Pensions are, of course, designed to enable you to save sufficient money during your working life to provide an income stream for you to live comfortably after you have retired.
There are many different 'tools' used to save for retirement and the taxation and investment elements of pensions can appear baffling. We specialise in explaining, recommending and monitoring pensions for you. Below are the most common sources of pension to fund for your retirement.
For people who have paid sufficient National Insurance contributions while at work or have been credited with enough contributions.
Referred to as the State Second Pension (S2P) but before 6 April 2002, it was known as the State Earnings Related Pension Scheme (SERPS). From 6 April 2002, S2P was reformed to provide a more generous additional State Pension for low and moderate earners, carers and people with a long term illness or disability and is based upon earnings on which standard rate Class 1 National Insurance contributions are paid or treated as having been paid. Additional State Pension is not available in respect of self employed income. From April 2016 both the basic rate pension and additional state pension will be combined to offer a simple single tier flat rate pension.
(Through an employers pension scheme) – This could be a Final Salary Scheme (sometimes referred to as a Defined Benefit scheme) or a Money Purchase scheme (usually referred to as Defined Contribution). Pensions deriving from Final Salary schemes are usually based on your years of service and final salary multiplied by an accrual rate, commonly 60ths. The benefits from a Money Purchase scheme are based on the amount of contributions paid in and how well the investments in the scheme perform.
(Including Stakeholder schemes) – these are also Money Purchase schemes and are open to everyone and especially useful if you are self-employed, your employer doesn't yet run a company scheme or just for topping up existing arrangements. From October 2012, the Government introduced reforms and all employers have to offer their employees, who meet certain criteria, automatic enrolment into a workplace pension. Employers can use the Government backed scheme, National Employment Savings Trust (NEST), or offer an alternative ‘Qualifying’ work place pension scheme such as a Group Personal Pension, providing it ‘ticks’ certain boxes. The process is being phased in between 2012 and 2018 depending on the head count of a firm. Employers are required to contribute a minimum of 3% of salary with Employees making a personal contribution of 4% with tax relief of 1% added on top, which again, is being phased in gradually.
There are now a vast array of different products that may be used at retirement to provide benefits from the traditional form of annuity that provides a regular income stream to Flexi-access drawdown which enables lump sums of benefits to be taken either as a one off payment or over a given number of years. Given the complexity and choice all individuals now have it is important to seek independent financial advice before making any decisions.
State Pensions may not produce the same level of income that you will have been accustomed to whilst working. The full Basic State Pension is only £115.95 per week (2015/2016) for a single person (though you would be able to claim means-tested state benefits if that was your only income). It's important to start thinking early about how best to build up an additional retirement fund. You're never too young to start a pension - the longer you leave it the more you will have to pay in to build up a decent fund in later life.
THE FINANCIAL CONDUCT AUTHORITY DOES NOT REGULATE TAXATION ADVICE.
In recent years the pensions industry has become more advanced in terms of the flexibility of investments available and the structure of the actual pension arrangements.
It is an area of constant change and you should consult us/me regularly to make preparations for a secure and enjoyable retirement.
Self Invested Personal Pensions (SIPPs)
A Self Invested Personal Pension (SIPP) is a tax-efficient wrapper within which a wide range of investments can be held. A new SIPP must appoint a scheme administrator, usually the recognised product provider. SIPPs have the same tax benefits and regulations as conventional personal pension plans but you and / or your advisers have control over the investment choice - each SIPP is unique to the individual. Otherwise, it operates in the same way as a conventional personal pension in respect of contributions and eligibility, for Her Majesty's Revenue & Customs (HMRC) purposes.
The complex nature of a SIPP means that it is not suitable for all investors. Often, the benefits of 'self investment' are only advantageous to people with very large funds and / or investors with some level of sophistication when it comes to investment decisions. Often, there are additional charges for arranging and dealing within a SIPP and these charges would erode smaller funds quickly.
The benefits of using a SIPP include being able to invest in:
- Stocks and shares listed or dealt on an Inland Revenue recognised stock exchange, including AIM
- Stock exchanges that are not recognised by HMRC, e.g. OFEX.
- Unit trusts, open ended investment companies (OEICs)
- Warrants, covered warrants
- Government stock and fixed interest stock
- Unquoted shares
- Commercial property
- Property funds
We will be able to provide more details and make a recommendation based on your own circumstances.
