Nearly one in five (18%) people planning to retire in 2010 will be retiring on the State Pension and savings alone. This is according to new research from Prudential.

The Class of 2010 study was conducted by Research Plus between 3rd and 10th December 2009 with 6,073 UK adults over 45 years old, using an online methodology.

Nearly a third (31%) of those surveyed did not know how much the basic State Pension pays or over-estimated the individual weekly amount by £25 or more.

The basic state pension for a single person is currently £4,953 per year, or £95.25 per week. Could you afford to live on that?

On average, the basic State pension represents 34% of likely income for those retiring in 2010. The balance is made up of income from company pension schemes (36%), other savings and investments (11%) and personal pensions (9%).

It is interesting to note that, despite the current debate on mandatory retirement ages and the Government message that we all need to be working for longer in retirement, only 6% of income is likely to come from part-time employment.

Retirement can be a very challenging time financially. It is even more challenging if you fail to plan ahead and have unreasonable expectations of the State pension.

As a first step, request a State pension forecast so you can see precisely what level income you can expect to receive from this source when you retire. This is completely free to obtain. Simply visit www.direct.gov.uk and request your copy.

It is also a good idea to collate projections for all sources of retirement income. Look at the total level of income you might expect to get in retirement and relate this to your likely level of expenditure in older age. The gap between likely income and likely expenditure is the scale of your retirement income planning objective.

The earlier you start this process of retirement income planning, the easier (and cheaper) it becomes.

Rather than putting blind faith in the State, start planning today and understand your retirement income.

Martin Bamford is Site Editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. You can follow him on Twitter @martinbamford.

With the country slowly coming out of recession, directors and business people tend not to be thinking of pension provision – but there may be ways in which their pensions could assist their businesses.

The Small Self-administered Scheme (SSAS) has been a favourite pension and tax-planning tool for advisers with corporate clients, particularly small to medium sized firms.

The original remit of such schemes was to attract shareholding directors into making pension contributions rather than just investing in their own business by allowing a degree of self-investment and it has been very successful. Since their introduction in 1989 Self Invested Personal Pensions (SIPPs) have also become very popular.

Pension simplification in April 2006 was supposed to remove the distinction between SIPPs and SSASs however the reality is slightly different. True the previous differences in contributions and benefits are removed but some differences remain on investments and constitution. For the Inland Revenue (HMRC) there is still a distinction between company-sponsored schemes, which for ease we will continue to call SSAS and provider sponsored which we will call SIPPs.

Loanbacks from the fund to the sponsoring employer albeit now secured can be made by a SSAS. A SIPP has no sponsoring employer and therefore cannot make any loanbacks to any connected business without being hit with a minimum 55% tax charge.

So how could a pension loan work?

A company director needs finance for his business – he could try a bank or his pension fund. He can transfer his existing funds into a SSAS set up for him by a specialist trustee company. The scheme can then lend to his company up to 50% of the fund for up to five years, although this must be secured by a first charge on assets of either the company or its directors. A suitable interest rate of at least 1% over base rate is charged and at least annual repayments of capital and interest made.

The result – the business can get an important loan, the director a good return on the money in his pension fund – there is obviously a risk in concentrating pension assets into the company but many directors feel more confident of this type of investment than they do in insurance companies etc.

Although a SIPP cannot lend to a company connected to the scheme it is worth remembering both a SIPP and a SSAS can lend to third parties. So a pension fund can be used for business angel type investing.

For share purchase a company-sponsored scheme e.g. SSAS is limited to buying 5% of the shares in its sponsoring employer. For a SIPP as there is technically no sponsoring employer the fund could invest 100% in the directors own company shares.

There are however some very complex rules that block purchasing shares in your own business except in a few cases but again third party investments are fine for those willing to take a high risk but investing in unquoted businesses.

As long as it is done commercially there is no problem with pension plans buying assets from their members or their members companies. The allowed assets are usually commercial property and quoted shares or other investments.

For example a company that owns its commercial premises but is struggling for cash could sell all or part of the building to its director’s pension scheme(s).

Or a sole trader might sell some shares they own personally to their own SIPP thus releasing cash from their pension scheme.

Also remember that if you are over 50 (rising to age 55 in April 2010) it is usually possible for you to access your pension fund and take benefits and after April 2006 you can take the tax-free lump sum and not draw income. Although it is usually best to defer drawing benefits until you really need to taking all or part of the lump sum to clear some expensive debt, for example may be a worthwhile option.

