When are you planning to retire? Your pensions and savings are key to your financial security.
Pensions are tax-efficient schemes designed to help you save a portion of your income regularly during your career, so you will have an income available in later life when you retire or decide to work less.
Along with the State Pension provided by the Government, there are two main types of pensions:
- Defined contribution (money purchase schemes) – based on how much money has been paid into your pension pot and how well the underlying investments have performed.
- Defined benefit (final salary or career average schemes) – based on your salary and how long you have worked for your employer.
Pensions may be held via your employer or set up as your own personal arrangement. However, all employers who employ one or more eligible staff members are now obliged to offer an Auto Enrolment pension scheme (subject to qualifying criteria), which they and usually you must contribute to, unless you decide to opt-out.
One of the main benefits of saving into a pension is the tax relief available. All taxpayers receive tax relief at 20% on their pension contributions – if you were to contribute £100, the Government would add a further £25, taking your total contribution to £125. Higher-rate taxpayers can receive additional relief via self-assessment. Additionally, there is no liability to Income Tax, Capital Gains Tax or Inheritance Tax on the funds whilst they are invested within a pension.
Currently, there is an Annual Allowance of £40,000 for pension contributions, which is the maximum amount that can be contributed from all sources (for example – you and your employer) into a pension tax efficiently (however you may be able to carry forward any unused allowance from the previous three tax years to boost this amount); your tax-relievable personal contributions cannot be any higher than your earnings (or £3,600 if more).
Although pensions are intended to be used for retirement planning, they can also be advantageous in terms of estate planning as, on your death, your pension funds can be passed onto your chosen beneficiaries, normally outside of your estate and therefore not liable for inheritance tax – if your beneficiaries leave the funds within a pension wrapper they remain free from inheritance tax; in addition, if you pass away before age 75, money purchase funds are free from income tax as long as they are either withdrawn as a lump sum or placed in a beneficiaries drawdown plan (or used for annuity purchase) within 2 years of your death.
Currently, you can draw benefits from a pension once you reach age 55. However, this is expected to increase to age 57 from 2028, when the State Pension age increases from age 66 to 67. Should you suffer poor health or have a protected lower pension age, you may be able to draw your benefits earlier.
At present, the full new State Pension is set at £168.60 per week and you can check your entitlement via the Government’s website at www.gov.uk/state-pension.
Under current legislation, it is usually possible to take a maximum of 25% of your pension fund as tax-free cash.
There is usually greater flexibility in how you can access your retirement benefits from a defined contribution plan. Options available currently include the following:
- Annuity – this uses your fund to purchase a guaranteed income for life or a set number of years.
- Uncrystallised Funds Pension Lump Sums (UFPLS) – allows you to take sums straight from your pension fund with each payment being 25% tax-free and 75% taxable.
- Flexi Access Drawdown – this allows you to take as little or as much income from your fund, as and when required. It can be taken as tax-free cash, taxable income, or a combination of the two.
- One-off lump sum – you could withdraw your whole pension as one lump sum with 25% paid tax-free and the balance as taxable income.
Not all pension providers will offer these options, but you have the option to transfer to a provider that does. Some pension contracts can offer a combination of these benefit options.
It is important to get financial advice on your pensions as you approach your planned retirement to ensure you choose the best benefit option(s) for your circumstances.
When considering your benefit options, you need to also be aware of benefit limits. The Lifetime Allowance (LTA) is a limit on the amount of pension benefit that can be accrued within pension schemes without triggering an extra tax charge. The LTA for the 2019/20 tax year is £1,055,000 and this is likely to increase with inflation thereafter.
If you have pension benefits approaching or above the LTA, you may be able to apply for protection and you should seek further advice in this respect.
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