At Absolute Finance we appreciate that every client is unique and complex, which has led us to develop a highly innovative approach to their provisions for retirement planning.
With so many different types of pension provisions available, it's hard to know where to start. Deciding how to save for your retirement is one of the most important financial decisions you'll ever have to make, so it's important to get it right. Creating a tailored solution that meets your specific needs will enable you to plan for your financial future.
This guide explains how to develop different strategies to accumulate wealth so that you can enjoy your retirement years. Your ability to enjoy a long and fulfilling retirement will depend partly upon how well you accumulate assets now.
Retirement may seem a long way off but the earlier you begin preparations for it, the sooner you can start to take control of your retirement savings and make full use of the tax allowances available. Alternatively, you may want to maximise your post-tax income in retirement.
If you've built up little or no pension, you may want to consider starting a personal pension arrangement, as well as looking into any options for saving for a pension through your employer.
The good news is that many of us are living for longer, but this means we may need more money to fund a successful retirement. Unfortunately, some pensioners find it difficult to manage on the current full Basic State Pension (£110.15 a week in 2013/14) and it's hard to predict what the payments could be in the future. This is why it makes sense to make provision for your retirement as early as possible to ensure your retirement years are free from financial worries.
At Absolute Finance we work with our clients to create tailored retirement planning strategies, that meet their financial goals and needs; and we're committed to ensuring that our clients enjoy the best financial planning service available.
As part of our service we also take the time to understand our client's unique needs and circumstances, so that we can provide them with the most suitable retirement planning solutions in the most cost-effective way. If you would like to discuss the range of retirement planning options we offer, please contact us for further information.
This following information is packed full of practical hints and tips on how to make more of your retirement money. It is not designed to provide specific advice. If you are unsure of your financial position, or about which type of financial product is right for you, please contact us for further information.
Receiving reliable and professional financial advice is essential – please contact us to discuss your particular situation.
The biggest change in pension legislation in a lifetime
The introduction of Pension Simplification legislation on 6 April 2006 (A-Day) brought about the biggest change in pension legislation in a lifetime with the following aims:
to reduce the complexity of pensions
to offer simpler and more flexible retirement arrangements
to encourage saving for the future
Since 6 April 2006, simpler rules have been applied to both personal and occupational schemes. The rules allow most people to pay more into their pension schemes and on more flexible terms than before.
The rules for claiming tax relief on your pension contributions are also more flexible, though tax charges will apply if you go above certain allowances. You can get tax relief on contributions of up to 100 per cent of your earnings (salary and other earned income) each year, provided you paid the contribution before age 75.
You can now contribute as much as you like into any number of pension schemes (personal and/ or occupational) each year. There is no upper limit to the total amount of pension saving you can build up. But the amount you save each year towards a pension is subject to an 'annual allowance'.
From April 2009 a 'Special Annual Allowance' was introduced to stop people making large additional pension contributions and getting higher rates of tax relief on them ahead of April 2011. The Special Annual Allowance will affect you if all of the following apply:
your total pension savings, including employer contributions, are more than £20,000
you change the amount you normally save towards your pension on or after 22 April 2009
your income is £150,000 or more in the current or either of the two previous tax years
Your Special Annual Allowance is normally £20,000 less your normal pension savings. You have to include any amount by which your pension savings have gone over your Special Annual Allowance on your tax return.
The government also announced that from 9 December 2009 the Special Annual Allowance applies if your income is £130,000 or more. The allowance will apply in the same way as for people whose income is £150,000 or more, except that it will apply in relation to changes you make to the amount you normally save towards your pension on or after 9 December 2009. This restriction will apply until 6 April 2011.
For the tax year 2014/15 the government announced new pension rules as part of their ongoing spending review and the promise to simplify and curtail the current pension contribution regime.
The maximum pension contribution limit will be reduced from £50,000 to £40,000 in 2014-15 (down from £255,000 before April 2011). Investors will benefit from tax relief at their highest marginal rate – that is, a basic rate taxpayer will receive 20 per cent tax relief, a higher rate taxpayer 40 per cent; and a 45 per cent taxpayer 45 per cent relief.
The current Lifetime Allowance will also be reduced from April 2012. The full Lifetime Allowance will be reduced to £1.5m, down from £1.8m. When you start to draw your pension, HMRC will apply a recovery charge to the value of retirement benefits that exceed the Lifetime Allowance. The amount will depend on how you pay the excess.
In 2014-15 the Lifetime Allowance the maxima will be £1.25m with new 'Fixed Protection 2014' and 'Personal Protection Option'.
More ways of taking your pension income, there are now four choices:
take a scheme pension – a secured pension for life paid out of the scheme assets or purchased from an insurance company
buy an annuity (an investment that provides a regular income for life)
Capped Drawdown – leave your fund invested; take PCLM and an income if required.
Flexible Drawdown – Use the invested fund as you wish subject to a minimum guaranteed minimum income.
