What Is a Pension? A pension is a savings plan with special tax benefits designed to build a fund at retirement.
Unlike a regular savings plan at a bank or building society, a pension plan is an ‘investment’ plan. The money you pay into the plan is often distributed across a number of smaller investments managed by your pension fund company. For this reason a pension fund has a ‘risk element’ to it and the value of your fund at retirement isn’t guaranteed, as your fund can go up or down, just like the stock market. How much risk you take is down to you and something we work with you on to help determine what level of risk level is acceptable to you. Obviously the more risk, the greater the potential rewards and of course, losses.
Employees, employers, self-employed and unemployed may pay into a pension plan.
What Types of Pensions Plans Are There?
There are three main types of pension plan that are familiar to most working people. These are: state pension, company or workplace pension and the private pension.
This is payable from state pension age, which is currently 65 for men born before 6 December 1953. For women born after 5 April 1950 but before 6 December 1953, it is between 60 and 65. A degree of rationalisation is taking place to align men and women pension ages. For women, pension age will rise to match that of men by December 2018. The state pension age will then rise to 66 for both men and women by October 2020.
The exact date for women can be found here: Women’s Retirement Dates.
How much you will receive depends on the amount of national insurance contributions you’ve paid. More information on this can be found on the government website at www.gov.uk.
Company Pension Schemes
Company or workplace pension schemes are pension plans set up by an employer for their employees. These are managed by a separate trust, so if the company goes out of business or is bought and disappears, the pension fund is protected. This is often how pensions get lost and forgotten.
Employers usually contribute to the pension an amount equal to a percentage of the employee’s salary.
Private Pension Schemes
A private scheme is just that; a scheme you have bought in to yourself and is entirely separate from a company or state pension scheme. These are available from a number of financial services companies. There are several types of these too including personal pensions, stakeholder pensions and self-invested personal pensions. Finding the one best suited for you is not straight forward. Each company is usually tied to its own set of products. It’s recommended by the Government and pension advice organizations, that you contact an Independent Pensions Advisor as they are qualified to provide an impartial and unbiased opinion on what pensions are best suited to you.
Why Save into a Pension?
You get tax relief on pension contributions. This means that if you are a basic 20% tax payer, for every £8 you contribute into your pension plan, you will get £10 deposited.
The £8 deposit is called the net contribution, the £10 deposit is referred to as the gross contribution and the difference between the two is known as the tax relief.
If you are a nil rate taxpayer and you pay £3,600 or less per annum you will still obtain 20% tax relief. This means the maximum net figure you would be able to contribute to get tax breaks is £2,880.
If you are a higher rate tax payer you will be eligible for 40% tax relief meaning for every £6 you contribute, £10 will be deposited.
The tax breaks, therefore, makes saving for retirement extremely attractive.
What Happens to the Pension Contributions?
Clearly your contributions have to be saved somewhere and that somewhere is called a pension fund. Pension funds are many and varied and this aspect can become very confusing. The fund choice largely depends on your attitude to risk and your age. Typically, but not always, the younger you are and the longer the time period until you retire, the higher the risk you can take and, hopefully, the higher the rewards you will obtain.
This is where specialist advice is required to ensure you are investing in a fund or group of funds aligned to your attitude to risk. Therefore, you should be looking for a pension with a wide range of funds and fund types to give you maximum investment flexibility.
What Charges can I Expect?
Financial Adviser’s fees will vary from adviser to adviser. It may be a flat fee, an hourly rate or a percentage of contribution.
Pension companies may take a percentage of the contribution as an initial fee. The pension companies will typically take a percentage of the fund value every year as their fees. This will include the administration and the fund management. The fees will vary from company to company, pension to pension and fund to fund.
The total Pension company’s fees are expressed as a reduction in yield and nowadays will typically be between 0.3% and 1%. This means that the total cost to run your pension will be between 0.3% of the total fund per annum to 1% of the total fund per annum.
Should I Increase My Contributions?
If your income is rising, it makes sense to increase your pension contributions in line with income so that your retirement income keeps pace with your earnings.
What Happens at Retirement?
At retirement the pension fund is used to provide a pension income, either by purchasing an annuity or by drawing down an income from the pension fund. The drawdown route is normally reserved for pension funds larger than £100,000.
Retirement income can be joint life, single life, level or increasing. There can also be a guarantee, which means if the annuitant dies within the guarantee period (typically 5 or 10 years) the balance of the income payments are paid out as a lump sum.
Don’t forget that you don’t have to accept the annuity rate that your pensions provider offers, you have the option to shop around. This is called the Open Market Option. It is possible to increase your annuity rate between 20% and 40%. We can help you secure this.
Taxation at retirement
Pension income is taxable but you are normally entitled to a tax free lump sum of 25% of the fund value.
What Is a Pension?