The Pension freedoms introduced by George Osbourne in 2015 have afforded savers more flexibility than ever, so it’s important to understand the options available. There hasn’t ever been a better time to be reviewing your pension and keeping on top of it, to ensure the pension is working its best for you, to enable you to have the most comfortable and enjoyable retirement as possible. Even with the ever changing financial planning landscape a pension remains one of the most tax efficient ways to save for retirement.
What is a Pension?
Basically, a pension is simply a savings scheme that offers very attractive tax reliefs and benefits which can then be accessed from age 55. Money is invested in different investment classes, from very basic funds to complex ones.
The basic state pension was officially launched in 1948 and was designed to provide a minimum amount of money to the UK population in retirement.
The state pension age has historically been 60 for women and 65 for men. By November 2018 the state pension age increased to 65 for all women. It will subsequently rise to 66 by October 2020 for both men and women. Further increases are planned. In all likelihood, it will then rise to 67 between 2026 and 2028, and to 68 between 2037 and 2039.
The new state pension was launched on 6 April 2016 to replace the basic state pension and state second pension. It pays a maximum of £175.20 a week (assuming 35 years of full rate national insurance contributions). The change will impact women born on or after 6th April 1953 and men born on or after 6th April 1951. The exact amount on how much you receive will depend on your National Insurance record, you can keep an eye on it here by getting a Government login and checking your state pension forecast here.
Defined Benefit Pension
A defined benefit pension or Final Salary pension as they can also be known is a scheme set up and run for company employees. The reason why they are known as final salary pensions is because the amount you will receive in retirement depends on the numbers of years you worked at a company running the scheme and the salary that you are on throughout the service will influence how much the pension pays out in retirement.
Defined Benefit pensions are generally seen as really good pensions to have but there aren’t many companies that offer them anymore due to the expense to the company of running and funding them. There are some still about such as Local Government Pensions for example which are defined Benefit.
These types of pension are set up by the individual for the benefit of the individual. It does not matter where you work or how much you earn, you can decide how much to contribute, and you decide which funds or investments are invested in. Obviously the more you contribute the more you will have in retirement its explained about contributions and how important contributions can be below.
- Tax relief on personal gross contributions is restricted to the higher of £3,600 or 100% of relevant UK earnings each pension input period and is capped at an annual allowance of £40,000 (unused allowances can be carried forward from the previous three tax years).
- Technically there is no limit on employer contributions. However, they will only receive corporation tax relief at the discretion of the local Inspector of Taxes.
- Contributions, including those paid by an employer or third party on behalf of the individual, are tested against the individual’s annual allowance. Contributions in excess of their available annual allowance will be subject to a tax charge at their marginal rate of income tax.
- If an individual takes benefits from their pension fund in the form of an income via flexi-access drawdown, an uncrystallised pension lump sum, or a flexible income via an annuity then their annual allowance is reduced to £4,000. This is known as the Money Purchase Annual Allowance (MPAA).
- Individuals with adjusted yearly incomes (this is in effect an individual’s total income and includes, amongst other things, their pension contributions but minus certain allowances) of more than £150,000 will have their annual allowance reduced by £1 for every £2 of excess income. The maximum reduction is £30,000 for individuals with adjusted yearly incomes of at least £210,000, which results in an annual allowance of £10,000.
Personal contributions to a registered pension scheme receive basic rate tax relief at source. This means for every £80 paid in, the pension fund will receive an additional £20 in tax relief. Higher and additional taxpayers can claim further tax relief through their tax return. No tax relief can be claimed on contributions paid after age 75. However, contributions will continue to benefit from tax-advantaged growth whilst they remain invested in an approved pension scheme.
There are three basic types of personal pension:
These are very simple pensions, they are designed to encourage those lower earners to save for their retirement.
Stakeholder pensions were introduced on 6th April 2001 as a pension vehicle with a minimum cost guarantee. Stakeholder products were initially limited to charging a maximum annual management charge of 1% of the fund value per annum, throughout the term of the stakeholder contract. However, from April 2005, they were allowed to charge up to 1.5% per annum for the first 10 years, reducing to a maximum of 1% per annum after this. We discussed setting up a stakeholder pension however this type of pension plan will not offer you the flexibility you desire with the pension. It will not offer you the ability to access your funds as an when necessary and therefore has been discounted.