‘A’ Day (the Appointed day) arrived on 6th April 2006 and brought with it sweeping and radical changes in relation to pension legislation.
This has created a single universal regime that replaced the previous eight tax regimes and the changes affect all savers in occupational and personal pension schemes, employers and financial advisers. Pension simplification introduced two new controls, the pension Lifetime Allowance (LA) and pension Annual Allowance (AA).
From April 2006, there is now just one set of tax rules for all types of pension, with an individual LA of £1.25 million (2016/2017) and an individual AA of £40,000 (2016/2017). All individuals are able to fund up to these limits with the possibility to also carrying forward unused AA from the previous 3 years. Exceeding the LA or the AA will simply trigger a tax charge.
Other changes included:
- Early retirement age available from age 55
- Full concurrency (i.e. being able to pay into any array of plans you wish), subject to the annual allowance and potential for carry forward
- Wide investment flexibility
- Up to 25% Tax Free Cash
- The ability to commute ‘small’ funds as a one off lump sum as opposed to having to draw a regular income from age 55 (subject to part of the fund being taxed)
- Flexible options at retirement when deciding to take benefits such as Drawdown
- No need to ‘have to’ secure benefits at age 75 via an annuity
In addition another raft of changes introduced in April 2016 also gives individuals further and greater flexibility to access their pension savings from age 55.
The changes also include:
- To increase the flexibility of the income drawdown rules by removing the maximum ‘cap’ on withdrawal and minimum income requirements for all new drawdown funds from 6 April 2015;
- To enable those with ‘capped’ drawdown to convert to a new Flexi-access Drawdown fund once arranged with their scheme
- To enable pension schemes to make payments directly from pension savings with 25 per cent taken tax-free, known as the Uncrystallised Fund Pension Lump Sum (UFPLS) option
- To remove restrictions on lifetime annuity payments;
- To ensure that individuals do not exploit the new system to gain unintended tax advantages by introducing a reduced annual allowance (£10,000 2016/2017) for money purchase savings where the individual has flexibly accessed their savings; and,
- To increase the maximum value and scope of trivial commutation lump sum death benefits.
Personal and Stakeholder Pensions
Personal Pensions represent a popular and attractive way of saving for your retirement.
All monies invested into your fund grow free of capital gains tax, and the contributions you make are enhanced by income tax relief at source. For example if you invest £80, the government adds on tax relief (currently 20%) to enhance your contribution to £100! If you are a higher rate taxpayer you can claim additional relief through your PAYE coding. An annual allowance of up to £40,000 (2015/2016) is available as well as the possibility of utilising potential carry forward of unused reliefs.
A personal pension is an arrangement made in your name over which you have personal control. You can alter your contributions, suspend them, or stop them completely.
You will be eligible to take 25% of your accumulated fund tax-free when you retire, the earliest age being from 55. There are a range of options when you decide to take benefits such as purchasing annuity or electing capped or flexible drawdown.
Personal Pensions usually offer a range of investment mediums to suit your attitude to investment risk, and you can change your investment at any time.
Stakeholder pensions are similar to personal pensions but have their charges capped at 1.5% for the first 10 years reducing to 1% thereafter. Whilst Stakeholders are generally considered a little cheaper than Personal Pensions, investment choices may be restricted.
Workplace Pensions (Auto Enrolment)
Many companies offer a pension scheme to their employees. There are numerous different types available and usually the company will put some money into your pension if you decide to join.
It is important that you take into account your existing pension provision or that from your previous employer before making any decisions. We will be able to explain the features of your company’s arrangements, and may be able to assist you to select the right investment funds for your own needs.
Auto Enrolment - People are living longer lives. This means people can enjoy more time in retirement and need to plan and save for their later years. The Government estimates that around seven million people are not saving enough to meet their retirement aspirations and as such has put changes in place, which commenced from October 2012 which affects both employers and employees.
What do the changes mean for employers? - Since 2012, employers have been required to automatically enrol all ‘eligible jobholders’ into either the National Employers Savings Trust (NEST) or an alternatively another form of scheme, such as a Group Stakeholder Scheme, Group Personal Pension Scheme or an Occupational Pension Scheme which is deemed as a ‘qualifying’ or a ‘certified’ workplace pension. Both Employers and Employees have to make minimum contributions into the scheme. The process is being staged, dependent on Employee head count, from 1st October 2012 to 1st February 2018, with large employers being the first to have to take action.
