Developed countries generally have a retirement scheme, or multiple schemes, in order to provide incentives for individual retirement saving and to reduce the burden upon the state pension system.
These vary widely by country, and include the 401(k) and IRA, both Roth and traditional versions (in the US),[i] personal pensions (the UK),[ii] the RRSP (Canada),[iii] or superannuation (Australia[iv] and New Zealand[v]).
Normally, the big carrot dangled in front of your nose is that putting money away for retirement via these schemes can save you a lot on tax. Sometimes the income going into these schemes is not counted as part of your income, and therefore goes untaxed. In some situations the withdrawals are also untaxed or attract low taxes.
Some schemes offer a government or employer co-contribution, which means they may match your payments into the system, in whole or part. And finally, Australia had the brilliant idea of making these payments compulsory, which I guess is even more effective than a tax incentive.
We shall not describe in detail all the retirement programs for each Anglophone country as that would be a book in itself – indeed, it would be a very large book. In fact, you could write a whole book about each nation’s retirement system. I encourage you to research your own scheme thoroughly online, then get advice.
In general, there are pros and cons to each of these programs. The pros having already been stated, let us look at some of the cons:
– You generally cannot access your money until you reach a certain age, or at least not without suffering a financial penalty. This is NOT the vehicle for money that you may need before reaching normal retirement age.
– The government sometimes moves the goalposts by changing the rules on you, perhaps by altering tax laws or the age at which you can begin to withdraw funds. I am not aware of any egregious changes to personal pensions. In fact, some reforms have improved the situation for retirees. Nevertheless, be aware that the situation may change.
– Generally, pensions are kept separate from the company’s other finances. In addition, employees are among the first in line to receive what is owed to them if a company goes bankrupt.[vi] Some pensions are also insured. However, check that these safeguards are present in your own jurisdiction, and keep all paperwork related to your pension scheme.
– One of the biggest and most irritating disadvantages these retirement plans can suffer is that they limit your ability to determine where your money goes. You previously would not have worried much about it, but now that you know why low-fee index funds are so much better than high-fee managed funds, you’ll be pretty annoyed if you find out that your scheme is primarily invested in the latter. Look around and see what your options are. Most readers will have at least some choice if they are proactive.
A huge problem with all these schemes is that most investors, having been plonked in them automatically, are far too passive. They pay no attention to their pension fund until they are a few years away from retirement and so are put in a ‘default’ option which might be unsuitable. In other cases they take no notice of their fund until they hear there’s a stock market crash in the news and then panic-sell everything, thereby realizing a significant loss.
Don’t be passive. Be active! Research your current pension fund online, if you have one. See how your money is invested and how high the fees are. Investigate your current investment settings and whether you can change them. And as always, get advice before making any decisions.
I would also suggest keeping at least some of your long-term investments outside of these programs for the extra flexibility and diversity even if you have to cop a higher tax rate to do so.
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