Pensions are 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.
When you are paying into a pension and planning for your retirement, there are several key questions you need to consider:
- Am I paying enough into my pension?
- What income will my pension fund provide in retirement?
- At what age will I be able to afford to retire?
- Where is my money invested?
- How will I draw an income at retirement?
There is no restriction on the number of pension schemes you can contribute into. However, there are limits on the amount of tax relief receivable. This is restricted to the higher of £3,600 or 100% of salary subject to the annual allowance of £60,000 (2023/24). If breached, the excess will be subject to a tax charge at the member’s marginal rates. However, it is possible to offset contributions in excess of the annual allowance against unused allowances from the previous three years, known as ‘Carry Forward’. No tax relief will be granted on contributions paid after age 75.
The government has introduced a tapered annual allowance for those who earn in excess of £260,000 per annum, including pension contributions (2023/24). The allowance is tapered by £1 for every £2 of income that exceeds £260,000. However the allowance cannot fall below £10,000.
The Money Purchase Annual Allowance (MPAA) is £10,000 for 2023/24 and this lower allowance is triggered when money purchase pension scheme benefits are accessed flexibly by the member (although not if just tax-free cash is withdrawn). This reduction only applies to money purchase pension schemes. For members subject to the MPAA, an 'alternative annual allowance' of up to £60,000 is retained for defined benefit scheme accrual.
Employer contributions count towards the annual allowance. It is up to the Employer's local Inspector of Taxes whether or not the entire contribution will be relievable for tax purposes.
A pension commencement lump sum recycling limit exists to prevent exploitation of pension’s tax relief. It seeks to avoid the pre-planned payment of the tax-free lump sum(s) received over a 12 month period, back into a registered pension plan as a new tax relievable contribution. The limit equates to 30% of the pension commencement lump sum received provided this exceeds £7,500.
The 2015 Pension Reforms have provided more choice in how pension savings can be used in retirement. With these pension freedoms you can access cash as early as age 55, which may help you pay off a mortgage or help a child buy their first property.
You have control as to how much you take from your pension account. So, for example, you could take out money to splash out on a once in a lifetime holiday or a sports car, rather than being restricted by an annual income through an annuity.
The ex-Chancellor, George Osborne, started a pension revolution in 2015 when he announced the introduction of the new pension freedoms. The rule change shone a spotlight on annuities as the traditional way to generate income in retirement, leading to a dramatic impact on annuity sales.
Annuity costs have soared in the last twenty years as risk free investment returns have fallen and life expectancy has risen. Annuities are effectively a very expensive and inflexible insurance policy against living beyond normal life expectancy and receive guaranteed income payments.
Annuities lock in current interest rates and lock out further investment opportunity or control over your capital. They look increasingly outdated for modern retirement, which can extend over 30 years with periods of very different income and capital requirements.
When the time comes for you to commence drawing from your pension, there are now several options available to you, as follows:
Flexi-Access Drawdown (FAD) – Allows any income amount chosen
Uncrystallised Funds Pension Lump Sum (UFPLS) – Allows a single or a series of lump sums to be withdrawn
Lifetime Annuity – Allows a guaranteed income for life that can increase or decrease
Scheme Pension – This offers a secure lifetime income payable to the member of the scheme
Small Pot Lump Sums – Where a pension fund is less than £10,000 (up to a maximum of three pots), the entire fund can be withdrawn as a lump sum (25% tax-free rule applies)
Trivial Commutation Lump Sum – Where a Defined Benefit pension is worth £30,000 or less the value can be surrendered as a lump sum (25% of which is tax-free)
Serious Ill Health Lump Sum – Individuals with less than 12 months to live can withdraw their entire pension fund tax-free up to age 75, or if over age 75 at date of payment, the lump sum will be taxed as pension income at the individual's marginal rate of tax
Unrestricted retirement benefits can be taken from a defined contribution or money purchase pension scheme at any time from age 55.