If you have a money purchase pension (also known as a personal or defined contribution pension), the pension provider will normally send you an annual pension statement, detailing the current value of your pension, any contributions added over the past year and the projected value at your chosen retirement date.
Statutory Money Purchase Illustration
The figures provided by the projection, called a Statutory Money Purchase Illustration (SMPI) are structured according to a standard set of guidelines, set by the Financial Reporting Council (FRC). The guidelines are intended to ensure transparency and consistency in how pension benefits are projected, but this means that the figures do not take any personal circumstances into account.
The SMPI shows the estimated pension pot at retirement and the amount of annual income it could provide. This is shown in today’s money terms, to allow for inflation.
It is important to be aware that the figures in the SMPI are not guaranteed and are for illustration purposes only.
Assumptions used
The guidelines dictate the assumptions that should be made about rates of inflation, growth rates and annuity rates at retirement. For example, when calculating the annual pension income payable, the assumptions made are:
• You will not take any tax-free cash, but use your full pension fund to buy an annuity.
• The annuity income will remain level, and not increase with inflation.
• The annuity will have a 5-year guarantee, but no other death benefits.
It is important to be aware of the assumptions being made, as they may not be suitable for your individual circumstances.
Inflation rate
The annual inflation rate stipulated for SMPIs is currently 2.5%.
This can lead to some confusion, as at other times the pension provider may use a slightly lower inflation rate of 2%, resulting in totally different figures.
Growth rates
There are four possible allowable growth rates, ranging from 2% to 7% per year, dependent on the volatility level of the investment. Generally, higher risk funds such as those that invest primarily in equities (company shares) tend to have a higher volatility and the higher growth rate of 7% would be used. Lower risk funds such as those that invest primarily in bonds would tend to have a lower volatility, and the lower growth rate of 2% would be used.
The provider will always confirm what growth rate has been used for the projections.
It is important to be aware that inflation will then reduce the real return – a growth rate of 7% would be calculated as a net return of 4.5% after taking inflation of 2.5% into account.
The ongoing charges (product, fund and adviser charges) also reduce the net return. This can sometimes result in a projected pension value at retirement that is below the current value, which is obviously pretty disheartening.
Conclusion
It is really important to be aware that the projected value of your pension benefits is purely an estimate, and can never be guaranteed. Generally, the further you are from retirement, the less accurate the figures are likely to be.
It is still important to read the annual statement, as it provides a useful guide as to whether your pension is on track to give you the level of income you will need in retirement.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
This article is for information only and should not be construed as advice or a recommendation. You should always seek independent financial advice prior to taking any action.
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