Today we have an article from Stuart from Periscope Wealth LTD our chosen financial advisors in Altrincham on everything you need to know about personal pensions. We also recently recorded a podcast with Stuart on this subject, you can find that here.
When I was asked by MyBump2Baby to write an article about pensions to coincide with the Expert Podcast it got me thinking.
I have a seven-year-old son and I always do the morning school run. So everyday I see and hear all the parents chatting away. “Do you see Corrie last night?”, “Where are you going on holiday this year?”, “I’ve been up all night with …….!”. You get where I’m coming from. The best though was two fathers, “When they migrate, how do the birds know which way to fly?” asks one, “There must be some sort of magnet attracting them” said the other, which apparently is quite close to the truth!
But I’ve never ever heard “How is your pension doing?”, “My workplace pension is really good” or “Do you know of a good financial adviser who can advise me on pensions?”. If I’d have heard that one, I would have stepped in straight away.
So why is that? Are pensions such a taboo subject? Are they not viewed as particularly important? Or are people so unsure as to what a pension is or is there is such a lack of knowledge and understanding about pensions that nobody wants to talk about them.
Well hopefully I’m going to provide some understanding, dispel a few myths and make pensions something that you will want to talk to your friends and family about.
So, lets start at the beginning.
What is a pension plan?
Quite simply, a pension is a means of saving for your retirement. You are building up a fund of money for your future.
Nobody really wants to work forever, but when you stop working you will want to be able to do things that you couldn’t do when you were working. More holidays or weekends away, shopping trips, more time playing golf or at a spa or just maintaining the standard of living you have worked so hard to achieve. But how are you going to pay for it?
So a pension scheme can be split into 2 aspects. Firstly, the saving up to retirement and then the receiving of an income. The options of how you can receive your income have been increased since the pension reforms in 2015. Giving people plenty of choice once they retire.
What is the State Pension?
The State Pension age is currently 66. This will rise to age 67 in 2028 and from 2044 to age 68. However, the government have already indicated that this timetable could change and see the State Pension age become 68 by mid 2030’s and 69 by 2048.
At the moment, as long as you have made National Insurance Contributions for 35 years or more, a full new State Pension is £175.20 a week. That’s £9,110.40 a year or £700.80 every 4 weeks.
As long as you have at least 10 years National Insurance Contributions, you will receive some State Pension and you will also qualify for National Insurance credits if you cannot work for various reasons, including being a parent and staying at home to raise your family.
However, would you want to solely rely on the State Pension in retirement?
This is why personal pensions and more recently why Workplace Pensions have been introduced to enable individuals to start building up their own pension fund. Letting people take control of when they can retire and on how much.
Saving into a Personal Pension or any Workplace or Occupational Pension Scheme does not affect the amount that you would receive from your State Pension. Therefore, saving in any pension scheme will be beneficial in retirement.
What is a Personal Pension Plan?
Let’s start with Personal Pensions. Sometimes also called Private Pensions. They are individual contracts between you and the pension provider and are set up by you, the member. You can have a personal pension if you’re employed, self-employed or not working.
A Personal Pension was traditionally arranged with an insurance company, but now due to technology there are many different pension providers to choose from. They are also referred to as Money Purchase Schemes and are also called Defined Contribution pensions as it is the contributions that help to build up your pension fund.
All UK pension schemes must be registered with HMRC and many are regulated by the Financial Conduct Authority (FCA) and the Pensions Regulator.
What are the Benefits of Saving in to a Pension Plan?
One of the main benefits of saving into a pension rather than say a building society savings account, or an ISA is the tax relief you receive.
When most people save it is from their income that has already been taxed before it is paid to them. If money is then saved into a Personal Pension, the tax paid is rebated back into the pension scheme. This is only done at the basic rate of income tax, but higher rate taxpayers can reclaim any extra tax paid via their Self-Assessment Tax Return. Furthermore, all the income or capital growth that is generated by the investments held within a pension fund is tax free.
All contributions that are made to your personal pension are invested and you can normally choose from a wide range of funds. There can be many different funds to choose from, although a provider can restrict the number of funds they offer you.
Different funds have different risk profiles. While higher risk funds can potentially provide higher returns over the longer term, these returns can be unpredictable as they will have more money invested in stocks and shares. Whichever fund or funds you invest money in, the value of these funds can go down as well as up.
Deciding which funds to invest in can be a complicated and time-consuming process, and you may wish to seek advice.