All types of pension schemes are now allowed to pay a tax-free lump sum of up to 25 per cent of the overall value of your benefits, provided there is provision in the scheme rules, to an overall maximum of 25 per cent of the Lifetime Allowance. If you're a member of an occupational company pension scheme, you no longer have to leave your job to draw your lump sum and a pension. You may also be able to draw all or some of your lump sum and pension while still working full or part-time for the same employer, depending on your pension scheme's rules.
From 6 April 2010, the minimum age at which you were able to take your company or personal pension increased from 50 to 55. However, you may still be able to take your pension before age 55 in certain circumstances, for example, if you are unable to work due to ill-health.
Between 2010 and 2020 the minimum age at which women will be able to get their State Pension will gradually rise from 60 to 65. State Pension age will also increase for both men and women from age 65 to 68 between 2024 and 2046.
Receiving reliable and professional financial advice is essential – please contact us to discuss your particular situation.
'Qualifying years' credited throughout your working life
The Basic State Pension is a government-administered pension. It is based on the number of qualifying years gained through National Insurance Contributions (NICs) you've paid, are treated as having paid or have been credited with throughout your working life.
The full Basic State Pension is £110.15 a week (2013/14). The current state retirement age for men is age 65, and for women it is changing. The state retirement age gradually increases to age 65 for women born between 5 April 1950 and 5 April 1955. This change started on 6 April 2010 and finishes on 5 April 2020.
This also has an effect upon Pension Credit for both men and women, as it moves the Qualifying Age (QA) to 65 over the next ten years from 6 April 2010.
The state retirement age for men and women will change again from 6 April 2024, moving everyone's retirement age gradually to 66, then in 2034 towards 67 and in 2044 towards 68. The rules for building up your Basic State Pension have also changed for those people retiring after 6 April 2010.
From 6 April 2010, men and women who reach state retirement age now need 30 qualifying years to obtain the maximum Basic State Pension. If you have less than 30 years, you receive a proportion, for example, 15 years equals 50 per cent of the maximum pension.
A qualifying year is a year when you paid enough NICs or were credited with NICs, for example, if you were receiving jobseeker's allowance or child benefit.
From 6 April 2010 there is now no minimum number of qualifying years. Before this date you were required to have at least 25 per cent of the maximum requirement to qualify for any pension.
Receiving reliable and professional financial advice is essential – please contact us to discuss your particular situation.
Building up your entitlement to an extra pension
If you are in work, you may also be building up entitlement to the Additional State Pension. The Additional State Pension, or State Second Pension (S2P), is paid in addition to the Basic State Pension. Your entitlement to the Additional State Pension, whether from SERPS (State Earnings-Related Pension Scheme) or S2P, is calculated when you claim the Basic State Pension.
The Additional State Pension is based on your earnings in tax years from April 1978 up to the last complete tax year before you reach state pension age.
Between April 1978 and April 2002, this extra pension was called SERPS. Since April 2002 it has been called S2P. The calculation of S2P is more generous for low and moderate earners, who receive proportionately more from the S2P. Also, since April 2002, it has become possible for people who are carers, or have a long-term illness or disability, to qualify for the Additional State Pension.
All employees who earn more than the lower earnings limit for the relevant tax year qualify for the Additional State Pension unless they join an occupational or personal pension scheme that is contracted out.
If you are a carer, you can build up your entitlement to Additional State Pension – for example, if you receive Child Benefit and look after a child under six years old; if you are entitled to Carer's Allowance; or if you look after a sick or disabled person and are receiving Home Responsibilities Protection.
Self-employed people do not qualify for Additional State Pension.
Comparable benefits in return for lower National Insurance Contributions
In 1988 it was possible for employees to contract out of the State Earnings-Related Pension Scheme (SERPS), now called the State Second Pension (S2P), where their work scheme did not do this for them already, and set up a form of Personal Pension Plan called 'Protected Rights'.
Protected Rights are pension funds built up with contributions paid by the government into a Money Purchase or Defined Contribution pension scheme when an employee decides not to participate in S2P (or its predecessor SERPS).
Occupational Final Salary schemes (also known as Defined Benefit schemes) have been able to do this for a much longer time period. Such a scheme provides comparable benefits to the Additional State Pension in return for lower National Insurance Contributions. Companies could also contract out via a Money Purchase scheme on a similar basis. The scheme would then be called a Contracted Out Money Purchase Scheme or COMP Scheme.
However, from 1988, contracting out was also possible for employees who were either in a contracted-in occupational scheme or in a personal pension.
Employees who contracted out paid the full National Insurance rate as normal and the Department for Work and Pensions repaid some of it in the following tax year, to the plan of the employee's choice. This money was invested as the employee chose from the range of funds made available by the insurance company they were using.
Planning for your retirement years
There are three types of non-State pension. Some are offered by employers and some you can start yourself. They are:
occupational Final Salary Schemes offered by some employers
occupational defined Contribution Schemes (also called money Purchase Schemes) – offered by some employers
Stakeholder Pension Schemes and Personal Pensions – offered by some employers, or you can start one yourself. You may also be offered a group personal pension at work (also called Money Purchase Schemes).
If you work for a business employing fewer than five employees, your employer does not currently have to offer you access to a pension scheme.