Who needs to be automatically enrolled? - All jobholders working in Great Britain aged at least 22 years old who have not yet reached State Pension age and are earning more than £10,000 a year (the income tax threshold at 2015/2016) will need to be automatically enrolled into either an employer’s workplace pension or NEST.
What is the minimum contribution employers must pay? - Under NEST (or an alternative ‘qualifying scheme’), employers will need to contribute 3% on a band of earnings for eligible jobholders – between £5,824 (the lower qualifying earnings band limit for 2015/2016) and £42,385 (upper earnings limit for 2015/2016). This is supplemented by the jobholder’s own contribution and around 1% in the form of tax relief. Overall contributions will total at least 8% for this type of scheme.
Who can opt in? - Jobholders aged between 16 and 22, and between State Pension age and 75 who are earning more than the above figure, are able to opt in to their employer’s workplace pension and will qualify for the compulsory minimum employer contributions. Those earning below the above figure may opt in to their employer’s workplace pension but their employer is not be required to make a contribution, but may do so if they wish. Individuals may opt out of NEST should they choose, but Employers will be required to auto-enrol those individuals again, 3 years later.
Which scheme can employers use? - Employers will be able to choose the pension scheme(s) they want to use provided the scheme(s) meet certain quality criteria (including any current scheme). These may be based on contributions or benefits people receive. There is in addition a ‘certification’ process whereby Employers can register an existing scheme ‘as good as’ or ‘better than NEST’ with any of the following being ‘acceptable’.
Money Purchase Schemes (existing) - A minimum nine per cent contribution of pensionable pay (including a four per cent employer contribution) or; A minimum eight per cent contribution of pensionable pay (with a three per cent employer contribution) provided pensionable pay constitutes at least 85 per cent of the total pay bill or; A minimum seven per cent contribution of earnings (three per cent employer contribution), provided that the total pay bill is pensionable Final Salary Schemes (existing): In order to qualify an existing final salary scheme will need to have a contracting out certificate in force as this is taken in evidence that the scheme already meets the ‘reference scheme test’ standard. This test requires for schemes to commence a pension at age 65, payable for life and must be:
- a) 1/120th of average qualifying earnings in the last 3 tax years, preceding the end of pensionable service multiplied by
- b) The number of years of pensionable service up to a maximum of 40.
When do the changes start? - They have already commenced, arriving in October 2012. The plan is to stage in automatic enrolment over a period of time, starting with large employers, medium and then small. To help employers adjust gradually, the plan is to phase in the employer contribution levels – starting at 1% and then moving to 2% and finally 3%. The jobholders’ contributions are also phased in over the same period. The Department for Work and Pensions (DWP) and The Pensions Regulator (TPR) is working to ensure that information will be available to help prepare employers and individuals for the changes. TPR will be writing individually to all employers at around 12 months and again at 3 months in advance of their automatic enrolment start date, to inform them when they need to take action and what they need to do to comply.
What should I be doing now? - If you are an Employer, you should ensure you understand the basic information on these changes, your staging date and which Employees will be affected. A review of existing arrangements should also be undertaken sooner rather than later. A review is also important as The Pensions Regulator, who will oversee the implementation process, does carry the power to levy fines of up to £400 or a fixed amount then daily fines of up to £10,000 on employers who do not take action.
If you are an Employee we can also undertake a full and tailored review as to where you sit currently within the proposed workplace pensions reform regulations.
Your Options At Retirement
From age 55, there are a number of options available to you including:-
- Draw your benefits available from the existing provider.
- Purchase an annuity with a different provider on the Open Market. This could potentially increase the payments to you.
- Move to Flexi-access Drawdown (or Third Way Plan)
- Use the Uncrystallised Fund Pension Lump Sum (UFPLS) rules
- Move to Phased retirement
- Move to a combination of the above
Draw your benefits from your current scheme.
Pension arrangements can usually provide an immediate Tax Free Cash (TFC) sum of 25% with the remaining fund generating an income which is subject to income tax.
Purchase an annuity with a different provider on the Open Market
Often taking the funds from the existing provider and shopping around on the open market can considerably increase the level of your income. This is because some providers offer better rates than others. Buying an annuity means using your built-up pension fund to buy the guarantee of an income for life from a company. Before you buy your annuity with another provider, you will still have the option to receive the TFC from the original pension scheme but the remaining fund value is passed to the new provider to secure your guaranteed income. The value of your pension income in these circumstances depends on several factors such as your age, current interest rates, the value of your pension fund and the type of pension you choose.
