How much do you know about your pension? Do you believe that you’re responsible for your retirement plans?
In the UK, around a quarter of individuals feel that their employer, the state or a pension provider is more responsible for their pension than they are, according to a report from State Street Global Advisers.
But while it can seem like a daunting topic to get to grips with, your comfort in your later years and ability to achieve retirement dreams is reliant on your pension. As a result, do you really want to hand over the reins?
The report assessed three core areas for retirement planning; responsibility, choice and advice. It evaluated these concepts on a scale of one to five, with five being the highest. The UK scored just 2.3. This compared to 4.9 in the US and 4.7 in Australia.
In the UK, the research found:
- Only 14% of the working population are extremely confident in being financially prepared for retirement
- But 18% don’t expect to make any sacrifices in retirement
- Just 33% of retirees are confident their money will last in retirement
The findings suggest that there’s a disconnect between Brits and their pensions. More than seven in 10 are not confident about their finances supporting them throughout their later years. As a result, getting to grips with how they work can give you more certainty and set you on the right path.
If you’re looking to boost your pension knowledge, here are seven things you should know about Workplace Pensions to get started:
1. Your pension will be made up from contributions from you and your employer
If you have an end pension goal in mind, it can seem like a daunting target to reach. But it can seem far more manageable when you break it down.
The first thing to note is that most people with a Workplace Pension will benefit from employer contributions. Thanks to auto-enrolment more people than ever before are seeing their pension savings increase due to employer payments.
The amount your employer pays in will depend on legislation and your workplace policy, so be sure to check your contract or employee handbook.
2. You’ll benefit from tax relief too
On top of employer contributions, you’ll also likely benefit from tax relief. Again, this helps to increase your savings beyond what you’re putting in. In fact, it’s estimated that tax relief spending costs the government around £55 billion a year, delivering a boost to the nation’s retirement savings.
Tax relief means that some of the money you would have paid in tax on your earnings goes into your pension. The level of tax relief you benefit from will depend on the Income Tax band you’re in.
3. Your retirement savings are invested
On top of employer contributions and tax relief, there’s another incentive to pay into a pension; the potential investment returns.
The money in a pension can be invested, helping contributions outpace inflation and grow. The compounding effect, where the returns are reinvested to generate returns of their own, means your initial contributions could grow significantly as you work towards retirement.
Pension providers will usually offer several different investment options, reflecting varying levels of risk. The general rule is the longer you will be investing for, the greater the level of risk you can take, but it’s entirely dependent on your personal preference. Your financial adviser can help you determine the appropriate level of risk to take.
4. There are contribution limits
If you want to maximise the benefits of saving into a pension, there are two limits to be aware of.
The first is the Annual Allowance. The amount you can put into a pension each year is currently capped at £40,000 or 100% of your earnings, whichever is lower. If you exceed this amount, you won’t receive tax relief and may face additional charges.
Once you start making withdrawals from your pensions, the annual limit is reduced to £4,000.
The second is the Lifetime Allowance. You will usually need to pay tax if your combined pensions are worth more than this limit, generally when tested at 75 or taking benefits. It is currently set at £1.03 million and is based on the total value of your pension, not just your contributions. The rate payable will depend on how you choose to take your retirement income.
5. Pension Freedoms give you more flexibility when you retire
In the past, you may have been put off saving into a pension as you had little choice when you came to collect it.
However, Pension Freedoms introduced in 2015 means you have far more flexibility. Freedoms mean that with the right financial planning, you can make your pension income match your retirement aspirations. Once you’re 55, you’re free to withdraw all the money from your pension should you choose, although usually, only the first 25% will be tax-free. This could create a large tax bill and is rarely the most appropriate option. Alternatively, you can leave the cash invested within your pension, buy an Annuity, use Flexi-Access Drawdown or create a hybrid retirement strategy that suits you.
6. You may pay Income Tax when you retire
How you take your retirement income will affect the level of Income Tax you need to pay. As a result, looking at the different options when it comes to withdrawing from your pension is important.
If you want to take a lump sum, the first 25% is tax-free. You can take more but this is often one of the most costly ways to access your pension in terms of tax. If you’re receiving an income from your pension, you’ll pay tax if the annual amount is more than the Personal Allowance, which will rise to £12,500 from April 2019. You should also note that other sources of income can use up your Personal Allowance too.
7. Your pension can be used for Inheritance Tax planning
Your pension can be an effective way to pass on wealth when you die. Most pensions allow anyone to inherit your pension, not just your spouse or civil partner.
Money that is still left in your pension can be accessed completely tax-free if you die before 75. After the age of 75, the money within your pension can still be inherited but will be subject to Income Tax. In many cases, a pension can still be an efficient way to pass on wealth as it may fall outside of your estate for Inheritance Tax (IHT) purposes.
If you have further questions about pensions or would like to discuss your retirement provisions with your goals in mind, please contact us. With our expertise, we can help set you on the right track for the retirement you want.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. Tax relief and the tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.