However, the government is planning changes that will mean all employers will have to offer and contribute towards a pension in the future.
From 2012 employers will need to automatically enrol their eligible workers into a qualifying pension scheme and make contributions to it. Employees will be able to opt-out of their employer's scheme if they choose not to participate.
Workers who give notice during the formal opt-out period will be put back in the position they would have been in if they had not become members in the first place, which may include a refund of any contributions taken following automatic enrolment.
Although you don't have to join any pension scheme offered through your employment, it usually makes sense to join an occupational pension scheme if it's available because:
your employer normally contributes
often you also receive other benefits, such as life insurance which pays a lump sum and/or pension to your dependants if you die while still in service; a pension if you have to retire early because of ill-health; and pensions for your spouse and other dependants when you die.
Not all pensions offered by employers are occupational pensions. Your employer may offer a Stakeholder Pension or a Personal Pension through a Group Personal Pension arrangement. These pensions are not called occupational pensions, even though the employer may contribute.
Joining your employer's scheme
Occupational pension schemes vary from company to company. Your scheme is likely to be one of two general types, Final Salary related or Defined Contribution Scheme.
Occupational pension schemes are pension arrangements that employers set up to provide retirement income for their employees. The employer sponsors the scheme and a board of trustees ensures that benefits are paid.
Public-sector occupational pension schemes are different in that they are established by an Act of Parliament, which lays down the scheme rules.
Final Salary Schemes
Final Salary Schemes are also known as Defined Benefit Schemes. With these, the amount you receive on retirement depends on your salary when you leave the company or retire, and the length of time you have been a member of the scheme.
It is usually paid at the rate of one-sixtieth of final salary multiplied by the number of years of scheme membership (the accrual rate). So someone who has been a scheme member for 40 years would retire on two-thirds of final salary.
Your pension will depend on your final earnings and not on stock market conditions over your working life. But these schemes are becoming rarer, and many companies are changing their plans from Final Salary to Defined Contribution Schemes.
When you leave a company, you normally have the choice of leaving the money where it is to claim on retirement or transferring it to a new company's occupational scheme or to a Personal Pension Plan. And if you leave a firm within two years of joining its pension you can have your own contributions, minus tax relief, returned to you, if the scheme's rules allow.
Defined Contribution Schemes
Defined Contribution Schemes are also known as Money Purchase Schemes. With these you know what you are contributing towards your pension, but what you receive when you retire depends on the performance of your pension fund(s) over the years and on economic conditions when you actually retire.
On retirement, the money would normally be used to purchase an annuity (a regular income for life), which pays an income until you die. You do not have to accept the annuity offered by the company running your scheme. You have the right to choose the open market option, in other words, you can shop around for the best annuity rates.
Joining an occupational pension scheme
Your employer is required to offer you the chance to join a pension scheme. If you work part-time and your employer has an occupational pension scheme, you will usually be allowed to join it.
Before you join an occupational pension scheme, you should check:
how much you will have to pay
what contribution your employer is going to make
You receive 'tax relief' on the money you pay into your pension scheme. This means you pay less tax because your employer takes the pension contributions from your pay before deducting tax (but not National Insurance Contributions).
Contributions you can make
HM Revenue & Customs (HMRC) sets a limit on the contributions you can make into occupational pension schemes. For Defined Contribution Schemes, the limit is on how much can be paid in total in a tax year. For Final Salary Schemes, the limit is on the value put on the increase in your pension gained during the tax year.
The annual allowance for the tax year 2010/11 was £255,000 this was reduced to £50,000 in April 2012 and further reduces in April 2014 to £40,000. If you pay more than the annual allowance into such a pension scheme, or the value of your pension exceeds the allowance, you will be charged tax at 40 per cent on the excess. The annual allowance does not apply in the tax year when you start to draw retirement benefits.
There is also a limit on the value of retirement benefits that you can draw from an approved pension scheme before tax penalties apply. This limit is called the Lifetime Allowance.
The Lifetime Allowance is £1.5m in the 2012/13 tax year. When you start to draw your pension, HMRC will apply a recovery charge to the value of retirement benefits that exceed the Lifetime Allowance. The amount will depend on how you pay the excess.
Increasing your benefits
Occupational pension schemes usually require you to make a regular contribution based on a percentage of your salary. You may also be able to increase your benefits by making Additional Voluntary Contributions (AVCs).
Money Purchase AVC
One of the ways you can do this is by paying into an Additional Voluntary Contribution (AVC) arrangement run by your scheme trustees. The majority of these are money purchase, which means that your contributions are invested, usually with an insurance company, to build up a fund. An AVC arrangement run through your employer's pension scheme is known as an 'in-house' AVC scheme. The employer normally bears the cost of administration of this scheme and so costs tend to be lower than topping up pensions through other means.
If your scheme allows you to buy added years, this will enable you to increase the number of years of service you have in your main scheme. The extra service will increase both the amount of pension that you will receive and your tax-free cash allowance, irrespective of when you started contributing. How much you pay as voluntary contributions will be worked out by your main scheme. The cost will depend on how many years you want to buy and certain factors such as your age and salary for pension purposes.
