When it comes to pensions, we know that things can quickly get confusing. What type of pension should you have? When will you actually be able to access it? What happens if you've had multiple jobs?
If you're after a no-nonsense guide that answers your pension questions, we spoke to Rowan Harding, Financial Planner at Path Financial, the first national financial advisory firm in the UK set up specifically to tackle the climate crisis, to help you out.
What is a pension?
Pensions are a great way to save for your future. Pensions come in all different shapes and sizes, but essentially, a pension is a pot that you pay into and which you access at retirement.
Why use a pension?
There are some great features to pensions. You can take advantage of things such as your employer paying into your pot, and government tax relief being paid into it too. The growth on your pension investment doesn’t incur any tax, and when you do access your pot, you even get up to 25 per cent of it is tax-free.
There are three main types of pension:
The State Pension
This is a very valuable pension pot. You build up your entitlement over time by making national insurance contributions. From your state pension age, you will get a guaranteed income paid for the rest of your life. You can check your State Pension forecast viathe GOV.UK website.
Final Salary or Defined Benefit Pensions
There are less of these types of pensions available nowadays. However, public-sector employees and a few private-sector employees will be entitled to membership of a final salary pension. You build up your pension entitlement, which is based on the length of time you work for the employer and your salary. At retirement, the pension scheme will pay you a guaranteed income for the rest of your life.
Money Purchase or Defined Contribution Pensions
These are common and can be set up by both individuals and companies. As an employee, you are likely to be eligible to be automatically enrolled on this type of pension arrangement. Even if you are not eligible, you can opt into your employer’s workplace auto-enrolment pension. Pension contributions from you - and if you are employed, also from your employer - are paid into this type of pension. These contributions are invested (hopefully ethically and sustainably!) and when you choose to retire, you can access the money you have saved. These types of pensions can be very flexible, as you can choose from lots of different features, such as how much you contribute, where it’s invested, when you access the pot, and how you access the pot.
What are the pension rules?
Pensions have been around for a while now - well over 100 years. Over this time, there has been plenty of rules introduced about how they should work. Today, there are some key pension rules it is useful to know about.
• Annual Allowance: You are allowed to put up to £40,000 into a pension in any one tax year. There are complications relating to this rule, particularly for individuals who are claiming tax relief on their contributions from the government, those who have accessed their pension pot flexibly, those who have used a facility known as ‘Carry Forward’ and very high earners. It is always best to seek expert financial advice on this, as there is a tax charge if you breach the Annual Allowance rules.
• Lifetime Allowance: This is the total overall limit you have on your pension savings during your lifetime. If you go above this limit, there is a tax charge. Currently, this limit is set at £1,073,100. There are also complications around the Lifetime Allowance, such as lifetime allowance protection, when the lifetime allowance rule is applied and what happens if you get divorced. Seek expert financial advice if you find you need help on this.
• Pension flexibility: The rules around how you access your pension changed a few years ago, and there are now more options than ever before. You can take benefits from your pension from the age of 55, although this will rise to 57 from 2028. You can take the pension in one lump sum, as ad hoc lump sums, as a regular income, or use some or all of the pension pot to purchase an annuity – which is a guaranteed income for life. Usually, up to 25 per cent of your pension can be taken tax-free and the remaining 75 per cent will be taxed at your own rate of income tax. When the time comes to start withdrawing from your pension, it is always worth speaking to an expert financial planner about the best option to suit your needs.
Why have a personal pension?
There are many good reasons to have a personal pension. No one should live in poverty when they retire - pension savings can be a crucial source of money to cover living expenses when you are no longer working.
This is particularly important for women, who often have gaps in their national insurance contributions and gaps in their employment. They might work fewer hours and often earn less. Women are often disadvantaged because they look after children or care for an older relative too. Women’s pension savings are on average 11 per cent smaller by retirement than pension policies held by men. This equates to a lot of women who are living on less, and who are likely to live longer in retirement.
Another positive reason to have a personal pension is that it is a very tax-efficient route to saving for the long term. For any personal contributions you make to your pension, you can get 20 per cent extra added to the pension as tax relief from the government and if you are a higher or additional rate taxpayer you can claim an extra 20 per cent or 25 per cent respectively. With very limited exceptions, any income and capital gains you make within your personal pension investment, are tax-free under the current legislation. This is a great tax saving, considering income tax rates of 20 per cent, 40 per cent or 45 per cent and capital gains tax rates of 10 per cent or 20 per cent or for property 18 per cent or 28 per cent!
A personal pension can also be a very good way of passing on wealth to the next generation - your children, grandchildren or great-grandchildren. As the rules on this are now much more flexible, you can pass on a pension to your chosen beneficiaries, who in turn can pass on residual pension again and beneficiaries can withdraw the pension flexibly too.
When can you start taking money out of your pension?
Most pensions will be accessible from the age of 55 under the current rules, although this does change to age 57 from 2028. There are some professions where you can access your pension from an earlier age, such as the armed forces and police services. If you are in ill health, there may be a possibility of taking money from your pension earlier than age 55.
Should you consolidate your pensions?
On average, over a working lifetime, someone will have 10 to 12 employers – this could mean 10 to 12 different pension pots! That’s a lot to keep track of. Consolidating can be right for some people, but should always be looked at by a specialist, as it is not always suitable. A qualified expert financial planner will be able to help with this, and the advice should always be in your best interests and based on your own circumstances.
Currently aged 55 however this is moving to age 57 from 6th April, 2028. The move has been made as people are tending to live longer and spending more time in retirement than they would have done in the past.
The State pension age has also been increasing and is now age 68. However, there are some people who may be entitled to their pensions before these ages and so it is always worth checking with your pension provider and you can also use the government's State pension age calculator.
Does equity release affect your pension?
Your personal or defined benefit type of pension is not affected by equity release. Your normal State pension entitlement is also unaffected, however, it is helpful to understand that if you are also receiving any state benefits which are ‘means tested’, such as pension credit, you may lose your entitlement to the benefit. Always seek clarification on this from an equity release specialist, as this could affect other state benefits which are means-tested.
What is tax relief?
This is another great benefit you get when you contribute to a personal pension. If you pay in £200 as a personal contribution to your pension, the government will pay in £50 – meaning your total contribution is increased to £250.
This tax relief is added automatically by your pension provider. You can also get a further amount if you are a higher or additional rate taxpayer, an extra 20 per cent or 25 per cent respectively. You would claim this via a self-assessment tax return each year.
What happens to your State Pension when you die?
This is dependent on when you reached the State Pension age. For those who began receiving their State pension before April 6 2016, your survivor can claim the level of State Pension based on your national insurance record. If you weren’t married or in a civil partnership, there will sadly be no entitlement of State Pension for you to pass on. If you reached the State Pension age on or after April 6 2016, your survivor might be entitled to more than their State pension.
As the rules around this can be confusing and not that easy to understand, especially if your partner has recently passed away, always seek help and advice. It is best to be informed and there are many organisations you can access offering support while you are grieving.