Pension. Retirement. Annuity. What do these words mean to you? Do you feel they are relevant to you personally?
Perhaps you feel like a pension is something that should be sorted out for you. Something that your employer, your government or your financial adviser will deal with on your behalf. Perhaps you feel like pensions are “for old people” and not something you should be concerned with right now. Maybe you feel that pensions are just financial products that a bank, broker or salesman will try to push you into having.
In the world of personal money management, pensions are far too often left to lurk at the bottom of a list of priorities. The most common excuse I have heard is "I have plenty of time to sort that out. I can do it later." However, the cost of delay or inaction can be huge.
The problem comes from the association with the word “pension”. If it were up to me, I would dispense with the word altogether and replace it with something more appropriate and descriptive. Perhaps “later-living allowance, deferred salary or post-work income” would be more suitable. That would certainly give a better indication of the reason why we should be saving for the future.
Such is the misunderstanding of the concept of pensions that I have heard people say "I don't trust pensions" or even "I don't believe in pensions" as if having an income in retirement is some kind of fairy tale to be whispered in hushed tones and left open to disbelief.
The fact is that a pension is your income when you are not working for it. How you produce that income is up to you. That's the important bit. UP TO YOU. Using the suggested homonym, post-work income, we can better appreciate how and why everyone should build and maintain their pension.
Let's explore three of the most common ways people can create a stable post-work income for themselves:
Cash doesn't breed cash. Many people choose to invest the money that they are not spending each month in order to make it grow and then generate an income later. The difficulty is locking your money up and having the self-discipline to resist dipping into it early.
Think of your long-term investments like a reverse mortgage. Instead of having the lump of money now in exchange for a twenty-year commitment to pay a fixed amount, you are making the commitment to pay regularly in order to receive the money later. If you break the commitment, you could lose out. If you stick with it, you promise yourself a tangible asset further down the line.
By this, I mean working your way to a point where the work is done for you and you continue to receive an income. Many people will do this by building their own company or by working their way up an organisation to the point where their shares, profits or holdings provide them with work-free revenue for life.
Some might think this is only for CEOs and company founders. Funnily enough, this is the principle of a staff pension. Your years of service for your employer should entitle you to a certain income or remuneration once you leave the organisation.
Considering this comparison, it astounds me to see how many people take no interest in frozen or forgotten pension funds that they have accumulated from previous employment. If that were your own company and your future livelihood depended on it then surely you would take some action to at least monitor its financial health and activity.
I have lost count of how many times people have said to me something similar to "I don't want a pension, I invest in real estate*." (*please insert another single asset class as necessary) The misconception here is that the investment here is a substitute for a pension.
The pension - sorry, post-work income - is the rent or regular revenue that you receive from your investment. There is nothing wrong with using any form of asset to pay your bills after you choose to stop working. As long as your portfolio is efficient, diversified and protected against unpredictable losses, who is to say that one asset class is better than another?
When it comes down to it, the three items above are just different methods of ensuring that you will have a regular income once you retire. To answer my initial question, a pension is what you pay yourself, and it is ultimately defined by how you divide your assets now.
Think about how much money needs to be spent now and how much will need to be spent somewhere down the line. Who really pays your bills? Ultimately, there will come a point when your only income will be what you have pre-defined.
We should never starve ourselves today to feed ourselves tomorrow, but seek help from a professional advisor and take notice of what you pay yourself now and what you have already squirrelled away. Someday, it will be all you have.
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