Free-Standing AVC (FSAVC)
It may be possible for you to pay into a FSAVC arrangement. This is similar to a money purchase AVC but is provided by external providers. Since 6 April 2006, it has no longer been compulsory for occupational pension scheme trustees to offer an AVC facility to its members.
If you joined your occupational pension scheme during or after 1989, you were restricted on how much you could put into the scheme. However, following changes to pension rules in April 2006, you can now save as much as you like into any number and type of pensions. You are able to do this at any age. You also receive tax relief on contributions of up to 100 per cent of your earnings (salary and other income) each year, subject to an upper 'Annual Allowance'.
Savings above the Annual Allowance and a separate 'Lifetime Allowance' will be subject to tax charges. These allowances will be restricted if you become unemployed and wish to continue to pay into your pension scheme.
Having an occupational pension does not affect your Additional State Pension entitlements. But you will lose some or all of your Additional State Pension if your company pension scheme is contracted out.
Your pension scheme administrator can provide you with an estimate of:
how much you will receive when you retire
the value of any survivor's benefits that may become payable
how much you will receive if you have to retire early due to ill health
Up until April 2006 you could not draw your pension from an occupational scheme and continue to work for the same employer. Following the 6 April 2006 changes, you are now able to do this, providing your particular scheme allows you to. Also, if you leave your employer, it's important to find out what your occupational pension scheme options are.
All employers currently with five or more employees have to offer access to a pension scheme. If your employer doesn't offer a pension, there are lots of pension providers for you to choose from and you should seek professional financial advice so that you can make an informed decision about which pension option is right for you.
From 2012 employers will need to automatically enrol their eligible workers into a qualifying pension scheme and make contributions to it.
How the new rules could affect your retirement provision
From 2011, private sector Final Salary Pensions need only be up rated in line with the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI). Typically, CPI runs below RPI and, consequently, over time this could mean some final salary members experience a reduction in their retirement income.
This may not apply to all schemes. Some schemes may specifically state in their rules that they will up rate benefits in line with RPI. It's also worth bearing in mind that, although the government sets what the minimum inflation-linking schemes must provide, it's perfectly possible for a scheme to provide increases in excess of this level.
If your scheme does intend to adopt CPI up rating, this could have a negative impact on the income you can expect to receive from the scheme. Ultimately, this depends on the RPI and CPI levels and how they differ, but historically CPI has trailed behind RPI. The impact on your income will also depend on when you built up benefits, because the inflation protection afforded to final salary scheme members has changed over the years.
Tax is not applicable on the money you are paid out on retirement. But from April 2011, if you earn more than £50,000 you will have to pay a tax bill based on your age, length of service and salary.
Contributing a preferential sum into an employee's pension plan
Salary sacrifice (sometimes known as 'salary waiver') in the context of retirement planning is a contractual agreement to waive all or part of an employee's salary in return for the employer contributing a preferential (equivalent) sum into their pension plan.
Salary sacrifice is about varying the employee's terms and conditions as they relate to remuneration, and is a matter for agreement between the employer and employee.
To be effective, a salary sacrifice must be 'given up' before it's subjected to tax or National Insurance Contributions (NICs). This allows the employee to save the entire amount of their sacrificed income in their pension plan free of tax and NICs.
There are also savings for an employer, as they don't have to pay NICs on the employee's sacrificed income. If the employer passes some or all of these savings on to the employee, they'll benefit from even larger tax and NICs-free at no extra cost.
For these reasons, salary sacrifice could significantly enhance the long-term value of the employee's pension plan, as well as allowing them to enjoy considerable savings.
However, salary sacrifice may not be appropriate for individuals with earnings of £150,000 as, in accordance with new pensions tax relief regulations for high earners, any amount of employment income foregone by salary sacrifice in return for an equivalent pension contribution, where the agreement was put in place on or after 22 April 2009, will be considered relevant income and could result in the application of a Special Annual Allowance.
Options available when an occupational pension is not provided
Your employer is currently required to offer you the chance to join a pension scheme if they currently employ five or more employees. If an occupational pension is not provided, then this would normally be a Stakeholder Pension Scheme or alternative Personal Pension Scheme. The requirement for employers to provide access to Stakeholder Pension Schemes is regulated by the Pensions Regulator.
Your employer must offer you access to a Stakeholder Pension Scheme so long as both the following apply:
you earn more than the National Insurance lower earnings limit
there are five or more employees where you work
Your employer does not have to offer you access to a Stakeholder Pension Scheme if one of the following apply:
you are able to join an occupational pension scheme
you are able to join an alternative personal pension scheme where your employer pays in an amount equal to at least 3 per cent of your pay
Your employer must allow you to pay into your Stakeholder Pension Scheme directly from your wages through the company's pay system. Many employers are prepared to pay into your Stakeholder Pension Scheme and pay the cost of the Stakeholder Pension Scheme provider's administration charges. However, they are not required by law to do so.
If you leave your employer, or transfer your money out of the Stakeholder Pension Scheme to another scheme, you don't lose the money your employer has already paid in.
