). And the employer can chip in as well, though the aggregate paid in by employee and employer will still have to fall within the Revenue limits (ie 40 per cent from age 61).

Before starting a personal pension plan however, it is worth going back through any previous arrangements to see whether any old plans or policies are lying around. If there were any plans which were in force before July 1988, it might be worth reviving those. A change was introduced to pension policies at that time and in many cases, the older style "Section 226" policies are the better ones to have.

"Above all, investors in this position should not agree to a standard regular premium policy - most of their first-year contribution will disappear in commission charges," cautions James Higgins, managing director of independent financial advisers Chamberlain de Broe. "They should insist on a single premium basis contract or even better, have all commission waived into the policy and pay the adviser a fee."

Other forms of investment do not reach the same level of tax-efficiency as pension plans - a higher rate taxpayer taking out a Pep, for instance, would pay contributions out of earned income taxed at 40 per cent but getting only 20 per cent relief on the dividends, assuming that their post-retirement income was within the standard rate band.

But the big advantage of these other options is that they generally allow access to capital for substantially lower penalties than does a pension fund - so they should be a serious consideration if there is any chance that the individual will need some cash sooner than expected, or indeed be forced into early retirement.

Furthermore, they remain part of the individual's estate on death, whereas a pension fund, once exchanged for an annuity, is lost forever.

One way of hedging one's bets after retirement is to buy a Pep with the tax-free cash drawn from a pension plan, to give a tax-free income.

Until retirement, however, the other main factor in determining the best savings vehicles for the pensions planning laggard will be attitude to risk. "It's not money you can play with," says Nigel Darnley, technical director with Foster & Braithwaite Investments. "Over a five-year period, one should be looking for a relatively safe investment, assuming that the income is going to be a significant part of retirement income."

Outside any pension plan, the "safe" portion of the portfolio could include Tessas, index-linked National Savings - the Eighth Issue gives 3 per cent over inflation - and (for those over 60) the pensioners' income bond, which currently gives 7.5 per cent gross.

For those with a less risk-averse nature however, James Higgins suggests regular savings into an investment trust. "As long as it costs nothing extra, the monthly savings could be held within a Pep, but avoid the highly charged "packaged" Peps. The tax breaks of a Pep are overrated for most people and in the short term, the average charges tend to outweigh the tax savings.

"If the capital is available, a lump sum into a Pep would make sense, but use the self-select type and buy good investment trusts and shares, paying only the conventional stockbroking charges."