WITH THE WEALTH OF CHOICE AVAILABLE
Personal Pensions, Pensions Freedom, Group Personal Pensions, Flexi Access Drawdown, Defined Benefit Transfers.
With the wealth of choice available, this is one area that most people need help with. Retirement planning includes thinking about income needs now and throughout your life, and how that can be maintained in a tax efficient way. Also, consideration as to what death benefits you need to put in place for your loved ones and family so their future is secured as well.
Personal Pensions represent a popular and attractive way of saving for your retirement.
All monies invested into your fund grow free of capital gains tax, and the contributions you make are enhanced by income tax relief at source. For example if you invest £80, the government adds on tax relief (currently 20%) to enhance your contribution to £100! If you are a higher rate taxpayer you can claim additional relief through your PAYE coding. An annual allowance of up to £40,000 (2016/2017) is available as well as the possibility of utilising potential carry forward of unused annual allowances.
A personal pension is an arrangement made in your name over which you have personal control. You can alter your contributions, suspend them, or stop them completely.
You will be eligible to take 25% of your accumulated fund tax-free when you retire, the earliest age being from 55. There are a range of options when you decide to take benefits such as purchasing annuity or electing capped or flexible drawdown.
Personal Pensions usually offer a range of investment mediums to suit your attitude to investment risk, and you can change your investment at any time.
Pensions are a long term investment. You may get back less than you put in. Pensions can be and are subject to tax and regulatory change therefore the tax treatment of pension benefits can and may change in the future.
10 facts you need to know about pensions
A pension is a good way to save for your future and ensure you’re set up to have money in retirement – and most people know that. So why are pensions a big turn off for many?
Maybe a pension might not seem a priority. The future can seem a long way away when you’re younger and struggling to make ends meet in the here and now. They can also be difficult to understand. There are so many different pension options and jargon to get your head around, it can sometimes feel overwhelming and complicated. If these sound like the reasons you’ve been neglecting your pension, a little guidance could be just what you need.
So at HFL, we’ve put together a 10 point, plain speaking guide that we hope can help you understand a little more about pensions. It also explains why it is important to start thinking about pensions as early as you can, because, quite simply, the earlier you start contributing to a pension, the more your ‘pot’ will grow and the bigger the fund you’ll have when you come to retire. We’ll also talk a little about alternative ways you can save for retirement.
1. What is a pension?
A pension is an income you receive when you retire. Where this money comes from, how it’s saved – and by whom – are all factors that determine what sort of pension it is.
There are three main types of pension in the UK: The State Pension (provided by the government), salary-related pensions (provided by some employers) and money-purchase pensions (which you and/or your employer may pay money into.) The latter schemes are also often known as personal pensions.
2. What about tax?
You might have heard that pensions attract tax breaks. This is how it works:
The government provides a tax incentive to encourage us to save for our retirement. Providing a pension scheme fulfils certain criteria, you’re not taxed on the money you put into it.
Everyone gets pension tax relief of at least 20% – the current basic rate of tax in the current tax year April 2016 – April 2017. This includes people who earn income up to the personal allowance of £11,000 (2016/17), or don’t pay any income tax at all, for example children, students or the unemployed. As an example, for every £80 you contribute to a pension, the government will put in at least another £20. And if you pay the higher level of tax (40%) or additional rate (45%), you can claim 40% or 45% back as pension tax relief via self-assessment.
There are various limits on how much relief you’ll get. For example, you’ll only get tax relief on contributions up to 100% of your yearly salary or a ‘basic amount’ at £3,600 if you are not earning. This is up to the Annual Allowance limit of £40,000 (2016/17). There are rules regarding tapering of this allowance for high earners over £150,000’adjusted income’ and carry forward rules for unused allowances for up to 3 years.
It’s worth bearing in mind that most people’s pensions do, in effect, end up being taxed. This is because tax will have to be paid on the income you receive from your pension fund when you retire. In other words, the tax is delayed (allowing your money to grow faster), but you will have to pay it in the end – but not of course on the tax-free lump sum that you are allowed to take.
3. How much you are likely to need for your retirement?
Obviously it’s difficult to know what money you’ll need in the future, because there are so many variables and your personal circumstances will almost certainly be subject to change from time to time. But you’ll have an idea of the type of lifestyle you’ll prefer in retirement, so you should be able to work out roughly how much you’ll need each year – and how many years you’ll need it for. Don’t forget that the trend now is that we are all living longer, so you’ll need to take that into account. You may have paid off your mortgage by the time you come to retire, but you’ll probably want to spend more on holidays, hobbies and leisure activities. It may well be that you’ll need, ideally, the same level of income in retirement that you enjoyed during your working years.
