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With a vast range of options available, the pension arena can be bewildering. The decisions and choices you make will affect the income you receive when you do reach retirement. It is essential, therefore, to take into account your needs and objectives and to receive expert advice in this complex area.
Pension Simplification
On the 6th April 2006 major changes were introduced to the structure of UK Pension schemes. These changes heralded probably the most radical overhaul of the UKs' Pension tax regime. The new simplified regime was largely a replacement of the past pension framework as opposed to the addition of another layer of legislation. Many changes were introduced, some of the main ones are as follows:-
Introduction of a Lifetime allowance
Each member of a pension scheme has a maximum permitted tax-exempt fund at retirement. This lifetime allowance is currently set at £1.25 million in (2014/2015 tax year)
Contributions & The Annual Allowance
There is an annual pension input allowance, (known as the Annual Allowance) set at £40,000 (2014/2015 tax year), for all pension schemes. An individual can now contribute up to 100% of their earnings or £3,600 whichever is the greater.
Pension Commencement Lump Sum (Tax free Cash)
The maximum pension commencement lump sum (Tax Free Cash) from any pension arrangement is 25% of the value of the pension rights or the available lifetime allowance, whichever is the lower.
However in some cases prior to pensions simplification, members may have built up the rights to a lump sum greater than 25%. If this is the case, these members can apply to protect these benefits. This is a complex area of pensions advice and consultation with an advisor would be highly recommended.
Retirement Age
The concept of a normal retirement age is less definite than it was in the past. Members of pension schemes can choose (within certain age ranges) when to take their benefits, making the process of retiring more flexible. The minimum age for drawing benefits rose to 55 years with affect from 6th April 2010. The different options at retirement are featured below and covered in more detail on the Annities, Pension Fund Withdrawal and Phased Retirement pages.
Death Benefits
The maximum lump sum death benefit is simply equal to the lifetime allowance, so this is currently £1.25 million.
(There are transitional provisions made in respect to some of these key areas of planning and in respect to overfunding the government have introduced some tax charges.)
Drawing your pension
Retirement income is now classified under 3 main headings:-
1) Scheme Pensions - typically, drawing your income directly from your employers occupational pension scheme.
2) Lifetime annuities - taking your income as an annuity. Commonly associated with drawing income from Personal pension / Stakeholder pension type schemes
3) Capped drawdown - Pension Fund Withdrawal / Income Drawdown and Phased retirement
Above is an overview of some of the headline changes to Pension legislation over recent years. More current are the changes that were introduced by the Finance Act effective from 6 April 2011, changing the amount that can be drawn from an income drawdown plan. The requirement to purchase an annuity at the age of 75 has been removed, and an individual will be able to continue in drawdown for their lifetime. This means it is possible to defer purchasing a pension annuity until the member is older or in poor health when annuity rates and the pension fund value could be higher.
The new rules are quite detailed and will effect different people in different ways, so to obtain further information or see how the new changes have affected you please contact us.
A PENSION IS A LONG TERM INVESTMENT THE FUND VALUE MAY FLUCTUATE AND CAN GO DOWN. YOUR EVENTUAL INCOME MAY DEPEND ON THE SIZE OF THE FUND AT RETIREMENT, FUTURE INTEREST RATES, AND TAX LEGISLATION
Personal Pensions
Personal Pension Plans (PPPs) were originally designed for the millions of employed & self-employed individuals who did not have access to a company pension scheme.
Introduced in July 1988, they were part of a government push to extend pension choice & encourage those people not in company schemes to build up a retirement fund; one that could cater for their retirement needs more realistically than the state. Many financial institutions offer PPPs, though most are run by the large insurance companies and banks.
We can research the market on your behalf to find a suitable Pension plan, it may be that a PPP meets your needs for retirement provision. These contracts are very flexible and can allow tax relievable contributions to be made of up to 100% of your earnings or £3,600 (whichever is the greater) subject to a maximum of £40,000 per annum which is the current annual allowance. Furthermore these plans can be set up for non-working spouses and even children and grandchildren.
How they work
Unlike some company schemes, all personal pensions work on a 'money purchase' basis. This means that the money you save each month or each year into your Personal pension plan is invested (typically in investment funds) and is then used at retirement to provide you with pension benefits. So in theory the more you save the better your pension should be at retirement.