When can a Personal Pension be Set up?
A Personal Pension can be set up at any age and even for young children or babies should parents or grandparents wish to make contributions to enable them to start building up retirement benefits from an early age.
How much can you pay in to a personal pension?
Some providers will open you a Personal Pension with as little as a pound. But there are limits to how much money you can save.
The maximum amount that you can pay into a Personal Pension each tax year is £40,000 or your Net Relevant Earnings (annual income) whichever is the lower.
If you are not working and therefore have no earnings or if you are saving for a child, the maximum amount that can be saved each tax year is £3,600.
The maximum amount that you can save during a lifetime is currently £1,073,100. This is known as the Lifetime Allowance and refers to the total amount of money from all pension schemes that someone holds. The allowance usually increases each year but has also been known to be reduced by the Government. If the Lifetime Allowance is exceeded, then additional taxation rules are applied to the excess.
The minimum age for retirement is currently age 55. This is also under review by the Government and is likely to rise to age 57 when the State Pension age rises to 67 in 2028.
The maximum age is 75. Although there are no rules stating that you have to start taking income from your pension even at age 75.
What are Workplace Pension Schemes?
In 2012 the Government started the phasing in of Automatic Enrolment. It has long been acknowledged that most people are not saving enough for retirement and, as a result may not be able to afford to live comfortably in their retirement on just the State Pension. As people are also living longer, there is increasing strain on the State benefits system, so private pension provision is becoming increasingly important.
In the past, many workers missed out on valuable pension benefits, because their employer didn’t offer them a pension, or they didn’t apply to join their company’s pension scheme.
Automatic enrolment changed this. It makes it compulsory for employers to automatically enroll their eligible workers into a pension scheme. The employer must also pay money into the scheme.
These schemes became known as Workplace Pension Schemes since 2018, as all employers should have established a pension scheme for their employees following Auto Enrolment.
These are also money purchase pension schemes, whereby contributions from both the employee and employer build up a fund of money for the employees’ retirement. During this time your money will be invested in a fund, which may include stocks and shares and therefore the value can go down as well as up.
An eligible employee is generally someone aged 22 and over, who earns at least £10,000 a year. However, someone who falls outside this can still request to join the scheme.
Whilst eligible employees are automatically enrolled into the workplace pension, they can still opt out of it should they choose. Whilst this is never advisable, it remains an option.
If an employee leaves an employer who had arranged a workplace pension, the pension becomes frozen. Neither the employee nor the employer can take money out of the pension fund once a contribution has been made. However, the fund can be transferred to another workplace or personal pension plan of the employee.
The retirement age for a workplace pension is the same as a personal pension, from age 55 up to a maximum age of 75.
What are Occupational Pension Schemes?
There are exceptions to the standard workplace pension schemes, but these are generally now only available to public sector workers, such as in Local Government or the Civil Service, the Emergency and the Armed Services and the NHS (National Health Service) and Teachers. But in the past many larger companies also offered this type of pension.
These pensions are usually Defined Benefit Pension Schemes, also referred to as a ‘final Salary pension’ and as such build up a member’s benefits based upon their level of salary and the number of years’ service within the scheme or up to their retirement date.
Both the employee and employer make contributions, but they do not directly affect the amount of pension a person will receive at retirement age.
The Trustees of the Defined Benefit pension scheme calculate how much both the employee and employer should contribute, but as employees leave and change jobs their accrued benefits are deferred until the normal retirement age of the scheme.
Therefore, the responsibility falls on the employer to keep funding the pension. Whilst this is done for public sector workers by the Government, the private sector schemes have, in some cases fallen into deficit by many millions of pounds.
When a company fails to meet its obligations, these schemes have applied to the Pension Protection Fund (PPF) for help. In these cases, the PPF protect at least 90% of members pensions.
The maximum pension that be received by a Defined Benefit Pension Scheme is the equivalent of two thirds of the members final salary.
More recently, the majority of occupational pensions are now money purchase pensions and you would build up a fund
Benefits in Retirement
Once you have saved as much as you can during your working life and the time has come to retire, what options are available when it comes to receiving the benefits from a pension?
This is split into two main types of pension scheme.
Defined Benefit Pensions
As previously mentioned, benefits are built up based upon the number of years membership of a scheme and the salary being earned. Calculated as a fraction, the maximum pension is 2/3 final salary, or a part thereof.
