It is important to understand what a pension is at any age and what it means for you in the future.
What is a pension?
A pension is simply a savings vehicle to help you save when you retire. The amount you receive depends on how much you contributed during your working life and the performance of the underlying investments. You will receive tax relief on contributions and it is a way of saving up money for your retirement. Then the idea is that when you are ready to retire, you will be able to draw money from you pension for a regular income until your death. There are a number of pensions available, the three main types being: an employer’s pension, state pension and a personal pension.
In the UK, you are able to access your pension plan from the age of 55 years old, however, this is set to rise to 57 years old in 2028. Although you are investing some of your disposable income now in exchange for a larger pot of cash in the future, it will definitely be worth it.
When you have a pension plan, you will also receive tax relief depending on whether you are a basic-rate or higher-rate taxpayer. This will result in the tax relief being added to the plan contributions, while the gains you receive in the future will largely be tax-free.
How much should you invest into your pension?
Your employer will have minimum contribution levels for your workplace pension due to auto-enrolment. However, if you can afford to, you should also contribute more to your pension. The general advice we give clients is to pay in as much as possible, as early as possible. There is no limit to how much you pay into your pension however there is a limit on how much tax relief you will receive.
Auto-enrolment means that employers now have to offer employees a pension, automatically enrol you and contribute on your behalf. From 6th April 2019, the minimum employer contribution level increased to 3% and under auto-enrolment, total contributions must be at least 8%.
What are the different types of pension?
A pension is either final salary or a money purchase pension. Final salary pensions (also known as defined benefit schemes) are largely funded by employers. You get a percentage of your final pre-retirement salary as an annual income. Money purchase pension (also known as defined contribution schemes) is when the money you pay into your pension plan is invested and what you have at retirement depends on how these investments have performed. Pension plans can also be referred to as workplace pension schemes, trustbased pension, group personal pensions, stakeholder pensions and self-invested personal pensions (SIPPs).
How do I access my pension when I retire?
Once you reach the age of 55 years old (57 from 2028), you can take 25% of it as a tax-free lump sum and then the remainder will provide an income for the rest of your life. When you stop earning money from a regular income then you should make some decisions about your pension. We always advise clients to start preparing or having conversations with us a couple of years beforehand.
Accessing your pension at 55 years old is often too early for many people. If that is the case for you, then you can leave it where it is. But if you want to access all of your pension cash at once the first 25% is taxfree and the remaining 75% will be taxed as income. Alternatively, you can speak with us and we can look into how long will the income withdrawn from your pension plan last.
Currently you can receive tax relief on your contribution to the greater of £3600 or 100% of your net relevant earnings to a maximum of £40,000 per year. This is known as the Annual Allowance. However, if you start to draw money from a defined contribution pension, the amount you can pay into a pension and still get tax relief reduces. This is known as the Money Purchase Annual Allowance or MPAA.
Pension flexibility
Having flexibility with a pension savings account enables the individual to access those savings in a more flexible way.
Reforms to pensions were made back in 2015, allowing pension saving holders a way to enjoy their pension savings in a way that best suits them. Flexibility can also be gained by setting up a personal pension where you can arrange a pension income drawdown with a more flexible plan to suit your needs.
If you have any questions regarding understanding your pension or would like any advice on a pension then please do get in touch and we can arrange a chat to go through all the details.
*Please note: A pension is a long-term investment. Your capital is at risk. The value of your investment (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. 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.