If your employer offers you an alternative Personal Pension Scheme instead of a Stakeholder Pension Scheme, its terms must meet minimum standards set by the government. Your employer is obliged to contribute the equivalent of at least 3 per cent of your salary if they are offering it as an alternative to a Stakeholder Pension Scheme. But they don't have to pay the administration costs of the pension scheme.
Your employer may arrange for a pension provider to set up a Personal Pension arrangement through the workplace. A Personal Pension Scheme (including a Stakeholder Pension Scheme) arranged in this way is called a 'Group Personal Pension Plan' (GPPP).
Although they are sometimes referred to as company pensions, GPPPs are not run by employers and should not be confused with occupational pensions. A GPPP is a type of Personal Pension Scheme arrangement where your employer chooses the financial provider on your behalf.
Some advantages of contributing to a GPPP arranged by your employer:
your employer will normally contribute to your pension and if the GPPP is offered as an alternative to a Stakeholder Pension Scheme your employer must contribute an amount equal to at least 3 per cent of your basic salary
if your employer has contributed to your pension and you leave your employment you do not lose the money they have contributed
your employer will normally deduct your contributions from your pay and send them to your pension provider
a GPPP is negotiated with the pension provider on behalf of a group of people and your employer may be able to negotiate better terms than you would get individually, for instance, they may negotiate reduced administration costs
you will usually be able to continue making contributions to your pension if you change employers.
A new, simple, low-cost pension scheme
In December 2006, the former government published a White Paper outlining its workplace pension reforms, including proposals for NEST (the National Employment Savings Trust) – previously called Personal Accounts. This led to the Workplace Pension Reforms set out in the Pensions Act 2008. These reforms aim to increase individuals' savings for retirement.
A new, simple, low-cost pension scheme, NEST will be introduced as part of the workplace pension reforms. The new employer duties under the government's workplace pension reforms will be introduced over a four-year period from 1 October 2012. The staggered introduction of these duties is known as 'staging'. Broadly speaking, the new duties will apply to the largest employers first, with some of the smallest employers not being affected until 2016. As part of the new duties, firms will be enrolled into NEST.
The former government established NEST as part of pension reforms aimed at tackling a lack of adequate pension savings among low- and middle-income UK workers. The NEST's investment strategy will be low-risk and there may be a possibility that, after five years, savers will be able to move their money out of the NEST into other pension schemes.
The reforms include the stipulation that from 2012 employers either pay a minimum contribution of 3 per cent into the scheme or automatically enrol workers in existing pension vehicles. NEST will launch its scheme for voluntary enrolment in the second quarter of this year.
NEST will be a trust-based defined contribution occupational pension scheme. It will be regulated in the same way as existing trust-based defined contribution schemes and will provide people with access to a simple, low-cost pension scheme. The charges are a 1.8 per cent charge on the value of each contribution to cover NEST's start-up costs, and an annual management charge of 0.3 per cent of the value of the fund.
The new two-part charge by NEST will work as follows: if a member has a fund of £10,000, they will pay £30, due to the 0.3 per cent annual management charge; if that same member makes a monthly contribution of £100, including tax relief, they will pay £1.80 on the sum, due to the 1.8 per cent contribution charge.
There will be an annual contribution limit of £3,600 (in 2005 earnings' terms) into NEST. This will be up rated by earnings year on year. This limit will be reviewed in 2017.
Workers will be automatically enrolled into the default investment fund but there is likely to be a choice of investment funds, which may include options such as social, environmental and ethical investments. Those not wishing to make an investment choice will stay in the default fund.
Employers will need to automatically enrol their eligible workers into a qualifying pension scheme and make contributions to it. Workers will be able to opt out of their employer's scheme if they choose not to participate.
Workers who give notice during the formal opt-out period will be put back in the position they would have been in if they had not become members in the first place, which may include a refund of any contributions taken following automatic enrolment.
Anyone who joins NEST will be able to continue to save in the scheme even after they leave the workplace or move to an employer that does not use NEST. The self-employed and single person directors are not eligible for auto-enrolment but will be able to join NEST.
Bringing your pensions under one roof
Pension transfers can be complicated and you should always seek professional financial advice before going ahead. Remember, whether a transfer is suitable or not will very much depend upon your individual circumstances and objectives.
There are a number of different reasons why you may wish to consider transferring your pension(s), whether this is the result of a change of employment, poor investment performance, high charges and issues over the security of the pension scheme, or a need to improve flexibility.
You might well have several different types of pension, including a final salary related scheme(s), which pays a pension based on your salary when you leave your job and on years of service. Your previous employer might try to encourage you to move your occupational pension away by boosting your fund with an 'enhanced' transfer value and even a cash lump sum. However, this still may not compensate for the benefits you are giving up, and you may need an exceptionally high rate of investment return on the funds you are given to match what you would receive if you remained in the final salary related scheme.
Alternatively, you may have a defined contribution (money purchase) occupational scheme or a personal pension. These pensions rely on contributions and investment growth to build up a fund.