There is always the ability to commute part of your income to receive a tax free lumpsum of cash. But this is based upon the pension scheme rules and can vary between different schemes.
Money Purchase Pensions
This includes personal pensions, workplace pensions and some occupational pensions.
With these types of pension, you build up a pension fund. An amount of money that has been achieved both by saving and from the returns from investments.
From age 55 anyone can apply to receive benefits from their pension. Although it is advised to only withdraw money when you decide to retire.
Free Impartical Advice on Pensions
Be sure to use the free, government-backed Pension Wise service to help you understand your options and get a regular financial review from a financial adviser.
Pension wise are the Government’s free, impartial retirement guidance service open to anyone seeking information about how they can turn their pension fund into a retirement income.
You can just take some of your benefits from age 55, previously this wasn’t an option. As most pension providers insisted that all the benefits had to be taken in one go.
The maximum tax free cash lump sum you can receive is 25% of the fund. Any additional amounts of money you withdraw, whether that be regular income payments or ad-hoc lump sums are liable to income tax.
What is an Annuity?
The main policy that was used to generate an retirement income was an Annuity. These policies are still available, but due to the low interest rates are less popular. An Annuity though gives you a guaranteed income for the rest of your life. If you are in poor health at retirement age, there could be an enhanced interest rate available. They can pay a fixed income or one that increases with inflation.
However, as you a buying an Annuity you are using your pension fund to purchase it. This means that unless there has been some provision included to pay an income to a spouse, the income dies with you. There is normally a minimum term of 5 years included, so should you die in the early years of retirement the income will continue for those remaining years.
Since the introduction of pension freedoms by the Government in 2015, the more popular way of receiving an income is by flexi-drawdown income.
After taking the tax-free cash lump sum, the remaining fund can be accessed in a flexible way to fit in with your income requirements in retirement. During this time your money will remain invested, which may include stocks and shares and therefore the value can go down as well as up.
The benefit of this is that more can be withdrawn in the early years, when you might need more prior to receiving the State Pension, so allowing for an earlier retirement. Or if you want to pay for more holidays or buy luxury items that may not be as greater importance as you get older.
The downside of pension freedoms is that once all the money has been withdrawn from the fund, there is nothing left to live on and then you are just living off the State Pension.
What are the Death Benefits of an Occupational Pension?
Occupational Pension Schemes – Defined Benefit schemes would normally have 2 features in the event of death prior to retirement. These are a death in service benefit, which is a multiple of your salary, plus a refund of pension contributions.
When death occurs after retirement, there is usually a widow’s pension that is payable to a spouse or civil partner. This is rarely for the full amount as the members pension, but a 50% widows’ pension is very common and is paid until their death.
Money Purchase Pension Schemes – Prior to retirement, 100% of the fund value is payable to the named beneficiaries of the plan. Where a beneficiary is not named, the pension trustees will refer to a members Will for beneficiary details.
Following retirement, providing the income is withdrawn by drawing down from the fund, all remaining monies within the pension is paid to the beneficiaries as above.
If a person dies under the age of 75, the pension is paid tax free to the beneficiary. If they are older than age 75, income tax is payable by the beneficiary.
If an Annuity is purchased to generate income in retirement, unless there has been some provision included to pay an income to a spouse, the income dies with you.
There is normally a minimum term of 5 years included, so should you die in the early years of retirement the income will continue for those remaining years.
Other Frequently Asked Help and Advice around around Pensions
What is an Appropriate Personal Pension?
These were the pension policies used when people could apply to contract out of SERPS (State Earnings Related Pension Scheme). Contracting out ended in 2012, but for people who have this type of pension, they are treated just like any other personal pension.
How much should I pay into a pension?
For workplace pensions, the employee currently pays in 5% and the employer 3% of a person’s qualifying earnings. This is a statutory minimum, which the Government may increase in the future.
Pensions are a long-term investment and once you have paid money into a pension the earliest age you can access the money is age 55.
Therefore, whilst the more money you can afford to save is going to increase the value of your pension fund, ensure that you have already built up an emergency fund in an instant access account. We recommend the equivalent of 3 months expenditure as an emergency fund.
In addition, if you have other things that you know you will need money for i.e. new car, children’s education, home improvements. Save for this in a product that is more accessible such as an ISA.
However, the more money that you can save in a pension, then potentially the earlier that you might be able to retire. This is why pensions are part of your retirement planning.