Finally remember that pension plans need to be invested carefully – some of these ideas can help both the business and the pension but equally could cause a large loss. For those that do not want to get involved in these more esoteric areas (even some SIPP providers are not flexible enough to do some of them – one of the reasons why we have our own in-house SIPP and SSAS) you should still review your pension provision in these unstable times. Review your arrangements to get a reasonably charged plan and a good mix of investments.

Ian Smith is a Chartered Financial Planner and Certified Financial Planner at Central Financial Planning. He has won several awards including being the FT Pensions adviser of the year three times and has appeared on television and radio. You can follow Ian on Twitter @iancfp.

Apparently it is a word that puts people off planning for their future. The presenter of that radio show certainly thought so, and this is backed up by new research from AXA which suggests the word ‘pension’ puts people off. They have gone as far as teaming up with the Collins English Dictionary in an attempt to find a new name for ‘pension’.

Can a name really influence our decision to save or not to save to fund our expenditure in retirement? I suspect it is a bit more complex than that.

For some people, there is nothing daunting about pension plans. They understand that pensions are simply a tax-efficient investment wrapper. What really matters is where you choose to invest the money within your pension plan or, in the case of defined benefit (so-called ‘final salary’) pension plans, the benefits you are accumulating.

Sure, there is some necessary complexity involved with pension legislation. Most people do not need to have a detailed working knowledge of the various tax rules and regulations surrounding pensions in order to use them to build a fund for retirement. They can instead rely upon their financial adviser to point them in the right direction. It is typically higher earners, those with significant pension fund sizes and people with complex income structures who need to get involved in the really complex bits.

Apart from knowing that it is where you invest your pension fund that makes the real difference, it is important to have a reasonably good understanding of what your pension fund is likely to produce in retirement, in terms of both capital and income. In simple terms, this means the ability to take up to a quarter of your pension fund as a tax-free cash payment when you retire. The remainder of the fund is then used to generate taxable income for the rest of your life.

There were some major changes to the pension rules back in April 2006, with the intention of making them simpler to understand, and therefore more attractive. Consensus within the financial adviser community is that this ‘pension simplification’ mostly failed to achieve that aim. For advisers, the rules are now mainly easier to understand. However, as with all new legislation, the unintended consequence of change was the introduction of some even more complex factors.

Another reasonably big change is coming up soon, on 6th April 2010. From this date, the minimum age at which you will be able to take benefits from a pension is being pushed up from 50 to 55. Unlike other changes to pension ages in the past, this is not happening in gradual stages but in one go overnight. For people who are over 50 but under 55, this will mean a wait of up to five years before they can access the cash from their pension funds, until they reach their 55th birthdays.

We expect more changes to be introduced to pensions in the future. The current system is failing to encourage sufficiently large numbers of people to save for their own retirement. As part of their campaign, AXA was looking for suggestions to replace the word ‘pension’. My suggestion was Later Life Survival Fund, shortened to LatLifSurFu. It might appeal to younger people who are turned off by the word ‘pension’. The alternative – retiring without a LatLifSurFu – doesn’t really bear thinking about.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. You can follow him on Twitter @martinbamford.

Yesterday evening we heard Mervyn King, the Governor of Bank of England, explain that British people will be paying the price for this financial crisis for a generation. He described the £1 trillion cost of the government bank bailout as “breathtaking”.

In addition to the bank bailout, the Bank of England continues to embark on their ‘asset purchase programme’, at a total cost of £175 billion. The amount of money allocated to this quantitative easing was increased by £50 billion in August.

Looking at massive numbers like this is one thing, but what will the real cost of economic recovery look like? What impact will all of this spending and money creation have on our personal financial planning in the years to come? Here are some educated guesses.

Higher taxes

Having to pay more taxes, particularly if you are a higher earner, seems inevitable if the Government is going to be able to reduce massive levels of public borrowing in a reasonable length of time.

A new 50% income tax rate for people earning over £150,000 a year is being introduced on 6th April 2010. This replaced the originally proposed 45% income tax rate for higher earners, which was due to come into force for the 2011/12 tax year. Whilst this is only likely to have an impact on 1% of earners, it will mean around £220 per month in additional income tax for people earning £150,000 a year.

