Relying on just a pension to get you through your old age? You could be setting yourself up for disappointment, pain and financial hardship.

Are you being manipulated and ripped off by financial companies? Read below and judge for yourself. This post is for all of you not lucky enough to have a final salary pension from your company.

“A Guaranteed Return” on Pensions

“Pensions Offer a Guaranteed Return” is a line repeated by financial advisors and commentators across the world to convince you to take out a pension. It’s simply not true. Here’s why:

Let’s start with some definitions. Some common definitions of “guaranteed” are:

“Something that assures a particular outcome or condition”
“An unconditional commitment that something will happen or that something is true”

And of “return”:

“To produce or yield”
“a coming back again”

So a “Guaranteed Return” should be something that without question will happen, and will come back to you. Pensions are sold on the idea that whatever contributions you make, the government will add the tax back that you’d paid on that money – therefore a “Guaranteed Return” exists cause you definitely get that tax back.

So here’s the thing with pensions – yes, you get the tax break and employer contributions if applicable… but they’re not guaranteed to come back to you. This is because you have to leave the money in there for 30-40 years – and a lot can happen in that time…

You’re Charging Me How Much?!

One of the main factors reducing your pension pot is over that period your pension company will be charging you an annual percentage fee based on the value of your total pot. This has been shown to reduce the amount of your overall investment by over 40% (yes, almost half!) by the time you retire.

Over those 30-40 years you will also have inflation eating away at the real value of your money, so even if you have got more in the pot than you put in, it may be worth less in terms of what you can buy with it.

Wanna Mess With Your Financial Advisor’s Head?

Just for fun ask a financial advisor the following question about the “Guaranteed Return” on pensions:

“So are you telling me that whatever happens (“Guaranteed”) that my pension pot will be at least the money I’ve put in plus the government tax breaks on top, and that’s what will be available to me (“Return”) on retirement as a bare minimum?”

The answer will be something like:

“Errr… no… ummm… not exactly”

You:

“So would I be right in saying that with the management charges, and your charges, and the fluctuations in the stock market, that even with your “Guaranteed Return” it’s perfectly possible that on retirement I will have less money than I put in, and even that will be worth less cause of inflation, just like it happened to thousands and thousands of people in the US and UK?”

“Errr… yes?”

“So how is that a “Guaranteed Return” then?”

Silence…

The Guaranteed Return line is so embedded in the pensions sales pitch it’s ridiculous. On TV recently I saw a husband and wife being told that their personal pension would pay out a fraction of what they thought, and they would barely be able to survive on retirement… and the financial advisor there said (yes you guessed it!) “Pensions are still a good investment because they offer you a guaranteed return”. I would say to that financial advisor try telling that to someone who’s got less money than they put in… but he actually did, on TV!

Oh, and did I mention that you of course do get taxed when you eventually take your pension.

So although pensions are sold as a rock solid “Guaranteed Return” investment, they are still an investment, with all the risks that come with investing. Plus unlike other investments, unless you’ve gone for a pension you personally manage, you have little real control over how that money is managed. Historically we can see that pension funds have NOT on the whole outperformed the market… but they still charged you for the priviledge of “managing” your money though.

Even the Power of Compounding is Taken Away

Pensions are also sold on the idea that the contributions you make will build and compound over time to give you a large pot of money at the end. Those of you who understand compounding (see my free debt report on the right for more information on this) will know that the amounts invested in the early years are the most important as they can build for the longest time.

Guess when most of the fees are taken for pension… yep, that’s right, in the beginning! So when your pension pot should be building up nicely to compound over the next 30-40 years, massive chunks of it are being taken away to pay for set-up fees, financial advisor fees. It’s not unheard of for these fees to amount to 60-70% of your contributions in the first few years, costing you massively by severely reducing your future pension pot.

Inflation is Going to Eat You Alive

Now let’s say you’re one of the lucky ones – you have a good fund manager, they make you a decent amount of money and you cash in your pension pot when the stock market is riding high.

That lump sum of cash now has to go into an “annuity” and a company will do that for you. So that cash goes into a relatively “safe” investment, such as government bonds, and gives you an income per year. How much this is depends on the annuity rates at the time (e.g. 5%) and how much you put in.

The problem is that the annuity doesn’t increase with inflation. So as you live into your retirement you’ll see prices increasing around you, and your money not being able to buy as much, year by year. With people living longer and longer inflation can literally eat you alive.

For example let’s say inflation runs at a relatively stable 3% and you’ve been “lucky” and have lived 25 years into retirement. Your annual income will now buy you less that HALF of what it did when you retired. (If you want to know the calculation for this let me know).

So even if you were able to get a decent annual income on retirement (no easy task) you could end up in your final years trying to get by on a very small amount of money. More than likely you were just getting by when you retired, so who knows how bad it could be after inflation has its way with you.

So what’s the alternative?

Well there’s no easy answer to this. I’m not saying that you shouldn’t invest in pensions – just that you should understand completely how they work and the risks you take on – and please don’t tolerate anyone spinning you the “Guaranteed Return” or “Safe Investment” lines.

Relying on the government to help is also a mistake. Government pensions are unlikely to even provide a basic level of income in most countries, especially with relatively less young people paying tax to support an ageing population.

The alternative is really a mindset shift. Stop thinking that you’ll be able to rely on your pension alone – it’s a dangerous game to play, a game where you can have little or no control. Ultimately it’s about building and creating multiple sources of income upon retirement (e.g. buy-to-let properties, other savings, investments in bonds etc.) and investing in yourself.

With people living longer and more importantly, maintaining their health, 65 is now just an arbitrary age for retirement, based on an industrial age way of thinking. Most people on retirement can be just as economically productive as they were, if not more, and age is less of a restricting factor. Chances are after working for 30-40 years, you’ll be bored to death (forgive the pun!) on retirement and looking for something to do anyway!

Why not teach yourself the skills now so you don’t have to rely on just a pension to get you by. Just a thought…