Can I set up a Personal Pension?
Anybody can arrange a Personal Pension, regardless of whether you are already a member of an occupational or workplace pension or have other personal pensions.
The criteria for pensions is based on a person’s annual contributions and not how many schemes they have. The maximum amount that you can pay into pensions each tax year is £40,000 or your Net Relevant Earnings (annual income) whichever is the lower.
How do I find a Pension that I have lost touch with?
It is not unusual to have paid into a pension and then forget who the pension was with. This could easily happen if you moved to a new house but did not notify the pension company of your new address. Which meant that you stopped receiving your statements.
Or you worked for various companies and were enrolled into a pension each time, leaving behind a previous pension that is now frozen. Keeping track of each old pension can be hard to do.
So what can you do to find a ‘lost’ pension? Thankfully, because every pension contribution gets a tax rebate, there is a record kept by HMRC. The same applies for old pensions that were used to contract out of SERPS, as a National Insurance rebate was paid into the pension.
The Government set up a free service for this purpose. The DWP online Pension Tracing Service helps reunite people with their lost pensions, giving details of providers to help people track them down. www.gov.uk/find-pension-contact-details.
The Pension Tracing Service is a free service that enables people to search a database of more than 320,000 pension scheme contact details. The service is simple to use and provides trace results immediately. There are many companies online, who will offer to do this for you free of charge, but usually your details are collated and sold to financial advisers. Not all of which are FCA regulated.
However, if you established the facts first of the pensions that you have paid into, it would be worth getting advice from a FCA regulated financial adviser. Whilst there would be a fee to pay if they make recommendations that you take up. It is likely to benefit you in the long term.
How much do I need to save in a Private Pension before I can retire?
There is no single answer to this question. Everyone’s income needs in retirement may be different. So, let’s take it in a few steps. Work out if you were to retire today, how much could you comfortably live on. Then decide at what age you would like to retire. If this is earlier than State Retirement Age, then you are going to need to save more.
Currently a new full State Pension is £175.20 per week, that £9,110.40 a year per individual.
As a general rule, withdrawing more than 4% a year from a pension fund could result in it not lasting your lifetime.
This means that a pension fund of £100,000 would equate to £4,000 income each year. So if you wanted an income of £1,000 each month (£12,000 a year), that would require a fund of £300,000.
If you retired after you start receiving your State Pension, then the amount required would be somewhat less. So, the straight answer is that people will retire when it is affordable to do so. If you want it to be before your State Retirement Age, then only you can affect this. It’s all in the planning.
Do Pension Scams exist?
Unfortunately, the TV advert showing the man on a jet-ski is a reminder that there is someone out there who might want to steal your pension fund.
Fraudsters promise high returns and low risk but, in reality, pension savers that are scammed can be left with nothing.
Scammers try to persuade pension savers to transfer their entire pension savings, or to release funds from it, by making attractive-sounding promises they have no intention of keeping.
When savers realise they have been scammed, it can be devastating – many lose their life savings. Once the money is gone, it is almost impossible to get it back.
It is vital that you keep up to date with current and evolving scam tactics and get to know the signs of a scam.
Common signs of pension scams:
· phrases like ‘free pension review’, ‘pension liberation’, ‘loan’, ‘loophole’, ‘savings advance’, ‘one-off investment’, ‘cashback’
· guarantees they can get better returns on pension savings.
· help to release cash from a pension before the age of 55, with no mention of the HMRC tax bill that can arise.
· high pressure sales tactics – time limited offers to get the best deal; using couriers to send documents, who wait until they’re signed.
· unusual high-risk investments, which tend to be overseas, unregulated, with no consumer protections
· complicated investment structures
· long-term pension investments – which often mean people who transfer in do not realise something is wrong for several years.
(source The Pensions Regulator)
All pension savers should speak to an independent adviser authorised and regulated by the Financial Conduct Authority (FCA) before making a transfer.
Carla is the founder of MyBump2Baby. Carla has a huge passion for linking together small businesses and growing families. Carla’s humorous, non-filtered honesty has won the hearts of thousands of parents throughout the UK.
She has previously written for the Metro and made appearances on BBC News, BBC 5 live, LBC etc. Carla is a finalist for Blogger of the Year award with Simply Ladies inc. Carla is also the host of the popular Fifty Shades of Motherhood podcast and The MyBump2Baby Expert podcast.