How to grow old graciously

Not even the most ostrich-like among us can have failed to notice the publicity; almost daily the message rings out. Britain, we are told, faces a demographic time bomb that threatens to produce a nation of pensioner paupers.

The dilemma is that the British population is ageing. While the number of people working today outnumbers our retired population by more than four to one, that ratio will fall below three to one by 2030. At the moment those of us in work finance the pensions of retired people. However, if the experts are right, that burden will become unsustainable. Already, the state pension, a mere pounds 60 a week, is declining in value, from about 20 per cent of national average income in 1980 to 15 per cent today. The only choice for anyone who wants to defeat the logic of these numbers is to make some pension provision privately.

There are two types of private pension - personal and occupational. Most investors have to pick one or the other: you are not allowed to invest in both.

In general, occupational pension schemes provide the better deal. In a company scheme, your employer will make a contribution to your pension fund and your final pension often depends on your salary, rather than the uncertainties of investment returns. But not every employer provides a company scheme. And if you change jobs regularly, say every two years, company schemes can prove inflexible.

Despite the scandal over personal pension mis-selling, these plans remain an excellent alternative if you don't have access to an occupational scheme. Since the Government is keen to encourage private provision, pensions contributions get attractive tax treatment - and the lump sum you get on retirement is tax free.

Tax relief works on two levels. First you get relief up to your highest rate of income tax on contributions. So a 25 per cent taxpayer only has to pay pounds 75 for every pounds 100 that goes into his or her fund. Second, tax relief is also available to those people who contract out of Serps, the state earnings-related plan.

There are maximum contribution rates on personal pensions, beyond which tax relief stops. The limits vary according to your age, beginning at 17.5 per cent of salary for under 35s, rising to 40 per cent for people aged between 61 and 74.

The importance of making substantial contributions cannot be overstated. Experts believe that, even assuming a relatively low inflation climate, with average investment returns, someone in their early thirties needs to pay at least 10 per cent of their salary in order to retire with a pension worth half to two-thirds of their final pay.

You can make your contributions through regular payments or through a series of lump sums. Regular plans are best for people with a steady, predictable income. Most insurers have minimum contribution levels, starting at around pounds 20 a month.

It's important to check what flexibility a pension plan offers. Can you miss a payment without being penalised if your finances take a turn for the worse? Equally, you may want to increase your payments when times are good.

The investment of your pension fund is vital. Your final pension fund buys an annuity that will provide you with an income in retirement. You need to maximise the fund's value in order to buy the highest income annuity possible.

The riskiest kind of pension investment is a unit-linked plan, but the pay-off is the potential of higher investment returns. Your premiums are invested in a fund of investments and allocated to units, the value of which rises and falls according to the performance of the investments.

Generally, you get a choice of fund. The most common type is a managed fund, which invests in a spread to invest in a high-risk/high-return fund, since if your units do fall in value they will have plenty of time to recover. As you near retirement you can switch to a lower-risk fund so that the value of your units doesn't suddenly plunge the week before you want to retire.

With-profits funds are for more risk-averse pension investors. Here, your contributions are invested in a wide range of assets. At the end of each year the insurer pays you a bonus according to how well the investments have done and how the insurer itself has performed over the year.

The annual bonus is locked in, so the value of your fund cannot fall. Insurers also pay a bonus when the plan matures, which can account for almost half the return on some with-profits pensions. However, insurers do not guarantee bonuses. In fact, over recent years, many insurers have cut their rates quite drastically. In an era of low inflation and low stock market returns, bonuses seem unlikely to climb for the foreseeable future. That said, surveys of the relative performance between unit-linked and with-profits pension schemes have, in recent years, shown that the latter outperform the former.

Charges can vary wildly between different providers but assessing them has become much simpler since the introduction of new rules on what information providers must give you. You are entitled to know exactly what charges they make and how that might reduce the value of your pension fund.

Broadly speaking, over a pension lasting 25 years you should expect to pay charges of no more than 1.5 per cent of the total value of your fund each year. Anything more is extortionate and there are plenty of cheaper alternatives.

Often, regular premium plans can be expensive. It is worthwhile checking to see if there are alternatives, such as "recurring single premiums", where each of your contributions is treated as a one-off payment even though paid monthly.

Charges tend to be higher in the first years of your personal pension, to take into account the supposed cost of setting it up. So although you have the right to transfer your pension fund to another provider at any time you like, this can be costly. Again, before you buy, your salesman must show you how your fund would be affected if you do transfer.

Despite this and other improvements, it can be difficult to compare plans. An independent financial adviser will offer guidance about the different personal pensions on the market. It may be worth talking to more than one adviser, but it you do buy a policy through IFAs, they will either take a commission on the sale or charge you a fee. It is almost always worthwhile paying this price. A few hundred pounds spent wisely today could leave you thousands better off when you retire.