Planning for the future can feel daunting, especially when it comes to your retirement and pension. Complex eligibility criteria, questions around investment amount and the overwhelming range of pensions available, means that many fall into a pattern of ‘I’ll sort it tomorrow’.

But it’s important to take the time now, perhaps with the help of a financial advisor, to sort your retirement and pension plan long before you need it.

With the Pensions Policy Institute finding that five million people approaching their retirement age in 2021 don’t have an adequate pension income to sustain themselves, it’s never been more important to plan for your retirement. (https://www.ageing-better.org.uk/news/five-million-people-approaching-retirement-risk-not-adequate-pension-income).

To help find the best solution for you, we’ve developed a jargon-busting guide discussing the variety of pension options available, top tips, a helpful terminology glossary and an FAQ section to answer your commonly asked questions.

1.    What is a pension plan and why should I have one?

A pension plan is essentially a ‘money pot’ or ‘piggy bank’ that is paid into or acquired over your working life. When you reach your retirement age, you can use this money to live on. It’s important to remember that pensions are an investment – while you may be spending more of your disposable income now in the case of some pensions, it will serve you well in the future when you stop working. Some pension plans can also offer a number of additional benefits:

• Tax relief – when you earn tax relief on your pension, some of the money that you would have paid in tax on your earnings goes into your pension pot rather than to the government. Tax relief is paid on your pension contributions at the highest rate of income tax you pay, so:

• Basic-rate taxpayers and nil rate tax payers can get 20% pension tax relief
• Higher-rate taxpayers can claim 40% pension tax relief
• Additional-rate taxpayers can claim 45% pension tax relief.
  
  
• Employer contribution – in some workplace pensions, your employer may contribute an extra amount into your pension when you pay in each month from your salary.

2.    What are the main differences in pensions?

Pensions can be very different depending on the type and plan. Firstly, it’s important to know the difference between a Defined benefit pension and a defined contribution pension.

• A defined benefit pension – while employees are also sometimes required to pay in, these are mostly funded by an employer. They provide an income when you retire, based on your final salary or your career average related earnings (CARE). With a final salary defined benefit pension, the amount you receive is dependent on how long you stay with the company. Each year of employment usually increases the percentage of your final salary you receive annually once you retire. 
  
  
• A defined contribution pension - this based on money you invest over your working life. The majority of workplace pensions and all personal pensions fall into this category. Unlike a defined benefit pension, the money you receive when you retire is dependent on how much you invest and how this has scaled over time. When you retire, you have the opportunity to take the cash and use it to sustain yourself or trade its amount for an annuity. This provides a set income for life until you pass.

 3.    What pension plans are available?

Under the above, there are many different types of specific pension plans available. The main ones include:

• Workplace pensions –these defined contribution plans involve monthly contributions from both yourself and your employer, which are invested by the pension provider until you reach retirement. To help workers save, the government introduced auto-enrolment to workplace pensions, meaning all eligible employees must be enrolled if not currently in a scheme. There are two types, both regulated. While both offer different benefits, a contract-based pension is often used by employers who do not have the capacity to instate a board of trustees.

1.  Trust based workplace pension – these are managed internally by an employer via a selected board of trustees who are duty bound to act in members’ interests.
   
   
2.  Contract based workplace pension – these are managed externally by a third-party provider, based on a contract between the individual employee and the provider. While these don’t have a trustee board who are required to act in your interest, you usually have more freedom in your investment choices.

• State pension – the current state pension is available from the state pension age. Anyone is eligible if they have paid National Insurance contributions for at least 10 years, at some point in their working life. The amount of yearly National Insurance payments you have made will determine how much you are entitled to.
  
  
•  Standard personal pensions – as a defined contribution pension, with a standard personal pension, you select the provider and pay in contributions, building your pot for when you hit your pension age. Anyone can set up their own standard personal pension and they also still include the tax-relief benefits of other pensions.
  
  
•  Stakeholder pensions – these defined contribution personal pensions are available to people of any employment status, including those unemployed and self-employed. They offer a flexible way to build income for retirement. Family members can contribute to this, as well as an employer (although they are not required to). These pensions will invest on your behalf, meaning you do not have to decide where you put your money.
  
