You often ask me pension questions and as it is Pension awareness Week, today seemed a good day to answer them for you. Recent research has shown that around half of us don’t know much about our pension saving options. Here are some of the common pension questions, answered.
This post is only covering defined contribution pensions (sometimes called money purchase schemes) – ones you and/or your employer contribute to – and does not cover defined benefit pensions, also known as Final Salary pensions or the State Pension.
What is a Pension?
The purpose of a Pension is to create a fund of money, saved and invested over a number of years that can be used to generate an income once you approach retirement.
In very simple terms, a defined contribution pension is an investment and functions much like other investments, for example a stocks and shares ISA. You simply pay cash into the pension (contribution) and select where to invest it, and then access it in the future.
Pensions have there own set of tax rules, annual allowances and age of access. Any UK resident can have one from birth and contributions can be made by yourself, parents, grandparents, a business or an employer.
So a Pension is simply a “tax wrapper” for your long term investment that you, and others can save into to create your future income.
What’s types of Personal Pension are there?
- Personal Pension – These are pensions that you arrange yourself and pay into yourself.
The choice for which one to use may come down to what the minimum contributions can be, costs and charges and funds available to invest in. You can set one of these up and contribute directly into it from your bank account on a regular or ad hoc basis.
- Stakeholder Pension – These are personal pensions that must meet specific government requirements, for example limits on charges. You can open one yourself or some Employers offer them.
- Self-Invested Personal Pension (SIPP) – these can be more complex than personal or stakeholder pensions as they allow you to hold a wider range of investments such as commercial property. As the name suggests it is a personal pension whereby you self-select the funds and investments yourself.
What’s a Workplace Pension?
In essence this is the same as a Personal Pension but is set up by your Employer. Your employer will choose which scheme they offer to employees and and make your contributions on your behalf.
They will top up your contribution with a contribution from them into your pension too. These are valuable extra savings going into your pension every time you get paid.
Standard minimums at the moment are 3% from your Employer and 5% from you, including the tax relief.
What this looks like if you earn £10,000 a year and 8% goes into your pensionWith just £400 from you, a total of £800 goes into your pension!
you put in £400
your employer puts in £300
you get £100 tax relief
All UK employers are required by law to provide a workplace pension. They automatically enrol you if you meet the criteria. However you can opt in voluntarily and you can opt out.
Think carefully before opting out as you will miss out on these additional contributions from your Employer which can be valuable additional savings into your pension. In short they are saving into your pension for you!
If you have earnings of £10,000 and your employer pays the minimum as do you, you would contribute £400 and year but £800 would go into your pension.
Some Employers will offer to pay more than minimum 3% and some offer a salary sacrifice scheme whereby you give up part of your salary and your employer pays this straight into your pension for you. In some cases, this will mean you and your employer pay less tax and National Insurance so it’s well worth asking them about this.
You don’t have to stick with your 5% minimum, you can simply ask your Employer to increase your contribution for you. Good practice is increasing it by 1% each year or when you receive a pay rise. If you’ve never been paid it you’ve not spent it else where but its invested in your pension for you to pay yourself in the future.
How much can I pay into a Pension?
- Each tax year, you could contribute up to 100% of your earnings to a maximum of £40,000, this is known as the Annual Allowance.
- This Annual Allowance may be reduced if you are a very high earner, have accessed your pensions flexibly or are not working, so seek advice.
- Children and those without earnings are still able to contribute up to £3,600 (£2,880 before the tax relief is added )
- Your Annual Allowance includes all pension contributions from yourself, your employer and anyone else into any UK scheme. You can have multiple pensions of all available types but the annual allowance applies to the total pension savings, not each pension.
- If you have a pension already and have not used previous years Annual Allowance you may be able to use that as well, this is called carry forward and again warrants advice.
- There is also a lifetime allowance of £1,073,100, this is the maximum pension contributions in life before penalty, more information on that Lifetime Allowance here.
Who can pay into my Pension?
Contributions can be from you personally. Family members can also contribute, meaning you can also open one for a child or grandchild or have parents pay into yours. Every personal contribution automatically receives basic rate tax relief (more on that below).
Employers can also contribute and so can your Business if it’s limited company. Contributions are treated differently and don’t get topped up with the tax relief in the same way.
What is Tax Relief on a Personal Pension Contribution?
Every time you contribute into your pension personally, you will receive tax relief from the government. Every contribution automatically receives 20% tax relief straight into your pension. However if you are a higher rate tax or additional rate tax payer you can claim the additional 20 or 25% tax relief via your self assessment. These bandings differ in Scotland.
Example:Your contribution is called Net. Once the tax relief is added that is called Grossed up.
If you wanted to put £1000 into your pension, you would actually contribute £800 as the government will add an extra £200 in tax relief. You have £1,000 in your pension but it only cost you £800.
What if I’m Self-Employed?
You can start your own pension and make your personal contributions into this.