People earning over £100,000 a year will see their income tax personal allowance (the amount of earnings on which you pay no tax) removed in stages from next April. Those earning £113,000 or more will have no personal allowance. It will be removed at a rate of £2 for every £1 of earnings over £100,000.

But will these higher taxes for big earners go far enough? The National Institute of Economic and Social Research (NIESR) suggested today that the basic rate of income tax will also need to be increased from 20% to 27% to pay off national debts.

In January we will all see Value Added Tax (VAT) return from the current level of 15% back to 17.5%. There is every chance that it could go higher than that. Britain has one of the lowest VAT rates in Europe, with the average (according to research from KMPG) standing at 19.8%.

Later retirement

Working longer and retiring later formed a key part of Tory proposals for public finances during party conference season. They suggested raising the State pension age from 65 to 66 (for men and then eventually women) starting from 2016.

We are already on track to see the State pension age increased to 68 for men and women from 2044, but more recently commentators have been calling for these necessary increases to be brought forward and even extended to age 70.

The National Institute of Economic and Social Research (NIESR) said today that the State pension age will need to be 70 if national debts are to fall to acceptable levels by 2015. The Institute of Directors (IOD) has also called for the State pension age to be increased to age 70, ‘as soon as is reasonably practical’.

Increasing the State pension age saves a huge amount of money each year; money that could be used to both reduce national debt and improve pension payments to older people. However, any sudden rise in State pension age is likely to be very unpopular, particularly if it leaves little time for people approaching the current State pension age to plan for the changes.

Price inflation

We are living in a low inflation environment, with the Retail Prices Index (RPI) recording inflation including mortgage interest and housing costs at -1.4% for the year to September.

The Consumer Prices Index (CPI) measure of inflation fell to an annual rate of 1.1% for the twelve months to September, down from 1.6% the previous month. This remains below the Bank of England target of 2% and is significantly lower than the spike of 5.2% recorded just last year.

Analysts are divided on the eventual level of price inflation in the medium to long term, but many expect an moderate (if only temporary) increase later this year. Petrol prices and the cost of clothing are expected to continue to rise, and these items could contribute to an increase back towards the 2% level by the end of this year or early in 2010. The increase in VAT from the start of next year will also feed back into inflation figures.

We might continue to benefit from negative or very low price inflation for another year or so, but eventually various pressures – including the impact of the government printing money – will feed through and result in a return of inflation figures we have been more used to seeing historically.

Low interest rates

Last week we saw a prediction from the Centre for Economics and Business Research (CEBR) that the Bank Rate will remain at 0.5% until at least 2011 and then stay under 2% until 2014.

The historically low Bank Rate has not necessarily resulted in lower borrowing costs. For those fortunate to be on Base Rate Tracker mortgage deals, most of this year has been a very pleasant experience with mortgage payments slashed to tiny amounts as a result. New mortgage (and remortgage) deals remains reasonably expensive and difficult to obtain as the banks continue to repair the damage to their balance sheets.

Savers will also have to cope with this low interest rate environment. The only saving grace for savers is that negative or very low price inflation means the gap between the interest rates they can get and inflation is now at record levels. This results in the preservation of the ‘real’ buying power of their cash, although it is little consolation for those who rely on interest from their savings to supplement other income in retirement.

Public spending cuts

Reducing national debt is likely to mean substantial public spending cuts and then freezes on capital investment over the next few years. The various political parties might argue about where these cuts should fall, but the end result is less money within the public sector. In fact, the CBI has called for an extra £120 billion in public spending cuts to help bring the national budget into balance two years earlier than current government plans.

This might not have a major impact on all of us, although those in public sector employment are likely to experience only moderate pay increases and also job uncertainty.

If you are a user of public services (as the overwhelming majority of us are) then your experience of these in coming years is unlikely to be the same as it has been during the past decade. This could result in greater use of private sector alternatives for those who can afford them, particularly if we start to see key services such as the National Health Service (NHS) suffer.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. You can follow BrilliantWithMoney on Twitter @brilliantmoney and Martin @martinbamford.

Employees and pensioners often rely heavily on their final salary pension benefits to provide an income in retirement.  The collapse of an employer can result in the loss of this valuable pension income and is rightly a worrying time for all involved.