Individual Personal Pensions
These are the most common type of pension, and suit a lot of peoples requirements. They have access to a wide range of funds and will vary from provider to provider. The charges can be higher than stakeholder pensions but usually aren’t and if they are its usually minimal, the fund selection is usually wider than stakeholder. There is also flexibility to switch funds or investments within the personal pension wrappers.
SIPP (Self invested personal pension)
These are the most complex personal pensions and allow a large amount of investment flexibility if you are very active in your investment allocation. SIPPs allow clients to access all types of assets to suit their needs. SIPPs are generally more expensive than individual personal pensions as there is a platform fee to pay but due to the number of platforms entering the market this again is very negligible and SIPP providers are competitively priced. Again if you have any questions we would advise you to contact one of our financial planners.
We would strongly encourage you to seek advice from a regulated financial adviser as the implications and significance of getting things correct are a lot more in depth that the information contained here. That’s why we suggest you seek advice from a suitably qualified financial adviser.
Options and choices available to you
Upon reaching 55, you’ll be able to
- leave your pension invested;
- withdraw cash in a single lump sum or a number of lump sums
- flexi access drawdown, you can take some of your money whilst leaving the rest where it is.
- a combination of all of the above;
- purchase an annuity;
- a combination of all of the above;
- cash entire pension in.
The first 25% will normally be tax free when taking an income or lump sum from your pension, with the remainder being taxed as income. Taxation in regard to pensions can be complicated, so we recommend that you seek a financial planner for explanation on how it may affect you.
Leave your pension fund invested
You don’t have to rush into a decision as the flexibility of pensions since the pension freedoms in 2015 were introduced, make it easier than ever to suit you circumstances and make any potential changes at the exact time that you need too. By leaving your fund if you don’t need it, it will give some advantages, you’ll give your pension fund a chance to grow.
Flexi Access Drawdown
From April 2015, depending on what pension you have some restrictions on accessing pension funds were lifted. Flexi-access drawdown allows you to take any amount to provide an income that suits your requirements, as and when you desire. The rest of the funds still stay invested and can continue to grow.
Flexi-access drawdown can provide a very flexible and tax efficient way of drawing benefits directly from a pension fund.
An individual can take up to 25% of the pension fund being crystallised as a tax-free lump sum at outset, and the residual fund remains invested within a tax advantaged environment. The individual can then take regular or ad-hoc income, or lump sum withdrawals from the residual fund to suit their needs and circumstances. There is no upper limit to the amount the individual can withdraw at any one time. However, each withdrawal is taxed at their marginal rate of income tax, and so consideration should be given to the amount and timing of a withdrawal to minimise any tax paid.
Flexi-access drawdown also provides an extremely tax-efficient way of passing assets down through the generations as any unused pension fund can be passed on to a wide range of beneficiaries without it ever falling into anyone’s estate for inheritance tax purposes.
Uncrystallised funds pension lump sum
You can take lump sum payments from your pension in addition to flexi access drawdown called Uncrystallised Funds Pension Lump Sums. This allows you to take lump sums without crystallising the rest of your funds. You could even choose to take the whole pot in one but again it would be worth talking to us about this.
Purchase an annuity
By purchasing an annuity you’ll be able to guarantee a set income for the rest of your life. Annuities are usually fixed so you won’t be able to vary what you receive to suit your needs and circumstances once you’ve purchased the annuity.
We are a firm of Independent Financial Advisers based in Shrewsbury and we serve clients in Shropshire and all over the UK. Please don’t hesitate to contact one of our Financial Planners if you would like to find out more about retirement planning.
We would highly recommend that you seek advice from a suitably qualified and regulated financial adviser before making any decisions about your pension.
There are many factors to consider such as longevity of funds, taxation, changes in personal circumstances and if the type of funds or investments you are in remain appropriate.