Pensions used to be viewed as rather boring: slightly mysterious and seemingly distant entities you begrudgingly handed over a portion of your salary to every month, in return for the vague reassurance that, at a far-off point in the distant future, you would have a greater or lesser degree of income to rely on when you retired at a set date.
Beyond that, many people gave them very little thought. And, when the time eventually came to call on those pension savings, the majority would simply begin drawing on the income their ‘defined contribution’ or ‘final salary’ schemes dictated they could have, or buy an annuity in return for a set monthly income for the rest of their lives.
The harsh reality of this was that there was little or no flexibility or control for the person investing into the pension, when it came to, for example, choosing at what age they wanted to retire. And, as a result, the pension and annuity providers were arguably the biggest beneficiaries, absorbing any capital left on the death of the pension holder. Of course, there were alternatives, but the average person didn’t have the knowledge or the confidence to be able to exercise their rights and choices.
Thankfully, though, all of that changed when the so-called ‘pension freedoms’ were introduced in April, 2015. These freedoms gave individuals greater powers and opportunity to shape their desired retirement, and decide how and where they wanted to save – and how they would eventually access their money. They’ve also contributed to a great deal more awareness among the population, of what rights and opportunities they have when it comes to their pension investments. While buying an annuity, for example, remains one of those options, you can also choose to manage how you ‘draw down’ your funds yourself, including how much you need, and how often, to support your desired lifestyle, while leaving the majority of your pot invested and, hopefully, continuing to grow.
Of course, pensions are complex, though, and exercising the freedoms isn’t something anyone should do lightly. The media was full of horror stories, when the change first came into force, of people going on spending sprees, buying themselves supercars or withdrawing all their cash in one go and giving themselves very large tax liabilities that they were often unaware of. For most of us, a pension is the biggest asset we ever own apart from our homes, and the fact still remains that pension pots need treating with the ultimate amount of care, because, like all the best things in life, when they’re gone, they’re gone.
Thankfully, most of the hype has died down now and what’s actually happening is a really positive attitude change in the way people view their retirement plans and savings. We see people starting to plan ahead much earlier, for the kind of retirement they want. Many are saving more, because they no longer feel like they are giving up their hard-earned cash to have it controlled by someone else, and it’s also changing lifestyles for the better – with many people choosing to partially retire earlier than planned, for example taking a small amount of their pensions before their originally-intended retirement date to top up their income levels, enabling them to go part-time, to make the most of their lives while they’re still fit and healthy. More and more people are exercising that ability to build their life plans around their pensions, in ways they couldn’t before.
Shedding light on pensions
With this in mind thought we would capture some important facts we feel everyone should know, when it comes to planning their future in retirement.
1. Adding real value to your savings: When you make a personal contribution to your pension, the Government tops up your deposit with the pension provider through tax relief from HMRC at a rate of 20 per cent. If you’re a higher-rate or additional rate taxpayer, the amount of benefit increases to 40 or 45 per cent and you can claim the extra relief on your tax return. Essentially, the Government grants you tax relief of whatever your marginal rate of income tax is at that time. Where else can you achieve that kind of return on your savings? While the money you draw from some other forms of savings, like ISAs, is tax-free when you withdraw it, you don’t benefit from tax relief on what you put in. For example, if you put £100 into your ISA, it is worth £100; whereas if you put £100 into your pension, it is immediately worth at least £125, before any growth has even had chance to take place. Let’s face it, how often do you have the chance to accept such incentives from the Government, and why would you want to miss out on that?
2. You can deposit up to £40,000 per year: And enjoy tax relief at your marginal rate. And, of course, these funds have the potential to grow further, in line with whatever risk level you’re comfortable with.
3. Especially useful for business owners: There are particular benefits for company owners, who can save corporation tax on any funds their company pays into their private pension. The business can claim corporation tax relief on up to £40,000 per year, invested this way, and the contribution is deemed an expense of the business which reduces or even completely removes any liability for corporation tax.
4. Tax-free cash from age 55: You can choose to take 25 per cent of your pension fund as a tax-free lump sum once you turn 55, and use that for whatever your priorities might be at that time, whether that be paying off your mortgage and any other debt to enable you to live on less and work less hours each month, or funding a complete change of direction, like starting a new career or travelling. Or, you can wait until later to access that lump sum, or not do so at all, so that it has chance to continue growing.
5. You Shouldn’t be tempted to cash in early: However, it’s important not to touch your pension fund before the age of 55, because you’ll be heavily taxed on anything you take out early, usually at least 55 per cent of the amount withdrawn. Unless you are in ill health and your pension scheme has agreed an ill health pension with you, then under no circumstances should you access your pension before you turn 55. If you are promised this by an advisor, it is highly likely to be a scam!
6. Flexible income options from age 55: From what’s left, you can choose to take a monthly income for the rest of your life, or periodic lump sums, depending on how much your fund is worth, how much you need, and your retirement plans. Anything up to the prevailing annual income tax threshold is tax-free, and then you’ll pay your marginal rate thereafter. However, it’s important to get professional advice to help you plan the most tax-efficient way of taking this so-called ‘drawdown’ income. The other really great thing about this, is that the capital within your pension has the potential to continue to grow, and, depending on the size of your fund, where it remains invested and how it performs, you could potentially find you can live well using your pension growth, without touching the majority of the remaining pension pot.
7. Leaving something behind: Something a lot of people don’t realise, is that your pension is also a fantastic option for any legacy you might want to leave your loved ones. Because, unlike other assets such as property, your nominated beneficiaries are allowed to inherit it from you without incurring any inheritance tax liability. And if your beneficiaries choose to reinvest the funds in their own pension, the value could potentially snowball over time, providing benefit for many years to come.
8. Chance to form a plan: Instead of simply waiting to be told what income you can have from your pension, you now have the freedom to decide how much income you want; and how much you wish to take from it, and plan and save accordingly. For example, you might sketch out a plan along the lines that, if you retire at the age of 65, you could have 10 years where you would hope to remain fit and healthy, and do all the things you want to do, and you might therefore want to take the majority of your pension income during those years. Then, when you reach 75, you might expect to need less income as you can do relatively less strenuous things, like travelling, and so scale it down from then. It might sound morbid, but planning in this way is really just a case of being realistic and giving you the opportunity to make your pension work best for you, when you’re likely to need it most, to ensure the retirement you want.
9. Seeking advice is crucial: Getting professional advice is critical, to understand how best to ensure your pension pot is substantial enough to support your future plans; and to help you draw down from your pot when the time comes, in a way that will ensure it lasts you as long as it needs to, and that you maximise the tax-efficiency of any income you do take out.
10. Review things regularly: Most of us don’t stay in one job throughout our working lives anymore. We move around and end up with multiple pension pots, in a range of places. From time to time, it’s a good idea to review how these funds are performing for us, and make sure they’re in the right places. We would recommend you do this at least every five years.
So, there is little doubt that our pensions – alongside our homes – are the biggest and most important investments any of us ever make. Done right, the positive possibilities around pension savings, and the potential impact to our family finances, are huge.
At Lairgate Financial, pension advice is one of the services we offer and we can review the performance of the pension savings you have and advise you on options for maximising their potential, from consolidating them all into a different fund/product with a good track record, to altering your risk appetite around your pension savings, depending on your objectives at a given time.
To arrange a free, no-obligation initial chat about your options, contact us via (01482) 860700 or email us.
This blog is intended to provide readers with viewpoints, opinions and inspiration regarding options they might want to consider. It is not intended to be taken as advice and we strongly recommend seeking professional financial advice before taking any action.