Fortunately, two pension rescue schemes were established in recent years to provide a much needed financial safety-net should the worst happen.  Both schemes offer compensation to replace lost pension benefits, but they have different features.

Here is our simple guide to the Financial Assistance Scheme and the Pension Protection Fund.  This is recommended reading if you are a current or deferred member of an occupational defined benefits pension scheme, or if you are already in receipt of an income from this type of pension scheme.

The Financial Assistance Scheme

This pension rescue scheme provides help to people who have lost their pension benefits because their final salary pension scheme was wound-up without sufficient assets between 1st January 1997 and 5th April 2005.

The Financial Assistance Scheme (FAS) provides a benefit of 90% of the pension benefit you had built up at the time the wind-up of your pension scheme started.  This compensation is ‘revalued’ (increased by inflation as measured by the Retail Prices Index, subject to a cap of 5% a year) from the date of the wind-up until the date you become entitled for compensation under the scheme.  Any actual pension income you are still receiving from the pension scheme is deducted from the amount of compensation you get.

This rescue scheme is now administered by the Pension Protection Fund, so for more information on eligibility (including a list of pension schemes which have been assessed for protection under the FAS) you should visit their website at www.pensionprotectionfund.org.uk/FAS/Pages/Fas.aspx.

The Pension Protection Fund

This pension rescue scheme is in place for people who lose out on pension benefits from a defined benefits (final salary) pension scheme where the employer becomes insolvent and there are insufficient assets within the pension scheme to pay benefits.

The compensation limit varies depending on whether you have already reached the normal pension age of the scheme.  If you have already reached scheme pension age, the compensation is 100% of the pension benefits you should have received when the scheme went bust.

If you have not yet retired then compensation is limited to 90% once you get to the scheme retirement age.  However, this 90% compensation limit is subject to a cap which is recalculated each year.  As at April 2009 this cap equates to £28,742.69 at age 65. It is adjusted based on age when the compensation is actually paid.

Once compensation is in payment, future increases are linked to the Retail Prices Index (RPI) but these increases are capped at 2.5% a year. This means that the increases to your pension income through the compensation scheme could be less than any increases you might have received from the original pension scheme.

Who pays for all of this?

The Pension Protection Fund is funded by a levy on defined benefit pension schemes. For the 2010/11 tax year, the Pension Protection Fund aims to collect a total levy of £720 million from pension schemes.

The Financial Assistance Scheme is funded by the taxpayer.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.  You can follow him on Twitter @martinbamford.

Pension tax relief is often misunderstood, so the new (and interim) rules on this are anything but simple.  Here is our hopefully quite simple guide to higher earners and pension tax relief.

The way it was

Before the Budget, higher earners received higher rate income tax relief on their personal contributions to a pension plan.  This tax relief was applied in two parts.

Basic rate tax relief (at 20%) was added directly to the pension fund when a personal contribution was made.  In practical terms, this means that a £1,000 net contribution to a UK registered pension scheme would receive £250 of basic rate tax relief, so £1,250 would end up in the pension fund.

Higher rate taxpayers were then able to claim the difference between basic and higher rate income tax relief on their contributions.  This difference is currently 20%, so that same £1,000 net pension contribution would enable the higher rate taxpayer to claim additional tax relief of £250, making the total tax relief £500, or an £750 net contribution resulting in an investment in the pension fund of £1,250.

What changed?

The new rules announced in the Budget earlier this year will result in pension tax relief limited to 20% for people earning over £180,000 a year.  In fact, the amount of income tax relief on offer will start to reduce once you earn £150,000 a year, being tiered down to reach 20% once earnings hit £180,000.

In the meantime, and to prevent any short-term abuse of the system before the new rules come into force, some interim measures were introduced.  These are known as anti-forestalling measures.

It is important to note that these anti-forestalling measures only apply to people who are categorised as ‘high income individuals’.  To get this special label attached, you need to have ‘relevant earnings’ of £150,000 per annum in this or either of the previous two tax years.

‘Relevant earnings’ is a fairly catch-all phrase, and includes income from employment and self-employment, savings interest and dividends. You have to add back in any earnings which have been sacrificed as part of a salary sacrifice arrangement with your employer but you can subtract pension contributions up to £20,000 made by the individual (but not employer pension contributions).

I’m a ‘high income individual’ – so, what now?

