DIY is needed more than ever.

Posted on 16th March 2010 by Trevor in Blog

Are you counting on Social Security and a Government Pension?

Portable pension plans are a means for people working abroad to build up a lump sum for their retirement when their employment circumstances will not automatically provide them with a pension. This article looks at who such plans are suitable for and how they work. The following month’s linked article will look at the issue of rogue advisers and the questions you should ask when considering taking out a portable pension plan.Portable pension plans are pension plans for expatriates, i.e. people working abroad. They are suitable for:

  • people whose jobs do not offer a pension
  • people whose jobs do offer a pension but which will be inadequate
  • people who will change employer and/or country of employment from time to time.

They may not be suitable for:

  • people who are about to become resident again in the country of their own nationality (‘about to’ meaning within the next year or so)
  • people approaching retirement (‘approaching’ meaning within the next three to five years).

They are particular suitable for people in their late twenties and early/mid thirties who have a career path in front of them but have not yet made any significant investments and do not want to spend much time on looking after and managing their investments.

They work like this:
In signing up for a portable pension plan you agree to a contract. This will be a minimum of five years but is best aimed at your earliest foreseeable retirement age. This will normally be between 55 and 60. You also agree a monthly amount to put away. The more you put into the plan, the more there will be for your retirement. However, you should not take on an obligation you cannot fulfill. All plans have a minimum contribution period, ranging from five to thirty-six months, in which you must make the contributions. Beyond that you are free to discontinue, but discontinuation makes the plan less efficient financially. The flexibility to miss a few payments, if you lose your job or decide to go round the world, is there, but in taking out the plan you should not set the contribution level unrealistically high – your income might increase, but then so might your responsibilities. You should choose a level you are completely comfortable with. A simple method for doing this is to take your annual disposable income (how much you have left over after you accommodation and living expenses are paid for, including an annual holiday/trip home) and divide this by two. Allocate the annual amount into twelve monthly portions: you should be comfortable with that (and the minimum is US$150 monthly).

This sum is best paid off using a credit card – this is convenient, is cheaper than using a bank to make transfers, and after a few months you don’t really notice the money going out. Your monthly contribution is then invested into a series of mutual funds. Doing things this way gives you four advantages:

  • Access to diversified range of funds. The days of opaque mystery funds and lack of choice are long gone. You can be in range of funds which will sustain overall performance and cushion you from the gyrations of the markets. Yes, you can be in a wide variety of stock funds; you can also be in high-grade or high-yield bond funds, in gold stocks, in resource stocks, or in property income funds. Diversified portfolios do better in the long run.
  • Free switching. You can change your funds at any time, switching at zero cost. Diversification matters, but your portfolio can be re-balanced at any time.
  • Averaging. Investing monthly gives a huge advantage over lump-sum investment. If the price of a fund falls, you buy more units the next month, and so on, until the unit price turns around. As you have a large number of units, your gains will be much greater than with a simple lump-sum investment.
  • Compounding. These plans are long-term, part of the financial structuring of your life. Anything over ten years affords you the power of compound interest (dubbed by Einstein ‘the eighth wonder of the world’). A return of 9% doubles your money in eight years and quadruples it in sixteen. Your money makes money and the profits make money too. (This is why these plans are particularly suitable for people in their twenties and early thirties.)

As mentioned, these plans are portable. You can take them to where you live next, even if that is the country of your own nationality (there will be some restrictions for residence in the USA). As they are written technically as life insurance contracts the investments are held by an insurance company with whom you have a contract for the value of those investments. There are no dividends or distributions. The whole value sits in your plan. There are no taxes to diminish the power of compounding and therefore the full value of the plan until you take the benefits at the end of the plan.

And don’t forget – all the money you put in is your money.