4. Start saving sooner rather than later
The longer you put it off, the more you’ll need to pay in later on to reach your desired retirement income. There are a number of calculators available online that can help you work out how much you’ll need to save to provide this level of income.
5. Are you auto-enrolled into a workplace pension?
If you are, you should have almost certainly been made aware of it by your employer. Auto-enrolment is a government initiative that compels all companies to provide a qualifying workplace pension for all eligible employees. The scheme originally started amongst larger companies but is now rolling out amongst smaller companies.
This essentially means that if you are eligible, you are auto-enrolled into a workplace pension to have at least 1% of you salary going towards your pension – and with this, your employer matches the contribution or may choose to contribute more.
Auto-enrolment is a bold initiative, but you may find that it alone will not provide the level of income you’ll need in retirement.
6. If you already have a pension, what type is it?
Defined Contribution (DC) Pensions build up a pension pot using your contributions (and if applicable, your employer’s input) plus investment returns and tax relief.
Defined Benefit (DB) Pensions, also known as ‘final salary’ pensions, are different, in that the amount paid to you at retirement is set by a formula based on how many years you’ve worked for your employer and the salary you’ve earned. If you currently work or have worked for a large employer or in the public sector, you may have a defined benefit pension.
7. Your family can benefit too
Having pension savings is not only a good way to save money for retirement, but it can also help provide security for your loved ones too. If you still have money in your pension pot, or if you’re taking your pension as a guaranteed income (annuity) or as an adjustable income, the rules are that your beneficiary will inherit your pension tax free if you die before 75, but will pay Income Tax on it if you’re 75 or over when you pass away.
8. Could you cope on the State Pension?
The State Pension is a pension paid by the Government when you reach State Pension age, which you get when you have paid or been credited with National Insurance (NI) contributions.
The state pension entitlement rules changed radically on 6 April, 2016, for men born on or after 6 April 1951 and women born on or after 6 April 1953.
The government introduced a ‘single-tier’ state pension with a ‘full level’ of £155.65 a week (£8,092 a year). But the name is confusing because you may get more or less than this. If you have made full NI payments, building up additional state pension, you’re likely to get more. If you ‘contracted out’ and paid reduced NI contributions for several years, you’re likely to get less. And whereas previously you were entitled to a full pension after 30 years of NI contributions, it’s now 35. To qualify at all, you need 10 years of NI payments.
If you are not currently planning on making any additional provisions for your pension, it is important to consider very carefully if the State Pension provides an amount you’d be able to live off.
9. Know all your options
Following the radical ‘pensions freedom’ changes introduced in April 2015, you now have more choice and flexibility than ever before over how and when you can take money from your pension pot.
10. Be wary of pension scams
There are many different types of scams, but this is essentially when fraudsters attempt to steal your pension savings. Since the new pension freedoms in April 2015, incidences of scams have been on the increase. They will often take the form of someone offering to invest pension money with the promise of large returns. If a retirement investment seems too good to be true – it probably is. We would advise that you always seek qualified, professional financial advice from a trusted source.
So, to sum up, what are the ‘pros’ and ‘cons’ of saving into a pension?
The tax relief on offer is a major pro.
You may work for an employer who is prepared to match your contributions to your personal pension scheme.
Personal pension funds typically invest your money in shares, and although there are risks involved, shares usually deliver a better return than cash savings over a long period.
Because money in a pension fund usually can’t be accessed until you retire, you won’t be tempted to fritter it away needlessly.
Because your money is inaccessible until you’re 55 (2016/17), you normally can’t lay your hands on it in a financial emergency. Please note that this will change to age 57 in 2028, when the state pension retirement age changes to 67.
Because of the way personal pension funds are usually invested, the eventual size of your pension fund can’t be guaranteed. If the investments chosen (such as particular shares) perform badly, you could end up with less of a return than you hoped for.
Many holders of personal pensions have been disappointed by the income they eventually received in retirement. In other words their pension fund generated a smaller income than they expected. This is due to problems with what are known as annuity rates.
What are the alternatives, or additional ways to save for retirement?
There are other ways of providing for your old age. Two of the most popular alternative sources of retirement income are property and Individual Savings Accounts (ISAs). But are these alternatives better to invest in than a pension?
Years of rapid house price growth have led many Britons to plump for property as their retirement nest egg. But buying a property for investment isn’t risk-free, particularly if that property is also your home. When you retire, you may be forced to downsize or release equity in your property to provide for your old age.