Assuming that you fall into the definition described above, you become subject to a special annual allowance. This is an annual tax allowance which places restrictions on the income tax relief you can get on your pension contributions.

The special annual allowance is one of three numbers. Firstly, there is a basic allowance of £20,000.

Secondly, there is an enhanced allowance of up to £30,000 which can be applied if you have made infrequent pension contributions (less often than quarterly). This enhanced allowance is calculated as the lower of average contributions made in the three tax years in the three tax years 2006/07, 2007/08 and 2008/09 and £30,000.

Finally, you might have a protected pension input amount. This is calculated based on your regular (quarterly or more frequently) pension contributions before 22nd April 2009, the date these anti-forestalling measures came into force.

Regardless of which level of special annual allowance applies, it will apply to both your personal and employer pension contributions.

What happens if more goes into my pension?

If you and/or your employer happens to contribute more to a pension, either before the end of this tax year or during the 2010/11 tax year, it is not the end of the world. The penalty is a special annual allowance tax charge.

The special annual allowance tax charge is a tax charge made on the individual at a rate of 20% for the 2009/10 tax year. What this means in practice is that you lose your higher rate income tax on those parts of the pension contributions above your special annual allowance.

This might not feel too bad if it is personal contributions at stake. It will simply mean you claim for and pay back any higher rate income tax relief on contributions over the level of the special annual allowance. Where it is employer pension contributions, you might feel a bit unhappy about having to pay a 20% tax charge on money you never actually received in your pocket.

What next?

This is only a basic guide and you should seek professional independent financial advice if there is a chance you have been caught up in these new or interim rules.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice. You can follow him on Twitter @martinbamford.

Pensions remain an important retirement planning tool, offering valuable tax relief on contributions and a tax efficient environment in which your money can grow. But they can sometimes be difficult to understand.

Use these top tips to start planning your own retirement strategy and to make sure you understand how pensions work before you get started.

1 – Before you start planning for retirement, make sure that you have a good plan to repay any debt that you have. Saving for the long-term is obviously important but short term debt (credit cards, overdrafts, storecards, etc can get you into real financial difficulty if you do not keep up the payments due on them.

2 – Find out if your employer (if you have one) has a pension plan to which they will contribute. Very often you will also have to make a contribution to join an employer sponsored pension plan but it makes real sense to benefit from any payment available from your employer.

3 – Think about the alternatives to a formal pension plan. You may for example need to access the money that you are saving ahead of your anticipated retirement age. If that is likely to be the case then a savings and investment plan such as an Individual Savings Account (ISA) maybe more suitable for you.

4 – Make sure that you choose a pension plan with low management charges so that your contributions can work hard for you. Avoid any plans that have high set up costs or exit penalties if you decide to transfer your pension fund elsewhere or retire early.

5 – You will want to have a pension plan that offers a wide choice of investment funds so that you can invest your pension contributions in a suitable manner. Remember that most pension investment funds can go down as well as up in value but some will be more suitable than others for you (take a look at some of the SIPP portfolio ideas that we have created for BrilliantWithMoney SIPP customers)

6 – Some people have decided not to save for retirement by using a pension plan because they have lost confidence in such plans. They think their money would be better off in a cash account earning interest. Of course there is no reason at all why your pension plan should not be invested in cash earning interest; so that you get all the tax benefits but remain in cash.

7 – Your chosen pension plan should allow you to access valuations online any time that you want. Many old fashioned pension plans are paper based and to know what your plan is worth you have to phone or write to the plan provider. Choose a plan that safely allows you to do this online just like you might do with your bank account.

8 – If you decide to change your pension plan investment fund choice you should also be able to do this online. Your plan provider should also be able to give you a lot of understandable information about the investment funds that are available.

9 – Your pension plan should be with a financially strong organisation so that you can rest assured that your pension plan is safe and properly managed.

10 – There is no reason why you should not be able to establish and run your pension plan without taking advice but if you are not confident to do this for yourself then take advice from an independent and properly qualified and experienced adviser.

The BrilliantWithMoney SIPP is low-cost, entirely transparent, offers a complete range of collective investment funds and competitive interest rates on cash; but is entirely web-based.

There is no set-up charge and no charge for contributions or transfers.  It offers access to more than 3,000 funds from over 230 fund managers, many with nil initial fund charges and discounted annual management charges.