If appropriate to your particular situation, it may make sense to bring these pensions under one roof to benefit from lower charges, make fund monitoring easier and aim to improve fund performance. But remember that transferring your pension will not necessarily guarantee greater benefits in retirement.
You will need to consider that your pension(s) might have or had other valuable benefits that you could lose when transferring out, such as death benefits or a Guaranteed Annuity Rate (GAR) option. A GAR is where the insurance company guarantees to pay your pension at a particular rate, which may be much higher than the rates available in the market when you retire.
In addition, some pensions may also apply a penalty on transferring out. These can be significant depending on the size of your fund, so it is important to check if one applies in your case.
It is also important that the investments chosen are appropriate for the level of risk you are prepared to take. Obtaining professional financial advice will mean that you are fully able to understand the risks and potential benefits of the different funds and investments and can make an informed decision about the level of risk you are prepared to take.
Transferring your pension overseas
The ability to transfer a pension from the UK to another country formed part of the pension reform known as A-Day, introduced on 6 April 2006. Under these changes people no longer resident in the UK, but who have UK pensions, are now allowed to transfer their pensions across to a Qualifying Recognised Overseas Pension Scheme (QROPS), provided they meet certain conditions.
Transferring your pension overseas into a QROPS, which has been approved by HM Revenue & Customs (HMRC) to accept a pension transfer from a UK pension scheme, is an important decision that may give you extra benefits.
It is vital that you understand all aspects of any QROPS pension transfer, which is why you should seek professional financial advice to evaluate your personal situation and to understand the process in full.
With reference to HMRC rules, a transfer into an offshore pension scheme qualifies as a benefit crystallisation event. This means that your UK pension is given a valuation against your Lifetime Allowance. The allowance currently set is £1.5m for 2012/13.
The possibility of transferring a UK pension into a QROPS can be extremely beneficial to expatriates living abroad in Europe and the rest of the world. A QROPS pension transfer can also be of great interest for someone who has not yet left the UK but is in the process of planning to do so.
QROPS pension schemes are not just for UK nationals either. People of different nationalities who have accumulated a pension fund through working in the UK can also transfer their pension into a QROPS.
Taking more control over your pension fund investment decisions Self-Invested Personal Pensions (SIPPs) have been around since 1989 but after the introduction of Pension Simplification legislation on 6 April 2006, they've become more accessible.
If you would like to have more control over your own pension fund and be able to make investment decisions yourself with the option of our professional help, a SIPP could be the retirement planning solution to discuss with us.
What is a SIPP?
A SIPP is a personal pension wrapper that offers individuals greater freedom of choice than conventional personal pensions. However, they are more complex than conventional products and it is essential you seek expert professional advice.
They allow investors to choose their own investments or appoint an investment manager to look after the portfolio on their behalf.
Individuals have to appoint a trustee to oversee the operation of the SIPP but, having done that, the individual can effectively run the pension fund on his or her own.
A fully-fledged SIPP can accommodate a wide range of investments under its umbrella, including shares, bonds, cash, commercial property, hedge funds and private equity.
How much can I contribute to a SIPP?
Many SIPP providers will now permit you to set up a lump sum transfer contribution from another pension of as little as £5,000, and while most traditional pensions limit investment choice to a short list of funds, normally run by the pension company's own fund managers, a SIPP enables you to follow a more diverse investment approach.
Most people under 75 are eligible to contribute as much as they earn to pensions, including a SIPP (effectively capped at £255,000 each tax year). For instance, if you earn £50,000 a year you can contribute up to £50,000 gross (£40,000 net) into all your pension plans combined in the 2010/11 tax year. The £50,000 maximum reduces to £40,000 from April 2014. Contributions post age 75 does not receive tax relief.
If your total annual income has reached £130,000 since April 2008, you may experience further restrictions on the amount you can contribute and obtain higher or additional rate tax relief.
The earnings on which you can base your contribution are known as Relevant UK Earnings. If you were employed, this would generally be your salary plus any taxable benefits. If you were self-employed, this would normally be the profit you make (after any adjustments) for UK tax purposes.
Even if you have no Relevant UK Earnings, you can still contribute up to £3,600 each year to pensions. Of this the government will pay £720 in tax relief, reducing the amount you pay to just £2,880.
Can I transfer my existing pension to a SIPP?
Before transferring to a SIPP it is important to check whether the benefits, such as your tax-free cash entitlement, are comparable with those offered by your existing pension. Make sure, too, that you are aware of any penalties you could be charged or any bonuses or guarantees you may lose.
If you have had an annual income of £130,000 or more since April 2007 and make regular contributions to a pension, changes announced in the 2009 Budget could affect you. Switching regular contributions to a new pension may mean future regular contributions are subject to a £20,000 limit.
A SIPP will typically accept most types of pension, including:
Stakeholder Pension Plans
Personal Pension Plans
Retirement Annuity Contracts
Executive Pension Plans (EPPs)
Free-Standing Additional Voluntary Contribution Plans (FSAVCs)
Most Paid-Up Occupational Money Purchase Plans
Where can I invest my SIPP money?