At Retirement
On reaching retirement, you use the money that has built up in your personal pension to purchase pension benefits, these benefits can be taken in the form of either income only or income with a tax free lump sum (The Pension Commencement lump sum). Alternatively the benefits can be transferred to another type of plan which provides a drawdown facility (see the section on Capped and Flexible Drawdown). These types of plan allow additional flexibility in that pension benefits can be drawn whilst your pension fund remains invested.
The value of your pension at retirement is mainly dependent upon:
* How much money you've paid in over the life of the plan
* How well the fund has performed
* The annuity rate that the provider applies to your pension fund (if you choose to take an annuity)
* level of Pension Commencement lump sum taken. (Up to a maximum of 25% of your pension fund)
So a Personal Pension Plan is really just a long term savings plan (albeit a very tax efficient one) that is designed to produce a fund at retirement.
At retirement, provision can be made to protect your pension from the effects of inflation, protect your income in the event of your death, and make provision for your spouse or dependants. (see the Annuities page). Benefits can currently be drawn from age 55 onwards.
A PENSION IS A LONG TERM INVESTMENT THE FUND VALUE MAY FLUCTUATE AND CAN GO DOWN. YOUR EVENTUAL INCOME MAY DEPEND ON THE SIZE OF THE FUND AT RETIREMENT, FUTURE INTEREST RATES, AND TAX LEGISLATION
Stakeholder Pensions
A Stakeholder pension is a form of low cost Personal pension aimed at encouraging those people who do not currently have pension provision to save for their retirement. They became available on 6th April 2001. They are not a form of state pension.
In order to reach as wide an audience as possible, Stakeholder pension schemes are intended to be flexible and easy to understand. Employers with 5 or more employees have had an obligation to provide their employees with access to a stakeholder pension scheme since 8th October 2001, although it is not compulsory to save for retirement with a Stakeholder Pension plan or any other savings related product.
Stakeholder pension plans are privately managed and funded but must operate within a standard framework laid down by the Government.
Stakeholder Pension plans are very similar to Personal Pension plans; they are individual pension arrangements, meaning that they are personal and portable - you can take them with you if you change jobs.
We can research the market on your behalf to find a suitable Stakeholder Pension plan, it may be that a Stakeholder Pension plan meets your needs for retirement provision. Following the recent sweeping changes made on the 6th April 2006 to pension legislation (see section on Pension simplification) these contracts are very flexible and can allow contributions to be made of up to 100% of your earnings. Furthermore these plans can be set up for non-working spouses and even children and grandchildren where up to £3600 can be invested annually.
An important aspect of the 'no penalties' rule in relation to these types of pension plan is that you don't have to delay starting a plan until you find the right provider. You can start a plan straight away. If the provider doesn't perform as well as you expect, you can simply take your fund and transfer it to another provider, without penalty. Another big plus for Stakeholder pensions is that providers must allow a minimum premium of £20. This provides much needed flexibility compared to other Pension contracts where minimum premiums may be higher; furthermore there is flexibility to stop and start contributions with unlimited frequency.
Company Pensions
Employers' pension schemes, Superannuation, Occupational schemes - defined benefit schemes / defined contribution schemes, Company pensions....... all refer to Employer related pension schemes.
A good proportion of the UK's working population are members of a company pension scheme. Occupational pension schemes are those run by your current or former employer/s. These come in two basic types: defined benefit, where the benefits paid in retirement may be based on a combination of your age, length of service and the pensionable salary you are paid just before you retire - your final salary; defined contribution, also known as money purchase, which will pay out an amount based on the size of the fund, into which your contributions have been invested, at retirement.
Group Personal Pensions are becoming more popular with employers, these are low cost personal pension plans bought by groups of employees under the auspices of their employer. The latter are personal pension schemes organised as a group to share lower costs of administration. (See section on Personal Pensions)
Your employer may make a contribution to your occupational pension scheme in addition to deducting a percentage of your salary and paying it into the scheme. You may make extra contributions to your occupational scheme to boost your pension provision up to a maximum limit (annual allowance), tax relief is available on pension contributions of up to 100% of your taxable earnings. (You may contribute more than your taxable earnings but no tax relief will be given on payments above that amount).