Find out more and apply online at brilliantwithmoney.co.uk/sipp

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

The BrilliantWithMoney SIPP is the result of collaboration between leading firms within retail financial services. Award-winning Informed Choice has worked closely with new third-party SIPP administrator Gaudi Ltd; believed to be the first SIPP provider able to operate totally online in the web 2.0 environment.

The BrilliantWithMoney SIPP is low-cost, entirely transparent, offers a complete range of collective investment funds and competitive interest rates on cash; but is entirely web-based.

There is no set-up charge and no charge for contributions or transfers. The annual SIPP charges ranges from 0.5% to 0.75% and this is described in detail here.

The online application process enables customers to open a SIPP, transfer existing pensions and set-up pension benefit options without resorting to a paper application. Users can manage their SIPP funds online through a single-sign on process with the investment platform.

This SIPP offers complete fund choice. You can choose from over 3,000 investment funds from over 230 fund managers. The BrilliantWithMoney SIPP also enables you to invest in company shares or keep your pension fund in cash earning a competitive rate of interest.

There are no initial fund charges on around 2,000 of the available funds. Most of the funds offer a heavily discounted annual management charge, usually chopped in half.

To find out more about the BrilliantWithMoney SIPP, simply visit www.brilliantwithmoney.co.uk/sipp/.

The choice you make about converting your pension fund into a retirement income can, in some cases, be irreversible. Get it right and you can see out your retirement in financial comfort. Get it wrong and the consequences are not pretty.

There are several options for converting the capital in your pension fund into the regular income you will need for the rest of your life. Each comes with a set of advantages and disadvantages. Here is a brief introduction.

1 – Buy an annuity

An annuity is simply a financial instrument for converting capital (your pension fund) into an income. The level of income you can get will depend on the size of your pension fund and a whole host of other factors – including your age, sex, the yields available on government debt, your state of health, smoker status, and the payment options you select when you buy the annuity.

In simple terms; the older you are, the better the annuity rate you will get. If you are in poor health or you are a smoker, you should expect to get a better annuity rate. If you are a man, you should get a better annuity rate than a woman.

The more income options you select (such as price escalation, guarantee periods or future income for your spouse when you die), the lower the level of retirement income you might expect.

Buying an annuity is usually a good choice if you take a cautious view of the world and you want to ensure your income remains steady during retirement. People who reach retirement with only the income from their pension fund usually opt for an annuity.

Once you buy an annuity with your pension fund, that is it for the rest of your life. If you die, the capital from your pension fund dies with you (other than any options you have selected for continuing income).

2 – Investment-linked annuities

A slightly more adventurous option for people still wanting the relative simplicity of an annuity when they retire is the investment-linked annuity. With this sort of annuity, your pension fund is invested in one or more funds, and the income you receive in retirement is linked to the performance of these funds.

What this means is that your retirement income could go up or down, depending on how well (or poorly) your chosen investment funds perform. If this is a risk you are prepared to take, then an investment-linked annuity might be a good choice for you.

This approach does allow you to tailor an investment strategy to suit your attitude towards investment risk.

3 – ‘Third Way’ Products

This is a new type of retirement product trying hard to make a splash in the UK market. Already well established in the US, ‘third way’ retirement products aim to deliver a mix of the types of guarantees you can get from an annuity with the investment growth and capital preservation potential associated with other more flexible retirement options. They are a good attempt to ‘have your retirement cake and eat it’.

As a relatively new market, there is not much competition just yet and product innovation is at an early stage. There are big predictions about how widespread the use of these ‘third way’ products could become in the not too distant future, but only time will tell if these predictions prove to be correct.

The products in this category vary in their design which makes a direct comparison of the competition challenging to conduct. In general terms, they pay a regular income and offer some guarantees about the level of investment growth or the amount of pension fund you will have left at a later date. It is well worth seeking professional financial advice before investing your pension fund in these.

4 – Unsecured pension

Previously known as ‘income drawdown’ or ‘income withdrawal’, this is now a well established retirement income option. It allows you to leave your pension fund invested and draw an income from the pension fund each year, within prescribed limits.

As your pension fund is invested, there is of course a risk that the value will go down if your selected funds perform poorly. This could have an impact on your retirement income in the future. The death benefits available from an unsecured pension, whilst often preferable to an annuity, are less attractive than being able to pass on the entire value of your pension fund (usually tax-free) to your beneficiaries if you die before taking retirement benefits.