Portable pensions plans – a means for people working abroad to build up a lump sum for their retirement when their employment circumstances will not automatically provide them with a pension. Such plans may form the backbone of an individual’s forward planning, as they confer a number of benefits:

  • access to a diversified fund range
  • free switching between funds
  • the ability to average a fund (so that a market fall can be profitable)
  • the power of compounding
  • tax sheltering
  • international portability.

However at the same time some members of the expatriate community have suffered problems with such plans. This article looks at two clumps of typical reasons for these problems.

Firstly, a pension plan is a contract. If you take one out you should expect to fulfill its terms, which involve putting in a pre-agreed amount of money away on a regular basis for a pre-agreed number of years. (Remember, by the way, that this is still your money!)

Such plans have flexibility, as they are designed for normal working people, who may from time to time lose their jobs, or decide on a change of career, or take further educational courses full-time – the plans can cope with periodic interruptions. But the more contributions that are missed, the less efficient a plan will be. It is highly inefficient and therefore inadvisable to take out a long-term plan and contribute only for the minimum period. You should be making as many contributions as you can, but should not be worried if life circumstances require you to cease contributions temporarily. You should also make sure that you set the amount you contribute at a level you can easily afford – allowing for realistic increases in your economic responsibilities or relocation to a lower-paying environment. Addressing your plan in this way will save you from over-extending yourself and allow you to reap its benefits.

Therefore it is a good idea to beware high-pressure sales people who will assure you that the more you put into the plan the better, and that you should go for maximum plan length (irrespective of your circumstances) as ‘all you have to pay in is the first twelve or eighteen months’. Typically these people come from companies that have not been in town all that long, or have changed their name in the not too recent past. And they assuredly do not have your best interests in mind. Whereas your planning should be based on a thorough discussion of your circumstances, goals and responsibilities, not on the dictates of the salesperson.

The second set of reasons why people get into trouble with these plans is unrealistic expectations about returns in the short term and the inability to cope with bad markets. In the life of a typical pension plan – say, 20 or 25 years – there will be a wide range of market conditions, unforeseeable except in their variability. Some of these years will be poor for a range of asset classes, and the value of a plan can fall in such years, especially if heavily exposed to the stock markets (where in general the greatest gains in value are to be had). A plan largely invested in stocks during the period 2000-2002 will have done very poorly. It would have rebounded steeply 2003-2004. However, inexperienced investors at the end of 2002 may have decided they were throwing good money after bad and ceased contributions for that reason (a mistake, as they were cutting themselves out of the averaging effect), or even decided to encash the plan. These plans have high penalties for early encashment, especially towards the beginning of the plan. There is nothing untoward about this as a pension plan should be there for your retirement; it is not a short-term savings vehicle and should not be seen as your source of instant cash. If you had a corporate pension in the country of your own nationality you would not in most cases be able to touch the money in it until you retired. Portable plans are more flexible, but the early encashment penalty is an advisable deterrent. Over time they make money, but they need time to make that money. The knee-jerk reaction of encashment because of (temporarily) poor performance is how people lose money big-time in these plans.

Given these negatives, is it sensible to take out such a plan? The answer is overwhelmingly ‘Yes’, but keep in mind these dangers: that you may take on a plan that is longer than you expected or need and into which you are contributing too much; and that short-term poor performance may scare you into the penalties of early encashment. The morals here are caution, patience, and a modicum of education. These plans are very much worth having, provided you know what to expect, and the plan fits your life situation.

Suggestions before starting such a plan:

  • review your circumstances and think forward as much as you can
  • read the policy documentation, especially the plan rules, and make sure you have discussed them with your adviser and understand them
  • investigate the company you are taking the plan out through
  • realize that markets do not deliver investment nirvana instantly, and that a diversified portfolio will see you better in the long run than a portfolio chasing quick gains

In addition, shop around for the special offer that sometimes come with these plans for limited periods – with one currently available offer you can get as much as 7% added to all the money you put into your plan, have a look at the attached.  All of us at Banner would be happy to discuss things further please get in touch.

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