Eligibility
Eligibility to join a company scheme varies from company to company. Some allow their employees to join either straight away or very soon after joining the company, whilst others put in place conditions before an employee can join, such as a minimum 2 years of service, or upon reaching a certain age.
The two main types
There are two main types of company scheme, final salary & money purchase . They differ greatly in what they offer and how they work. At present, final salary schemes are the most common in terms of number of members, but many large firms are now switching over to the money purchase type because they are cheaper for the employer to fund .
Annuities
Annuities are used to provide a pension income, in the case of pensions this income is guaranteed for life. The pension fund is exchanged for a pension income. Once the annuity has been bought, the income is fixed, the contract cannot be reversed - the pension fund becomes the permanent property of the annuity provider.
The level of income that you will receive from an annuity depends upon several main factors:
- The level of Investment
- Age of 'annuitant'
- Health
- Gender Genre
- The prevailing annuity rates at the point of annuity purchase
In general, the older an annuitant the higher the income which can be secured. Furthermore males usually receive a higher income than females due to generally have a shorter life expectancy.
However a new european wide law could prevent providers from discriminating by gender in the future.
How they work...
Annuities, in the main, are supplied by Life Assurance Companies. The underlying 'annuity fund' is usually invested in fixed interest investments, such as long term government gilts in order to maintain the guaranteed income and ensure regular income payments are made to annuitants.
Annuities can be set up to provide different benefits / options:-
- Spouses pension (to protect a spouse, by providing an income, following the death of the annuitant)
- Guaranteed payment periods; 5 years is typical but 10 year guarantees are possible
- Escalation of benefits; income can be protected from inflation - RPI linked escalation, alternatively a fixed % annual increase in income can be secured at outset e.g. 5%.
Annuity income can be linked to investment performance for example by a 'With Profit Annuity' or 'Unit Linked Annuity'
Annuities: The options available
It's important to understand the options available to you when you buy an annuity. Like all things, there are pros and cons to each. Which option suits you depends upon your circumstances and attitude to risk.
Level Annuity
Income will not increase in payment. It provides the annuitant with the highest attainable income from outset compared to other options. However, as time goes by and inflation sets in, the value of the pension, in real terms, decreases. In the case of someone who retires early and then lives a long time, this reduction in 'buying power' could be considerable.
Joint-Life Basis
With this option, either a full or reduced income will continue to be paid to the partner if the annuitant dies. Because women tend to live longer than men, a wife several years younger than her husband could reduce the income payment offered at outset significantly. Joint life annuities are usually taken out by married couples, especially when the spouse has no other independent pension income.
Guaranteed Annuity
It is possible to ensure that the income to be paid is guaranteed at a set level for a period of time after the death of the annuitant. Typical guarantee periods may be 5 or 10 years. This option will almost certainly reduce the starting income.
If the annuity is on a joint-life basis and both parties die within the guarantee period, the payments will continue to be paid to the deceased annuitant's estate.
Escalating Annuity
These provide an income that will increase annually at a predetermined rate, or sometimes in line with the retail price index. The advantage of this is the income provides some protection against inflation. However, the initial starting income will be reduced in comparison to a level annuity.
With or without overlap
Applicable when a joint life guaranteed pension has been chosen. With overlap, the spouse/dependent's pension will commence immediately upon the annuitant's death. Without overlap, the pension will commence at the end of the guaranteed period or immediately upon the annuitant's death, whichever occurs latest.
With Profits & Unitised Annuities
Traditional annuities provide a guaranteed income; however, there are other types now available, namely With Profits & Unitised Annuities. They differ from traditional types in as much as the guaranteed element is either reduced or taken away altogether in exchange for the possibility of increased income in the long term.
In respect to a with-profits annuity, a low guaranteed income level is initially secured and then an annual bonus is payable from the (linked) with-profits fund. The level of income therefore fluctuates from year to year and is dependent upon the success or otherwise of the With Profits fund.
Under a unit linked annuity, no guarantees are provided. The income received is dependent upon the underlying performance of the linked fund/s, which will undoubtedly fluctuate over time. With favourable market conditions, a unit linked annuity may, in the long term, produce income that exceeds that of a traditional level or escalating annuity. The problem is that the reverse is also true; adverse conditions may seriously affect the value of a pension income.