Flexi-access Drawdown (FAD)
Under the option of FAD you can choose to immediately take 25% tax free cash from your plan. Instead of buying an annuity with the remainder of the fund, the money remains invested and can continue to benefit from investment performance in a tax-efficient environment. There will be no limit on the income taken.
After you have taken your entitlement to the tax free lump sum at outset, you can choose to take as much or as little of the remaining pot as you wish and it will be added to any other income you have in that tax year to determine the income tax rate that will apply. Please note that if you draw any income from this plan, your future money purchase pension contributions will be limited to a £10,000 maximum Annual Allowance.
As the rest of your pension fund remains invested in a tax-efficient environment, your final pension - and the income you may withdraw each year - will be determined by the continued investment management of your funds. Careful attention, therefore, needs to be given to investment management whilst in Flexi-access Drawdown to try to ensure that your income can continue for as long as possible and, if you do finally buy an annuity, you would be in a similar situation to that if you had bought an annuity at the start.
You are able to vary your income each year and the level of income you choose to take will have an effect on the value of your invested fund which will influence both future levels of income as well as the amount of any annuity income you may choose to buy.
Whilst in the short term many clients wish to consider drawing large amounts of income from their funds, in the medium to long term, it is important that you balance your income requirements with the investment policy to ensure the annuity purchasing power of your pension fund is maintained.
With this type of contract 9together with the UFPLS option shown below):
- The capital value of the fund may be eroded;
- The investment returns may be less than those shown in the illustrations;
- Annuity or scheme pension rates may be at a worse level in the future;
- When large amounts of income are taken or the maximum short-term annuity is purchased, high levels of income may not be sustainable.
- Benefits are means tested by the DWP.
Draw your benefits as an UFPLS payment from your current scheme.
Your current pension arrangement could provide you with multiple or a one off lump sum. 25% of this would be tax free, the remaining pot initially taxed at emergency rate then falling to marginal rate in the future. There is no limit on the size of the lump sum you chose to draw. Please note that this type of payment will limit any future money purchase pension contributions to a £10,000 maximum Annual Allowance.
This option allows you to retire gradually. It can make the most tax-efficient use of your pension fund and it also allows you to build up the value of your pension when it suits you.
Generally, your pension fund is split up into 1,000 equal segments, and these segments can be phased in over a number of years. Every time you phase in some segments, you can choose to receive a TFC sum of up to 25% of the value of these segments, and the remainder of the fund will be used to buy you an annuity. The pension bought will be guaranteed to be paid to you for life, and you can choose whether to buy a pension to continue for your spouse when you die, or one that increases in value each year. The remaining segments will continue to be invested in a tax-efficient environment, thus providing you with the possibility of higher future income.
A Combination Plan
A Phased Flexi-access Drawdown / Combination plan consists of two distinct parts. Firstly, the funds are transferred into the plan. The plan is split into a large number of identical “mini plans”, benefits from which can be taken at different times. This provides a large degree of control over the amount and timing of the income to be taken.
Income is released by “opening” sufficient numbers of these mini plans to produce the required level of income. This is achieved by transferring the funds to the FAD element of the plan. When each mini-plan is opened, 25% of its fund value is released as tax-free cash. The residual fund from each mini plan then remains invested in real assets and an income is drawn directly from this remaining fund. The income that is drawn from the FAD funds can be varied. Each income payment that you actually receive is therefore made up of part tax-free cash and part (taxable) income from the FAD element of the plan.
HMRC has advised that where an individual flexibly accesses their pension benefits and takes an income stream, that they then have a duty to tell the scheme administrators of any other pension schemes they have or join in the future, that they have done so. This is your own personal responsibility. This is because the Annual Allowance will fall to £10,000 where an UFPSL payment is made and scheme administrators have a duty to inform HMRC if they think someone has paid pension contributions which exceed this limit.
You should note that, if you do not inform other scheme administrators that you have drawn income from your FAD within 91 days, you will be liable for a penalty of up to £300. Where information is not provided after the initial penalty, a further penalty of up to £60 per day may be applied until the information is provided. If incorrect information has been provided a penalty of up to £3,000 may be due where that incorrect information has been negligently or fraudulently provided.