If you opt for unsecured pension, it is important to keep the arrangement under regular review. This enables you to make adjustments to the investment choices and your income levels. It also means you can make regular comparisons to the level of annuity income you might secure for the rest of your life.

Unsecured pension comes with extra costs that you do not have when you buy an annuity. It is typically not for the risk-averse investor, those with smaller size pension funds or people who rely on one source of income in retirement.

5 – Alternatively Secured Pension (ASP)

This is effectively a continuation of unsecured pension, available as an alternative to annuity purchase when you reach age 75.

Before the pension rules were changed in April 2006, annuity purchase was compulsory before you reached your 75th birthday. Following objections from certain religious groups who did not like the concept in sharing in the profit of people in the annuity pool dying earlier than expected (a key financial benefit of buying an annuity), this retirement option was introduced.

It is really a more restrictive version of unsecured pension and usually unattractive for the majority of people, as a result of the punitive tax treatment of the pension fund on death and the limited income levels on offer. However, it can suit some people in retirement. Knowing that annuity purchase at age 75 is no longer compulsory should at least prompt you to have a conversation with a financial adviser should you find yourself in that position.

6 – Mix and match

The great thing about selecting a retirement income option is that you do not have to commit your entire pension fund to one option, at one time.

Phasing the taking of your retirement benefits or using parts of your pension fund to pursue different retirement income options can make a lot of sense. For example, you might choose to secure a base level of annual income by purchasing an annuity with part of your pension fund but then use another investment-related option to chase a higher future income with the rest.

If you do decide to ‘mix and match’, then it is important to have a clear strategy and review things on a regular basis. Also keep in mind the need to have a simpler retirement income strategy the older you get. Juggling and reviewing several different sources of retirement income might seem manageable today, but how will it feel when you are twenty years older?

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

Higher earners saw their ability to get full income tax relief on pension contributions attacked in the 2009 Budget. New ‘anti-forestalling’ measures were introduced which restrict the level of higher rate income tax relief on offer for some investors. In simple terms, people earning over £150,000 in this or either of the previous two tax years face tax relief limits on pension contributions over £20,000 (or slightly higher in certain circumstances).

This year also sees the ISA contribution allowance increased from £7,200 to £10,200. The new limit comes into force from 6th October 2009 for investors who have reached their 50th birthday ahead of 6th April 2010. For the rest of us the ISA allowance goes up to £10,200 from the start of the 2010/11 tax year.

Pensions and ISAs have some different features, particularly when it comes to the tax treatment of contributions and eventual benefits. Deciding on what works best as a tool for your retirement planning depends on your personal circumstances, goals and objectives.

Here is a quick guide to some of the main features to consider. Let battle commence.

Tax relief on contributions

A key difference between pensions and ISAs is the tax relief each receive on the contributions. Whilst contributions to a UK registered pension scheme are usually eligible for income tax relief, investments into an ISA do not get these generous tax breaks.

Assuming you have sufficient earnings to justify the contribution (more on that later), your pension contributions should result in income tax relief at your highest rate of income tax, with a minimum of basic rate income tax relief added. This means that non-taxpayers and basic rate taxpayers get 20% tax relief added directly to their pension fund. Higher rate taxpayers are then able to reclaim the difference between basic and higher rate income tax (currently an additional 20%) as additional tax relief.

This income tax relief on pension contributions gives the pension route to retirement planning a big head start. It means that a pension investor can afford to take more risk with their money, as a 20% or 40% short-term fall in fund values would simply take them back to the starting point equivalent to an ISA investment. Of course these tax breaks on contributions come at a price.

Contribution limits

With pensions, you can contribute up to 100% of your earnings in a given tax year and receive income tax relief on the whole lot. This is subject to a couple of restrictions.

There is an annual allowance which limits the maximum pension contribution you can make in a tax year. This is £245,000 for the 2009/10 tax year, so unlikely to bother the vast majority of investors.

Since the 2009 Budget there has also been a special annual allowance which applies to pension contributions made by ‘high earners’; people with ‘relevant earnings’ of more than £150,000 in this or either of the previous two tax years. This is a basic allowance of £20,000 or an enhanced allowance of up to £30,000 where previous pension contribution levels can justify this higher amount.

