Oran Hall | Retirement savings options for the self-employed
ADVISORY COLUMN: PERSONAL FINANCIAL ADVISER
The self-employed have several options to build up financial resources for retirement – the Approved Retirement Scheme, unit trusts, managed funds and self-managed investment portfolios, most of which can deliver tax-free investment returns.
The Approved Retirement Scheme is a private pension arrangement offered by financial institutions and is open to persons who are not members of a similar scheme or of a superannuation fund. Members of such schemes can contribute up to 20 per cent of their pensionable salary.
The portion of income which is contributed to the scheme is not taxed, neither is the income that it earns while it remains invested in the scheme, but the pension the contributor receives during retirement is.
As the contributions of the many participants are pooled, the scheme is able to invest in a diversity of instruments, thereby reducing risk, and the fact that the funds are managed full-time by professionals removes the need for the contributor to devote time to manage the investments.
The retirement schemes are defined contribution, or money purchase, schemes so retirement benefits are based on the contributions made by the member and the returns earned on them. The contributor takes all the risks and can expect good benefits when the returns are good but risks getting low benefits when investment returns are poor. There are no guarantees. Further, although contributors may choose from several funds, the portfolios are not customised.
Before deciding to become a member of a retirement scheme, it is important to check its track record, performance and fees. Comparing several schemes is a prudent course to take before making a decision.
As much as possible, it is important to have other sources of savings to supplement a pension considering, among other things, increasing life expectancy and the corrosive effect that inflation tends to have on income and on pensions that are fixed, that is, they are not increased periodically to compensate for inflation.
The unit trust is an option. It generally has several professionally-managed funds which invest in diverse investment instruments and re-invests the income earned. The returns on most are not taxed, but, like other professionally-managed funds, the managers charge a fee for managing the funds.
Self-employed individuals may also engage other professional investment managers to invest their retirement savings. Many of the funds that they offer are pooled funds but some create customised portfolios to meet the requirements of their clients.
One other option is to manage one’s own portfolio. This exposes the investor to more risk due to the limited scope for effective diversification. This option does not require the payment of management fees but can be costly if the investor does not have the time and expertise to manage the portfolio effectively.
Two sources of retirement income that are often overlooked are life insurance policies and the National Insurance Scheme. Some life insurance policies can provide retirement income from their cash values and their equity values. Equity-linked policies supported by segregated funds, which are managed by professionals and are diversified, have the potential to generate good returns but do not guarantee returns.
As its name suggests, the National Insurance Scheme is an insurance arrangement, but it gives several types of pension benefits. Employed and self-employed persons and others specified under the National Insurance Act who are 18 years old and over but below the retirement age are required to make contributions.
The benefits payable include the following: old age benefit, which includes old age pension and grant; invalidity benefit, which includes invalidity pension and grant; widow's or widower's benefit, which includes widower's pension and grant, widow's pension and grant; orphan's pension, including orphan's pension and grant; special child's benefit, which includes special child's pension and grant; funeral grant; employment injury disablement benefit; employment injury death benefit and, through the NI Gold Health Insurance Plan, a range of health insurance benefits provided by participating providers island-wide.
It is important that all contributors to the NIS ensure that their contributions are up to date, particularly if retirement is just around the corner.
We may also add as a source of retirement income proceeds from the sale of business for business owners who opt to discontinue operating their business.
The options for generating retirement income are not only for the self-employed. What is clear is that the self-employed do not have to spend their entire lives working. They too can have a comfortable retirement.
Oran A. Hall, principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.