You can typically choose from thousands of funds run by top managers as well as pick individual shares, bonds, gilts, unit trusts, investment trusts, exchange traded funds, cash and commercial property (but not private property). Also, you have more control over moving your money to another investment institution, rather than being tied if a fund under-performs.
With a SIPP you are free to invest in:
Cash and deposit accounts (in any currency providing they are with a UK deposit taker)
Insurance company funds
UK shares (including shares listed on the Alternative Investment Market)
US and European shares (stocks and shares quoted on a Recognised Stock Exchange)
Permanent interest-bearing shares
Ground rents in respect of commercial property
Open-ended investment companies (OEICs)
Traded endowment policies
Futures and Options
Once invested in your pension, the funds grow free of UK capital gains tax and income tax (tax deducted from dividends cannot be reclaimed).
Why would I use my SIPP to invest in commercial property?
Investing in commercial property may be a particularly useful facility for owners of small businesses, who can buy premises through their pension fund. There are tax advantages, including no capital gains tax to pay, in using the fund to buy commercial property.
If you own a business and decide to use the property assets as part of your retirement planning, you would pay rent directly into your own pension fund rather than to a third party, usually an insurance company.
Ordinarily, a business property will, assuming that its value increases, generate a tax liability for the shareholders or partners. Unless, that is, you sell the property to your SIPP. Then the business can pay rent to your pension fund, on which it pays no tax, and any future gain on the property will also be tax-free when it is sold.
What are the tax benefits of a SIPP?
There are significant tax benefits. The government contributes 20 per cent of every gross contribution you pay – meaning that a £1,000 investment in your SIPP costs you just £800. If you're a higher or additional rate taxpayer, the tax benefits could be even greater. In the above example, higher rate (40 per cent) taxpayers could claim back as much as a further £200 via their tax return. Additional rate (50 per cent) taxpayers could claim back as much as a further £300.
When can I withdraw funds from my SIPP?
You can withdraw the funds from your SIPP from the ages of 55 and normally take up to 25 per cent of your fund as a tax-free lump sum. The remainder is then used to provide you with a taxable income.
If you die before you begin taking the benefits from your pension, the funds will normally be passed to your spouse or other elected beneficiary free of Inheritance Tax. Other tax charges may apply depending on the circumstances.
What else do i need to know?
You cannot draw on a SIPP pension before age 55 and you should be mindful of the fact that you'll need to spend time managing your investments. Where investment is made in commercial property, you may also have periods without rental income and, in some cases; the pension fund may need to sell on the property when the market is not at its strongest. Because there may be many transactions moving investments around, the administrative costs are higher than those of a normal pension fund.
The tax benefits and governing rules of SIPPs may change in the future. The level of pension benefits payable cannot be guaranteed, as they will depend on interest rates when you start taking your benefits. The value of your SIPP may be less than you expected if you stop or reduce contributions, or if you take your pension earlier than you had planned.
Taking greater responsibility for your financial future
An annuity is a regular income paid in exchange for a lump sum, usually the result of years of investing in an approved, tax-free pension scheme. There are different types. The vast majority of annuities are conventional and pay a risk-free income that is guaranteed for life. The amount you receive will depend on your age, the size of your pension fund and, in some circumstances, the state of your health.
Your pension company may want you to choose its annuity offering, but the law says you don't have to. Everyone has the right to use the 'Open Market Option', to shop around and choose the annuity that best suits their needs. There can often be a significant difference between the highest and lowest annuity rates available.
Some insurance companies will pay a higher income if you have certain medical conditions. These specialist insurers use this to your advantage and will pay you a higher income because they calculate that, on average, your income should be paid out for a shorter period of time.
Some older pension policies have special guarantees that mean they will pay a much higher rate than is usual. Guaranteed Annuity Rates (GARs) could result in an income twice or even three times as high as policies without a GAR.
A conventional annuity is a contract whereby the insurance company agrees to pay you a guaranteed income either for a specific period or for the rest of your life in return for a capital sum. The capital is non-returnable and hence the income paid is relatively high.
Income paid is based on your age, for example, the mortality factor, and interest rates on long-term gilts, and income is paid annually, half yearly, quarterly or monthly.
Annuities can be on one life or two. If they are on two lives, the annuity will normally continue until the death of the second life. And if the annuitant dies early, some or all of the capital is lost. Capital protected annuities return the balance of the capital on early death.
Payments from pension annuities are taxed as income. Purchased life annuities have a capital and an interest element; the capital element is tax-free, the interest element is taxable.
Types of annuity
Types of annuity include the following:
The purchase price is paid to the insurance company and the income starts immediately and is paid for the lifetime of the annuitant.
Income is paid for the annuitant's life, but in the event of early death within a guaranteed period, say five or ten years, the income is paid for the balance of the guaranteed period to the beneficiaries.
Also known as open market option annuities, these are bought with the proceeds of pension funds. A fund from an occupational scheme or buy-out (S32) policy will buy a compulsory purchase annuity. A fund from a retirement annuity or personal pension will buy an open market option annuity, an opportunity to move the fund to a provider offering higher annuity rates.
