Have you lost the plot on pensions? If so, you’re not alone.

The government, employers, workers and even the finance industry itself all seem to be in a state of disarray and even denial.

We are simply not saving enough for our retirement. The shortfall is now estimated to be more than £27 billion a year. And stakeholder pensions, which were supposed to provide an entry for lower-paid workers, have made little impact since their introduction in 2001.

FINAL SALARY

The classic ‘final salary’ occupational pension is a rare beast now because of its relatively high cost.

These schemes offered a comparatively simple proposal to employees: a guaranteed proportion of your salary at retirement, based on your number of years’ employment, up to two-thirds after 40 years’ service.

Many employers have now closed such schemes to new members. Instead they offer money-purchase schemes, which work in exactly the same way as personal pensions, including stakeholder schemes.

In these the value of your pension is dependent entirely on the amount of money put in, together with the performance of the fund which looks after it.

RAINY DAY SAVING

Putting-off starting to save could well be the bigger mistake.

The effect of compound interest means that even a few years’ delay in starting a plan can have a disproportionate effect on the size of the final pot.

If you start saving £100 a month 20 years before your retirement, with around six per cent per annum growth, you’ll end up with £47,000.

Wait five years before starting, say to age 50, and you’d receive just over £29,000 on retirement at 65.

On the other hand, if you’d started 10 years earlier than that, say at age 35, your pot would be worth £102,000, and if you’d been saving for 40 years, from age 25 you’d have a nice little nest-egg worth more than £200,000.

HOW MUCH WILL YOU NEED?

When you take your pension, you are required to use it to buy an annuity, which will pay out a fixed amount (inflation-linked if you wish) for the rest of your life.

If your annuity pays out at the rate of five per cent, then for every £1,000 of annual income you want in retirement, you will need, as a rule of thumb, a fund of £20,000.

So £100 a month, saved for 40 years - amounting to £48,000 - with interest becomes £200,000, which, in turn, becomes a reasonable pension of £10,000 a year.

PERSONAL PENSIONS

These often come with strings attached.

The stipulation that you have to use most of your fund to buy an annuity means that you are provided for to the end of your life, but, unfortunately, when that day comes there is no capital left to pass on to your heirs.

That is part of the bargain made by the government in providing tax relief on pension-fund savings, at the full 40 per cent for higher rate taxpayers, and 22 per cent for the rest of us.

That means that for a basic-rate tax-payer £100 of after-tax income becomes £128 immediately at the moment it is invested.

For higher-rate payers, £100 becomes £166.66.

Of course, we shouldn’t forget income tax either.

Pension income is subject to income tax, but you are allowed to take a tax-free lump sum, 25 per cent of your fund, on retirement, which you can spend or invest as you wish.

STAKEHOLDER PLANS

These are simple, cheap, and have none of the front-end commission loading which used to swallow up much of the first year or two’s contributions and got financial advisers a bad name.

With a one per cent management fee stakeholder plans are good value, but this will rise to 1.5 per cent from April 2005. This will include advice for the first time, and the fees will drop back to one per cent after a plan’s first 10 years.

SELF INVESTMENT

SIPPs, or self-invested personal pensions, offer an alternative vehicle, and this is suited to the self-employed in particular.

The benefit is that you can choose your own investments, and these can even include commercial property, including your own, via mortgage and lease-back, and shares you already own outside the plan which you can sell to realise the capital gains and then buy back within the SIPP.

This do-it-yourself approach needs a ‘wrapper’ from a pension provider, and the fees levels may indicate a fairly high investment level, though cheaper (albeit simplified) versions are now available on the internet.

For more information from the government, visit www.pensionguide.gov.uk

Peter Willis is a freelance business journalist.