Scared of retiring poor but fearful of investing more: the new age dilemma

As falling markets put us off buying a pension, Melanie Bien looks at the mix of funds that could allow us to save with confidence

There was a time when retirement was something to look forward to: an escape from the rat race and a chance to put your feet up. But now it's becoming something to be feared.

Concern over lack of help from the state, and scare stories about penury in our old age, are forcing many of us to rethink the possibility of early retirement while we look at our own finances and take steps to redress any shortfalls.

The trouble is that this isn't as easy as it sounds. One Independent on Sunday reader says she knows she should be investing an "enormous amount more each month to get a decent pension", but she isn't sure she can afford it and doesn't know where she should invest it.

Vanessa Darnborough, 45, has been paying into a Scottish Widows plan for the past 15 years, but after calculating how much she needs for a decent retirement with the help of the TUC's online calculator (see below), she realises it won't be enough.

"When I started the plan, I was investing £50 a month and I've increased that over the years to £200," she says. "But even though I know I should be investing more for retirement, I don't want to put any more into this plan as it could turn out to be a black hole like Equitable Life. With everything so uncertain at the moment, the worst-case scenario would be to end up with nothing."

But Tom McPhail, pensions research manager at independent financial adviser (IFA) Hargreaves Lansdown, says investors shouldn't worry too much about life firms going bust. "I am much more relaxed about the financial security of other life companies," he says. "Even Royal & Sun-Alliance, which has struggled recently, is quite a long way off finding itself in the same position as Equitable Life. Yes, people have lost big chunks of money, but then we are at the bottom of the biggest bear market seen in a long time. A pension fund invested with a life company still makes long-term sense."

The other factor putting Ms Darnborough off investment products is that her endowment policy has performed badly. "I already have to pay more money into my endowment as it won't cover my mortgage at the end of the term," she adds. "I almost feel as if I'd be better off putting it all under the mattress."

Ms Darnborough is not alone. Financial advisers are having trouble convincing us to invest in pensions because of the prolonged bear market, which has seen the value of many funds plummet. But as companies close their final salary schemes, the onus is increasingly on the individual. Making the right decision is more important than ever.

Most advisers reckon pensions should still be the first port of call when saving for retirement, although there are ways to minimise the risks involved.

"Unit-linked funds, as opposed to with-profits, are a much better bet because the money in your pension pot is directly related to the underlying investment performance," says Donna Brad- shaw, director at IFA Fiona Price & Partners. "They are more transparent."

"I would recommend owning several pension funds," she adds. "Spread the risk around as much as possible with funds that invest in commercial property, fixed interest and equities, which is what the most sophisticated investors tend to do."

Owning several funds may not have been cost-effective in the past because you would be duplicating management charges which tended to be quite high in the first place. But the introduction of stakeholder pensions means charges have come right down. So spreading your investment, instead of putting all your eggs in one basket, is more feasible.

One way of spreading risk is to use another investment vehicle alongside your pension, such as individual savings accounts (ISAs). These increase the flexibility of your savings because you can get your hands on the money as needed. ISAs also come with tax breaks, although they are not as favourable as those you get with pensions.

"The ideal solution is a mix of pensions and ISAs," says Mr McPhail. "If you put all your spare cash into a pension, you are restricted when you come to retirement: you can take a maximum of 25 per cent of your pot as a lump sum, while the rest must be used to buy an annuity. With ISAs, you can boost your lump sum as you can get hold of the money when you want it."

The advantage for those who have 15 or 20 years to go to retirement is that they can afford to take on some risk. "You certainly don't have to stick with cash or bonds," adds Mr McPhail. "A 45-year-old could probably afford to invest half their pension pot in equities."

Investing solely in property probably isn't the best solution either. "Property as an alternative to pensions has worked for some investors but we are in the middle of a sustained property boom," warns Mr McPhail. "There is no guarantee that this will be the case 20 or 30 years from now when you need the money."

The TUC pensions calculator can be found at www.workSMART.org.uk