Since April 2011 investors have the freedom to choose when and how they take their pension with the compulsory annuity age of 75 being withdrawn.
Phased Retirement
If you intend to ease yourself into retirement gradually, then you might want to consider phasing your retirement. On a regular basis, usually annually, you can use part of your pension pot to provide a taxable income, or take a tax-free cash lump sum and reduced income. Your income can be provided either by buying an annuity, or by income drawdown.
Phased retirement, (also known as 'staggered vesting'), allows the purchase of a pension to be phased, thereby allowing flexibility when considering retirement.
Each year the level of required pension income is determined, this subsequently determines the number of segments which must be encashed to meet the income need. The annual pension income is composed of a combination of tax free cash and annuity from the individual segments. The remainder of the fund remains invested and may benefit from any market growth in its underlying investments.
These plans are available up to the plan holders 75th birthday, at which point the remaining segments must be converted into either pension annuity income or transferred to an Alternatively Secured Pension plan.
Phased retirement plans tend to carry higher management charges and due to their nature are usually only considered suitable for clients holding pension assets in excess of £100,000. One other drawback of these types of plan is that the Pension Commencement Lump Sum (tax free cash) is not available on vesting the pension benefits into the Phased plan. The tax free part of the encashed segments form part of the annual pension income. (Any remaining tax free lump sum is not available until the final vesting of the remaining segments).
the option of what type of benefit to include upon death is made each time an annuity is purchased. The remaining fund (i.e the part not vested) can be paid on death as a tax free lump sum to a nominated beneficiary.
Phased Retirement plans are relatively complex and are not suitable for everyone, but they can for some individuals offer a flexible approach to retirement. Careful consideration must be given to an individual's personal circumstances, including the value of their existing pension/s. We strongly recommend advice from us be sought if you are considering this option.
Pensions Fund Withdrawal
Pension fund withdrawal (also known as Income drawdown) is an important retirement option worth considering, particularly for individuals who have pension capital of at least £100,000.
Pension Fund Withdrawal plans were introduced following changes to Pension law in 1995. The changes removed the previous requirement to purchase an annuity at retirement. Pension Fund Withdrawal allows an income to be taken directly from the pension fund itself.
Pension Fund Withdrawal enhances the flexibility in that annuity purchase can be deferred until a time when it may be more suitable. Most of the major insurance companies now offer 'Income drawdown' plans. These plans still allow up to 25% of the retirement fund to be taken as Tax Free Cash.
Under Pension Fund Withdrawal there are now two options, Capped Drawdown or Flexible Drawdown.
Capped Drawdown
With capped Drawdown you can elect to take a tax free lump sum and rather than buy an annuity leave the fund invested to continue growing tax free.
An annual income can be taken from the fund if required. However a maximum level is set by the Governments Actuary Department (GAD) based on the size of the fund, age, sex and current gilt yields. These GAD tables are broadly equivalent to a single life annuity that you could have purchased. The maximum income can be no more 100% of the GAD rate. This GAD rate will be reviewed every 3 years.
There is no minimum income limit so an annuity does not need to be purchased so funds can remain invested until death. Upon death the residual fund can be taken as a lump sum with a 55% tax charge or the fund can be used to buy an annuity for the nominated beneficiary or they can continue to undertake drawdown until their death.
Flexible Drawdown
Flexible drawdown was introduced from April 2011, allowing individuals to take as much income as required from the pension fund from age 55, whilst keeping any remaining fund invested. However it is possible that the whole fund could be utilised as income, subject to a personal tax liability, and on the basis that flexible drawdown is only available to individuals who have other secure pension income from other sources amounting to £20,000 a year (this can include state pensions).
This minimum income requirement (MIR) will be reviewed every five years although there will no further test of the MIR once flexible drawdown has been opted for.
Upon death any remaining fund in flexible drawdown would be subject to a tax charge of 55% if paid to a named beneficiary otherwise the fund would pass to a nominated charity.
Flexible drawdown could be suitable for individuals who have no need to guarantee any further income because they already have pensions of at least £20,000 a year. Given the nature of the facility that this type of drawdown offers the inherent risks would mean that any individual considering this type of drawdown needs to be relatively sophisticated in understanding the implications.
A pension is a long term investment. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation. We strongly recommend advice from us be sought if you are considering this option.
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