Planning for a long retirement is one of life’s many priorities, especially as we're living much longer than previous generations on average. With pensions a vital component of any retirement plan, it's important to start your pension as early as possible so that you'll have a better chance of achieving the retirement you want.
A pension is a long-term saving plan that you build up across your working life in order to create enough income for later life. Typically you can’t access your pension until at least age 55 (rising to 57 in 2028). Pensions are one of the most tax efficient ways to save for retirement, as you are able to receive tax relief on your contributions. This means the government will add money every time you contribute.
It’s vital to use all of the tax-efficient options available to create a flexible retirement plan, as well as trying to start saving as early as possible, with the earliest savings having the longest period of time to grow. Employers are now obliged to make contributions for their staff, which helps many savers get on the retirement planning ladder. Some company pension schemes even offer additional 'matching' contributions if the employee pays more than the minimum. That can be as good as a pay rise and the money will grow, tax free, in the pension scheme for many years. Starting early therefore is vital.
Your wealth adviser will be able to guide you through the somewhat tricky pensions landscape, but to help your understanding of pensions, here are some of the more frequently asked questions:
A defined benefit (DB) pension (also known as a final salary pension) is a special type of workplace pension, which provides you with a guaranteed annual income throughout your whole retirement based on your final or average salary. When you are a member of a DB / final salary pension scheme, your employer pays into a central fund on your behalf (unless you work for the public sector in which case your scheme is directly funded by the taxpayer).
A defined contribution (DC) pension is where the amount you receive on retirement is dependent on how much you (and your employer) have contributed to your pension savings over time and how much that money has grown (through investment returns and tax relief). DC schemes can be workplace pensions set up by your employer or private pensions that you set up yourself. (See SIPP below.)
Pension arrangements remain amongst the most tax-efficient means of retirement saving, although there are restrictions on the level of contributions that can be made.
In general, contributions in any one tax year are limited to 100% of your UK earnings, or £3,600 if you have no earnings or earn less than £3,600 a year. Contributions you make personally can be paid net of basic rate tax. The pension scheme administrator will claim the tax relief from HMRC on your behalf. If you are subject to income tax at the higher or additional rate you can claim further tax relief on your Self-Assessment tax return. (See also annual allowance below.)
Contributions made to registered pension arrangements are also subject to a total annual limit known as the annual allowance, which is currently set at £60,000. Both personal and employer contributions count towards the annual allowance. If your pension contributions are more than the annual allowance you will pay a tax charge on the excess amount.
If your total income is greater than £260,000 your annual allowance will be reduced. This “adjusted income” figure includes not only your earnings, but also any income from savings, rental income and both employer and employee pension contributions. The annual allowance is reduced by £1 for every additional £2 over this income limit, with a maximum possible reduction of £50,000, leaving you with an annual allowance of £10,000.
Until recently, there was a limit to the total value of your lifetime pension savings which applied to both company and personal pension arrangements. This lifetime allowance is currently set at £1,073,100, and prior to 6 April 2023 pension savings in excess of the lifetime allowance were subject to additional tax charges. Following the 2023 Spring Budget, for the 2023/24 tax year the lifetime allowance tax charge will be 0% and from the 2024/25 tax year the lifetime allowance will be abolished.
Taking a long-term approach to investing means allowing your investment to access better growth over time. This takes significant patience, but the results can pay off substantially over time. Why is this? This is due to the process of ‘compounding’, which typically proves much more pronounced over longer time periods. Of course, past performance is never a reliable guide to future performance, and the value of investments can rise or fall depending on a huge array of factors. However, remaining invested and leaving your investments to work over a longer time period provides the most reasonable opportunity for this process to work. When we talk about compounding, we are effectively referring to the process of letting any gains build on themselves over time.
If you have not made the maximum level of contributions you may be able to carry forward any unused amount of the annual allowance for the previous three years. To qualify to carry forward unused allowances you must have been a member of a pension scheme at some point, but you do not need to have paid any contributions during that time.
If you are making the contribution yourself this is limited to 100% of your earnings in the tax year. However, if your employer is making the pension contribution this restriction will not apply.
It is possible to transfer funds from one or more UK pensions to a single plan. This could be to access different benefit options or because you want a single wealth manager to manage your pension fund alongside your other investments. It can be helpful, but it is not essential, to consolidate pension savings into a single plan prior to drawing benefits. Holding your pension assets in one arrangement can also offer greater flexibility for estate planning.
It is important to note that there are costs involved and obtaining professional advice is essential to ensure that you take the appropriate course of action for your own situation. An adviser will research your existing plans and ensure that, by transferring, you are not giving up valuable benefits that cannot be replaced.
A self-invested personal pension (SIPP) is a pension ‘wrapper’ that allows you to save, invest and build up a pot of money for when you retire. It is a type of personal pension and works in a similar way to a standard personal pension. The main difference is that with a SIPP, you have more flexibility with the investments you can choose, including for example:
- company shares (UK and overseas)
- collective investments – such as open-ended investment companies (OEICs) and unit trusts
- investment trusts
- property and land – but not most residential property.
Historically, one of the least popular aspects of pensions was that they died with you. However, pension freedoms provide increased flexibility as to how any unused pension fund can be used after your lifetime. If the fund remains invested, on the death of a beneficiary a new successor beneficiary can be nominated, therefore allowing the remaining pension fund to benefit further generations.
The pension fund is generally outside of your estate for inheritance tax purposes and can be regarded as a key component of your estate planning. It is no longer the case that the pension should be the first port of call to source retirement income. Appropriate advice is key to maximising the benefits of all the options available at retirement.
Funding your retirement
In the current environment of high prices and rising interest rates, saving for retirement can seem little short of a luxury. But with state pensions increasingly deemed insufficient for a comfortable retirement, private pension savings are becoming an ever more critical part of long-term financial planning.