Investors with no income can still contribute up to £3,600 each year into a pension and receive basic rate income tax relief. Remember that these figures are all ‘gross’ contributions after the addition of basic rate income tax relief.

The investment limit for ISA investors is currently £7,200. This is set to rise to £10,200 each tax year from 6th April 2010, or from 6th October 2009 for people who are 50 or older by the end of the 2009/10 tax year.

Of this ISA allowance, up to half (so £3,600 or £5,100) can go into the cash ISA component, with the balance available to invest in the stocks & shares ISA component. You can choose how much of the overall ISA allowance (up to half) to invest in cash.

Tax treatment of the fund

This is one area where pensions and ISAs are broadly neutral.

The money invested within a pension fund or an ISA fund is generally free of income tax and capital gains tax. The one exception to this is the dividend income from UK company shares. This dividend income comes with a 10% tax credit (which means it has already been taxed). You cannot reclaim this tax credit within the pension or ISA.

A difference in tax treatment of the funds does exist when it comes to inheritance tax (IHT). In the event of your death before taking retirement benefits, a pension fund is generally free from inheritance tax at 40% because it can remain outside of your estate for tax purposes.

The ISA tax wrapper ends automatically on death and the assets are included within your estate for IHT purposes. This means that if your total assets exceed the nil rate band (£325,000 for the 2009/10 tax year) then the balance is subject to tax. Married couples can effectively double this nil-rate band on the second death, if the first spouse to die does not utilise their own nil-rate band.

Range of funds

This is another area where pensions and ISAs are broadly similar, although much will depend on the particular product you select. Some pension plans, including many Stakeholder pensions, will offer only a limited range of investment funds from which to choose. Personal pensions now increasingly offer access to a wider range of funds from third-party external fund managers.

The widest range of pension investment options comes from using a Self Invested Personal Pension (SIPP). These enable to you access any investment permitted by HM Revenue & Customs rules, although some pension providers impose additional restrictions on investment choice.

With an ISA, the main choice in ‘product’ is between an ISA from an individual fund manager or an ISA from a fund supermarket. The former might only offer funds from that single fund manager whilst the fund supermarket will offer access to investment funds from a wide range of fund managers. Self Invested ISA products are also available, offering similar investment choice to a SIPP.

Access to the money

Actually getting your hands on your money again is an area where pensions differ quite a bit from ISAs.

Starting with ISAs, there are effectively no rules or restrictions to prevent you from accessing your money once invested. When you take money out of an ISA, you cannot replace it without using up whatever remains of your ISA allowance for that tax year. There might also be planning considerations when it comes to removing money from ISA funds if investment values have fallen.

Pensions come with a number of restrictions in terms of accessing benefits. Firstly, there is an age restriction. At present this is a minimum age of 50. From 6th April 2010 the minimum age at which you can access pension benefits goes up to age 55.

Secondly, there are rules about how much of your pension fund you can access as cash and how much of the fund has to be used to provide an income in retirement. Generally the rules enable to you take up to 25% of the pension fund value as a cash lump sum with the balance reserved for the generation of income.

Some older pension plans offer the possibility of taking more than 25% of the fund as cash, reducing the amount left over to provide an income. This is worth checking, particularly if you are thinking of moving your pension fund to a new provider when your entitlement to greater than 25% cash benefits could be lost on transfer.

Tax treatment of benefits

Capital withdrawals or income generated from an ISA are largely free of tax. With a pension, the cash entitlement is tax-free but the income generated by the remaining pension fund is subject to income tax.

Some people, when they start to take retirement benefits, use their tax-free cash (more accurately described as a pension commencement lump sum) as ‘income’; gradually phasing the taking of pension benefits to produce tax-free ‘income’ for the first few years of their retirement. This can be a particularly helpful strategy if there is no immediate need for a cash lump sum or if you are gradually phasing in your retirement and have other sources of taxable income.

Summary

Pensions and ISAs are two very different tax-wrappers used for retirement planning, but they do share some similarities. It is rarely a case of one being ‘better’ than the other.

Often people planning for their income requirements in retirement will use a combination of pensions and ISAs to create a total retirement fund that has the right balance of tax breaks (but access restrictions) and easy access.

Martin Bamford is a Chartered Financial Planner at Informed Choice and site editor of BrilliantWithMoney.