How you contribute could depend on whether you are a sole trader or a limited company but the contributions will go into the pension and be invested according to your instructions.
If you are self-employed, use an existing pension or set up a new pension with a regulated provider and choose your investment funds or pathway for your contributions to go into.
As this is a personal contribution you will receive the tax relief (see above) but you wont benefit from an employer contribution too.
If you have a limited company, you could consider the company making all or some of the contribution for you as an Employer contribution. This can be a tax efficient way of making long term pension savings by accessing profits from the business. You wont receive the tax relief as this is an employer contribution rather than a personal one, but you may benefit from reduced corporation tax.
It is advisable to consult your accountant and a financial adviser in this situation.
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Which Pension should I choose?
If you are setting up a pension yourself, do your research but know that the basic pension rules are still the same. Choosing which pension provider becomes a choice based on service, ease of use, differences in costs, choice and style of investments available and any minimum contribution limits.
Once you have a pension you’ll need to then decide on your investments.
Unlike cash, pension values once invested will fluctuate. This movement up and down is an integral part of any investment and does not mean you should stop contributing (or never start!)
Some providers offer a selection of “managed” funds, portfolios or investment pathways where they select the underlying investments for you. These may differ based on level of risk, for example cautious, balanced, adventurous. Others will offer a wider range of funds and investments that you can select yourself which would warrant more research on your part or seeking advice.
If you are uncomfortable with this research or the rises and falls in investment value I would suggest working with a financial adviser who can recommend specific funds based on your feelings toward risk, personal and ethical choices and support you through the ups and downs.
What costs might I incur with a Pension?
There are costs associated with any investment, however don’t let this be a reason not to invest. Just be careful to ensure you understand all the costs and when and where they apply.
You should expect to pay an annual fee for the provider (or platform) as well as fees for the management of the funds you select. Some providers combine these into one annual management fee but be mindful to check. These costs are usually taken directly from your pension on a regular basis.
You should also be aware of additional one off charges such as when buying or selling the funds or exit fees if moving the pension elsewhere. These should be disclosed by the provider, but do your homework.
If you choose to use a financial adviser they will have their own costs for their service, advice and value they provide. These can include an initial advice charge f and an ongoing advice fee taken regularly for service, advice and review. These will be disclosed by your adviser, along with how you can pay for them, so be sure to ask..
When can I access my Pension?
You can access your pension from the Minimum Pension Age which is currently 55 but is set to increase to 57 from 6 April 2028. You are not obliged to access it at that age and can leave it and continue to contribute until you need it. It is worth noting that some pension tax rules can change at aged 75 so be aware and check that out)
What happens to my Pension if I die before I’ve accessed it?
You can nominate a beneficiary or beneficiaries. Your full fund value will then go to them should you pass away before using it. If you are under 75 when this happens it will pass to them entirely tax-free. If you are over 75 they may be taxed at their individual income tax rates at the point they access it.
You can contact your pension provider and request this nomination form and amend it at anytime.
How much might my Pension give me in income?
This is a hard one to answer here and can depend on factors including the amount you pay in, the fund’s investment performance and how you take your pension at retirement.
You can work with a financial planner who will use known assumptions and specific information about you and your plans to help you answer this. They’ll aoso work with you to review on an ongoing basis.
There are some useful online pension calculators which can give you an indicative idea of the sort of retirement savings and income you could expect. For example the Aviva Retirement Planner
Should I seek financial advice?
This will depend upon your personal set of circumstances and preferences.
Financial advisers or planners offer a lot of value often beyond the advice given and a lasting relationship with a good adviser could make a real difference to your investment value, tax savings and even help you retire with pension income earlier.
You should definitely consider working with one if your circumstances are complex. For example if you have a Limited Company, you are getting divorced and a pension is involved. If you already have various pensions they may warrant research and review with a view to consolidating.
Likewise if you want to build wealth over the longer term, or more quickly to make working a choice or you simply value the peace of mind in knowing that someone is working for you and with your interest at heart.
Hopefully that’s’ many of your pension questions answered, but as a final note, If you don’t yet contribute into a pension then start today.
They are easy to open, straightforward to pay into and offer a diverse range of investments to choose from. Contributions can be small to start with, but consider the power of consistency, so make them frequent, automatic and increase them regularly.
Yes, there are risks and costs associated with any investment including pensions, but there is also a risk of not acting. Not saving into a pension will simply guarantee you have no personal pension savings of your own to supplement your State Pension.
Whereas paying something into your pensions regularly and starting early so you have a longer time horizon in which to benefit from the potential growth, could give you more freedom of choice and a greater chance of increased income come retirement.
If you have any other pensions questions not answered above above, please comment below and I’ll be sure to try and answer them for you.
Disclaimer. The information provided in this post is not advice and is intended for guidance only and should be taken as such. Information provided is sourced at the date of publishing, which is subject to change. Investment values can fall as well as rise and your capital may be at risk. For advice find a qualified, authorised adviser regulated by the Financial Conduct Authority.September 2021
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