Pensions might seem complicated, but in reality, the concept is relatively straightforward. Complications have arisen over the years as different types of pensions, schemes and rules have been introduced.
It’s worth understanding the benefits of pension savings as it could have a significant impact on the quality of your retirement. Here, we will provide answers to commonly asked questions and help guide you through the pension maze. Getting to grips with the basics is an ideal place to start.
What is a pension?
A pension is simply a type of long-term savings plan designed to help you save money for later life. Fundamentally, it allows you to save regularly during your working life to provide you with an income when you decide to retire or work fewer hours. The money contributed to your pension is usually invested, along with other pension savers’ cash, in some form of investment product. Pension contributions also benefit from particularly favourable tax treatment, which makes them more appealing than other types of long-term investment.
What are the different types of pensions?
There are three major pension options and most people fund their retirement through a combination of one, two or all three of these types.
Workplace pensions: These are arranged for you by your employer and are sometimes called ‘company pensions’ or ‘occupational pension schemes’. A percentage of your salary is automatically deducted and, in most cases, the amount you pay is then topped up by a contribution from your employer, as well as tax relief from the government. The phased introduction of automatic enrolment since 2012 has now resulted in companies enrolling the vast majority of their staff into a workplace pension.
Personal pensions: These are sometimes called ‘defined contribution’ or ‘money purchase’ pensions. Basically, you pay a portion of your earnings into your pension pot which, along with tax relief, is then placed by your pension provider into a range of investments. The amount you ultimately receive in retirement will depend upon how much you pay into your pot, fund performance, the administration fees charged by your provider and how you ultimately take your cash.
The State Pension: This is a weekly payment (currently £175.20 per week) payable at State Pension age. Entitlement is built up by either paying or being credited with National Insurance contributions (NICs) during your working life. To qualify for the new full State Pension, you need a 35-year NICs record.
Whatever type of pension plan you hold, you get tax relief at the highest rate of Income Tax you pay on all contributions you make, subject to annual and lifetime allowances.
You receive ‘relief at source’ if you pay money into your personal pension yourself meaning you automatically receive 20% tax back from government in the form of an additional deposit into your pension pot. If your workplace pension contributions are taken directly from your pay packet, they are paid gross of tax into your pension. So, for instance, in both circumstances, if you are a basic-rate taxpayer investing £800 of your take-home pay into your pension, the tax relief would amount to £200; effectively the taxman tops up your £800 contribution to £1,000.
If you do not earn enough to pay Income Tax at all, you still qualify for tax relief up to a certain amount. The maximum annual contribution you can currently make is £2,880 which, along with tax relief, would amount to £3,600 a year being paid into your pension scheme.
Is there a limit on how much I can pay into a pension?
Although you can contribute as much as you like into your pension, there is a limit on the amount of tax relief you are able to claim each year. For 2020-21, this Annual Allowance is £40,000, or 100% of your earnings, whichever is lower. However, once you have used up the current year’s Annual Allowance, if you have unused allowances from the past three years, you can use these, by carrying them forward, provided you were a pension scheme member during those years, and your total contribution does not exceed 100% of your current year’s earnings.
In an attempt to control the cost of pensions tax relief and to make sure pensions tax relief is fair and affordable, a Tapered Annual Allowance was introduced in 2016-17 which looks at an individual’s taxable income in the tax year - currently the Tapered Annual Allowance applies for individuals with ‘threshold income’ of over £200,000 and ‘adjusted income’ of over £240,000.
For those who have flexibly accessed their pension, under the new flexible pension rules, the Money Purchase Annual Allowance (MPAA) applies, which limits the amount of money which can be contributed to a money purchase scheme to £4,000pa, effective from 6th April 2017.
A Lifetime Allowance also places a limit on the amount you can hold across all your pension funds without having to pay extra tax when you withdraw money. This limit is currently £1,073,100.
When can I access my pension?
Pension freedoms introduced in 2015 allow you greater flexibility in how you can access your pension from age 55; you’re free to take as much or as little as you like from your pension pot, whenever you like. This greater flexibility gives more options, but these also need careful consideration.
It's never too early – the sooner you begin, the longer your savings have to grow
But better late than never – favourable tax treatment and opportunities for investment growth can still make a huge difference
Don’t delay if you’re self-employed – as you are responsible for your own pension provision
Keep on track with regular reviews – to make sure you meet your retirement goals. Getting a State Pension Forecast will help your planning.
Nominate beneficiaries – so that your pension wealth can be passed on in the event of death
Take control of your retirement – consider the pros and cons of different options from age 55
Most importantly, make sure you get good advice – it’s vital to get advice tailed to your own individual circumstances
How we can help
Our expert pension advisers will help you see the bigger picture and talk to you in plain language to help you understand your options.
They will start by finding out more about important factors such as your attitude to risk, investment perspective and tax position. Understanding your relationship with your finances will help your adviser create a plan that encompasses what you want your money to accomplish for you and your family in the years ahead.
So, if you would like to discuss your pension options and retirement planning, do get in touch. We are only a phone call away. You can be sure that all our advice and recommendations will be focused on getting you the best possible result.