A single payment or regular payments are made to an insurance company, but payment of the income does not start for some months or years.
A lump sum payment is made to the insurance company and income starts immediately, but it is only for a limited period, say five years. Payments finish at the end of the fixed period or on earlier death.
The income is level at all times and does not keep pace with inflation.
Increasing or escalating annuity
The annuitant selects a rate of increase and the income will rise each year by the chosen percentage.
Some life offices now offer an annuity where the performance is linked to some extent to either a unit-linked or with-profits fund to give exposure to equities and hopefully increase returns.
Relaxing the law requiring everyone to buy an annuity
Since 2011 it has not been a requirement to purchase an annuity by age 75.
The aim of these changes is to revolutionise investor attitudes towards pensions and encourage greater retirement saving, so that we take greater responsibility for our financial futures. It will also mean that everyone who invests in a pension can retain control of their pension assets right through until the day they die.
The proposed law change is aimed at giving individuals greater flexibility over how they use the savings they have accumulated. This would see the replacement of some pension tax rules with a new system that gives people greater freedom and choice.
This consultation is a revolutionary change and also includes tax breaks available on pensions. It is expected that investors will have the choice of buying an annuity, as at present, and in addition they will have a choice of two drawdown options to select from.
Investors who can demonstrate that they have secured a minimum level of income will have the choice of taking money from a flexible drawdown plan at will. This means receiving it all back in one go as a cash sum if required. Income withdrawals will be subject to income tax.
For those investors with insufficient income to satisfy the 'Minimum Income Requirement', there will be the option of a capped drawdown. This capped drawdown will have fairly conservative income limits, designed to ensure that investors never run out of money.
Those investors who do not want to take the high risk involved with drawdown will still be able to convert their pension fund into an annuity, which will pay a secure taxable income for life. The death benefit rules are changing and becoming simpler and the government has confirmed that it will be ending the Alternatively Secured Pension.
Keeping your pension funds invested beyond your normal retirement date
Income Drawdown allows people to take an income from their pension savings while still remaining invested and is an alternative to purchasing an annuity. You decide how much of your pension fund you want to move into drawdown and then you can normally take a 25 per cent tax-free lump sum and draw an income from the rest.
Pensioners funding their retirement through Income Drawdown are permitted to keep their pension funds invested beyond their normal retirement date. They continue to manage and control their pension fund and make the investment decisions. There is also the opportunity to increase or decrease the income taken, as they get older. However, the fund may be depleted by excessive income withdrawals or poor investment performance.
From 6 April 2010 you are now able to choose to take an income from your pension fund from age 55 (previously this was from age 50). Tax rules allow you to withdraw between 0 per cent to 120 per cent (26/03/2013) of the equivalent relevant annuity you could have bought at outset. The Government calculates these limits
Currently, on death in drawdown before age 75, there is a 55 per cent tax charge if benefits are paid out as a lump sum.
If you die under the age of 75 before taking benefits, your pension can normally be paid to your beneficiaries as a lump sum, free of tax. This applies currently and under the new proposals.
For pensioners using drawdown as their main source of retirement income, the proposed rules would remain similar to those in existence now with a restricted maximum income. However, for pensioners who can prove they have a certain (currently unknown) level of secure pension income from other sources, there will potentially be a more flexible form of drawdown available that allows the investor to take unlimited withdrawals from the fund subject to income tax.
As a general rule, you should try to keep your withdrawals within the natural yields on your investments. In this way you will not be eating into your capital.
Since 6 April 1996 it's been possible for Protected Rights money – funds accrued from contracting out of SERPS or State Second Pension (S2P) – to be included in an Income Drawdown plan, but before A-Day Protected Rights couldn't be included in a phased Income Drawdown plan.
As with any investment you need to be mindful of the fact that, when utilising Income Drawdown, your fund could be significantly, if not completely, eroded in adverse market conditions, or if you make poor investment decisions. In the worst-case scenario, this could leave you with no income during your retirement.
You also need to consider the implications of withdrawals, charges and inflation on your overall fund. Investors considering Income Drawdown should generally be prepared to adopt a significantly more adventurous attitude to investment risk than someone buying a lifetime annuity.
In addition, there is longevity to consider. No-one likes to give serious thought to the prospect of dying, but pensioners with a significant chance of passing away during the early years of their retirement may well fare better with an Income Drawdown plan, because it allows the pension assets to be passed on to dependants.
New rules will be introduced in the 2013 Finance Bill.
Content of the articles featured in the sections above are for your general information and use only, and is not intended to address your particular requirements. They should not be relied upon in their entirety and shall not be deemed to be, or constitute, advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received, or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough examination of his or her particular situation. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. The pension and tax rules are subject to change by the government. Tax reliefs and state benefits referred to are those currently applying. Their value depends on your individual circumstances. The performance of the investment funds will have an impact on the amount of income you receive. If the investments perform poorly, the level of income may not be sustainable. Given the number of recent changes to pension legislation, it is now more than ever critical that you receive reliable and professional financial advice – please contact us to discuss your particular situation.
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