Plan for a richer retirement

IN GENERATING an income for retirement, you should start by exploiting the generous tax breaks on a good pension scheme. Only around half of all employees are entitled to an occupational pension, and only two-thirds of those get the best kind - a "final salary" scheme.

Final salary schemes offer a tax-free lump sum worth 11/2 times your leaving salary. But if income is a priority, it is often better to use this lump sum to boost your pension entitlement.

Employees can also increase their retirement savings through additional voluntary contributions (AVCs). These are employer-sponsored savings plans which you pay into tax-free. All employers offering final salary schemes must also offer these. In general, avoid "free-standing" versions of AVCs offered by insurance firms; you pay commission to a sales person.

Company pensions are almost always better than personal pensions because they carry lower charges. If employers do not offer final salary schemes, they may offer "money purchase" schemes - tax-efficient savings plans to which your company may or may not contribute. Under money purchase, the employer makes no guarantee about your benefits. However, the tax breaks are better than on other schemes, such as PEPs.

There is a danger as you approach retirement that your investments may suddenly lose value - drastically altering the income you can expect. Because most pension managers invest your savings on the stock market, the value of the funds can drop when the market falls.

There is a further risk in money purchase schemes and personal pensions: you must exchange your capital for an annuity - a contract provided by an insurance company to pay an income guaranteed until death.

The risk is that the amount of income you can get for your capital varies with the yield on the assets that back annuities - 15-year gilts. These can be subject to wild market fluctuations.

There is a way to minimise this risk. If a pension fund is fully invested in gilts, its value will reflect the cost of buying a gilt-backed annuity. As the annuity becomes more valuable, so will your fund. So there is no longer such a threat that your fund will buy less income when you retire and buy an annuity.

Because, in the last 30 years, shares have grown faster in value than gilts, it is best to be invested in shares until you near retirement. By gradually shifting to gilts, you can minimise the risk without missing out on growth potential. This is known as "lifestyle switching". Amazingly, fewer than 5 per cent of pension savers use this option.