  
•  SIPP (self-invested personal pension) – these pensions are entirely personal and involve you choosing your investments. While advice and pre-established funds are available for investment, SIPPs offer more flexibility and autonomy when choosing where to invest. This is good for those who are more experienced in investing, want to combine their pension pots under one account as they near retirement or want to save additionally outside their workplace pension.

 4.    What else should I know?

Pensions are complex and take time to understand what the suitable solution for you is. While this guide has covered the fundamentals, your unique situation and needs will determine what will work best for you.

• If you’re dealing with divorce, your pension can be considered an asset, read our guide on the impact of divorce on pensions.
• If you’re considering annuity, you can visit our page on Income Drawdown plans, an alternative that allows you to keep some of your funds invested while still having a regular income.

For any advice, queries or support when planning your retirement and pension, get in touch or call 0121 285 8528.

Disclaimer: A pension is a long-term investment. The fund value may fluctuate and can go down. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.

Pension FAQs:

What is the difference between a pension scheme and the state pension? – a pension scheme is designed to give you an income alongside the State Pension. The new State Pension provides up to £179.60 a week (2021-22). A pension scheme would add to this income once you retire.

Is it too late to start saving into a pension? – regardless of your age, it’s often a good idea to save into a pension, particularly if your employer is also willing to contribute. It’s also a tax-efficient way to save money and you might be able to take some or all of what you save as a tax-free lump sum.

How much should I invest into my pension? – the general rule is to invest as much as you can, as early as you can. This means that you will achieve your retirement goal quicker, giving you more flexibility in later life. It’s important to make sure that you balance your pension payments alongside your current outgoings though, so you don’t pay in beyond your monthly means. Use our income expenditure calculator to estimate how much you may have available to pay in each month.

Am I allowed more than one pension? – yes, you can have more than one pension, but it’s important to keep in mind that there is an annual allowance to what you can invest into your pensions tax-free, currently this is £40,000. If you haven’t invested a lot over the last three years, you may be able to exceed the limit while still receiving tax relief by using unused annual allowance from those years – this is called a carry forward. However, it’s important to note that a ‘carry forward’ is capped on your total earnings in the current tax year.

If I leave my employer, what happens to my pension? – the money from the pension is still yours. You can take it as a lump sum if you’re aged 55 or above, or in some cases, transfer and combine this with a new workplace pension if you are not yet able/ready to retire. It’s best to chat with a financial advisor to discuss the benefits and downsides of doing this, as well as any costs or conditions that may be involved.

What if I die before I take my pension benefits? - in most cases, your pension scheme will provide benefits on your death. If you’re in a defined benefit pension scheme, your dependants might be paid an income.

If you’re in a defined contribution scheme, your dependants may be paid a lump sum. The lump sum is usually the value of your fund. They may also be able to use the money to take income regularly or as and when they want.

It’s important to check with your pension provider what death benefits might be paid.

 

Pension Glossary:

Adjusted income: this is your annual income prior to tax and the amount of contributions made by both yourself or an employer.

Dependant’s pension annuity: with these, if you die, a dependant, spouse or legal partner will be able to receive your pension income. It’s important to keep in mind that this will reduce the income you receive while alive.

Fixed term annuity: this annuity plan is set for a fixed term, paying out a regular income for an agreed number of years. After the term is over, you can decide what you want to do with the remainder of your pension pot.

Guaranteed annuity rate (GAR): this is a guarantee ensuring a specific income from your pension providers’ lifetime annuity plan.

Investment linked annuity: this annuity will pay an income for life, but it is not a fixed amount, as they rise and fall based on investment return. The amount of income you receive is based on the investment value at point of annuitising.

Lifetime allowance: this is the maximum you can save into a pension without paying excess charges.

Open market option: this is the choice available to move your pension pot to another provider or scheme. People may do this to receive a higher income than their current provider offers or to find benefits that are more suitable for their circumstances and needs.

This is also used to consider higher income due to health and lifestyle issues. Often known as an enhanced annuity.

State pension age: this is the age you become eligible for your State Pension. This can vary, so it is best to check using the government website.

For any more questions, guidance and advice, or to discuss your retirement and pension, get in touch or call 0121 285 8528 to chat with one of our advisors.

 

Picture sources: 

https://unsplash.com/photos/5OUMf1Mr5pU

https://unsplash.com/photos/eIkbSc3SDtI