Pensions
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Pensions
Guy Layman talks to us about pensions. Podcast recorded in October 2024.
What are my pension options?
We would typically divide the lifetime of a pension between the accumulation phase – where someone is building the fund for retirement, and the decumulation phase – where people are drawing from the fund in retirement.
Within that, there are different options and schemes available. During the accumulation phase, people usually find themselves building a pension with their employer’s scheme, or they might have their own personal pension plan.
An employer’s scheme could fall into different categories. It could be a ‘final salary’ scheme also called a defined benefit (DB), or they could be in a defined contribution scheme (DC).
Schemes like Nest or the People’s Pension, where employers have auto-enrolled the employee, are typically a DC or defined contribution scheme.
What are the most common types of pension and how do they work?
We don’t see a huge amount of final salary or defined benefit schemes anymore, because it relies on the employer making sure there’s enough money in the pot to retain the benefit. It’s a known outcome.
With a defined benefit plan, the employer guarantees a specific amount in retirement based on various factors like salary and number of years’ service. The employer bears the investment risk. For the employee, it’s a predictable, regular income in retirement, typically for the rest of their life. But as I said, we don’t see a huge amount of these and certainly not many new schemes of that type.
We see more defined contribution schemes, where the retirement benefit depends on the contribution and investment performance. The scheme member or employee takes on the risk of that performance. All we know at the start is the amount that’s being contributed into the pension scheme.
Most schemes receive contributions from the employer and the employee. An exception to that is people who are self-employed, who have the ability to influence their own contributions.
The government has set minimum levels for employer/employee contributions, currently at 8%, where 3% comes from the employer. People in the workplace typically have contributions made via pay deductions.
Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.
How does tax work with a pension?
Pensions are by far the most tax efficient savings plan available. Most of us will receive or benefit from some form of tax credit when we make our contributions. Basic rate taxpayers get relief immediately, and higher rate taxpayers can claim further relief to their tax level via their self-assessment.
The type of tax relief available is either known as a Net Pay Arrangement or a Relief at Source payment. It should be quite easy to see the scheme people are in, just by looking at pension deductions on a pay slip. Is it shown before or after tax and NI?
With the Net Pay Arrangement, the employer will take your contribution and the government’s tax relief from your income before tax. Therefore, you don’t pay any tax on the contribution and that’s the immediate benefit.
With Relief at Source, the employer takes your contribution after deducting tax and your pension fund benefits from a grossing up effect. The tax relief from the government is added to the pension plan.
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What about if I’m self-employed?
For people who are self-employed, personal pension plans are typically Relief at Source, which means that any personal pension contribution is grossed up within the pension scheme. Effectively, you’re getting your tax back, which is great, and that’s why they’re such a good product for tax efficiencies and for saving for the long term.
Those who have limited companies will actually benefit from a reduction in their corporation tax liability because of the contribution. So it’s very much a win-win.
How can I access my pension savings?
That’s our decumulation phase. People in a defined benefit or final salary scheme would be offered an income for life. But these schemes are actually quite restrictive. At that retirement age, or a date set by the scheme, they would be offered an income for life or a lump sum and a slightly reduced income for life. But you can’t disassociate the two. If you take an income, you’ve got to have the lump sum and vice versa.
So whilst they’re great because of what they offer, these final salary schemes can be quite limiting, particularly in this day and age where no one really just stops work and does nothing. A lot of people want to mix and match retirement with part-time work.
In 2015, we saw new government Pension Freedoms rules, which gave greater access to personal pension or defined contribution schemes. With modern day schemes, access is available from age 55 – much younger than with some defined benefit schemes.
Pension Freedoms was all about giving people access to their money that they’d saved over their working lifetime, and now you can take that money in different ways.
What are the main options for accessing a pension?
The first option is to buy an annuity, ultimately swapping your pot for an income for life. You would go to a life insurance company and tell them how much is in your pension pot. Based on current rates and some other factors, such as age and health status, they will then confirm the amount they will offer you as a lifetime income.
The second option, which has been the most popular since 2015, is Flexi Access Drawdown. Pensions allow a tax-free lump sum to be withdrawn, and as of today in October 2024, that’s 25%, capped at just over £268,000. That’s entirely tax-free.
Flexi Access Drawdown lets you take that and not take any further benefit from the pension until a later date. You can disassociate your tax-free cash and your income.
The advantage is that if you wish to mix part-time employment with pension income, you can decide what income you take from the pension. That could have a beneficial impact on your tax position, and also make the pot last longer.
So Flexi Access Drawdown is the ability to take some or all of your tax-free cash. Other schemes let you combine some of the tax-free cash with taxable withdrawals – because once you’ve used your tax-free cash, anything else you take from the fund is taxed as income.
Sometimes that’s known as a Cash Out or a Part Cash Out scheme – it’s the ability to mix and match how you draw from the pension plan.
How do I know what my current plan is?
It’s not uncommon for people to have built up different schemes, especially if they’ve moved around over the course of their career.
If you were to engage with an advisor, they would be able to tell you what the type of scheme is. But you should get annual statements for your pensions. If not, you can track old or historic pension schemes on the Government website.
It’s fairly common and popular to amalgamate different schemes where you can. It’s easier to administer and you will have a better understanding of the overall benefits.
Can I review my pension plan?
You can, and almost certainly you should. Some defined contribution schemes pre-2015 don’t adhere to the pension freedoms rules. Pensions are very complicated and they could have lots of different intricacies. Some schemes have protected rights, and might offer slightly greater levels of tax-free cash.
Equally, they may not offer the freedom you might get from a newer, modern-style scheme. A great example is death benefits. Some schemes offer very little death benefits, while others could let you pass the entire pot tax-free to a beneficiary.
So for various different reasons and different motivating factors, everyone should review their pensions for a better understanding of what they’ve got and the benefits and drawbacks of that particular scheme.
What costs are involved with pensions?
As is often the case with financial services, the costs are divided into different sections. As an advisor, we would levy a charge. The initial consultation is at our expense – we wouldn’t charge to meet with someone for a chat to understand their circumstances and see whether we can be helpful.
If we move forward, we agree on a charging structure that seems fair and reasonable, and hopefully everyone would be happy with that.
The pension plan itself will almost certainly be attracting some costs, including platform charges for the online account that holds the money. There could also be fund manager charges. These are disclosed in the statement, but because people are not paying for a service per se, they often don’t appreciate what those costs and charges are.
An advisor like myself would want to understand the benefits, drawbacks, costs, fees and charges really to get a clear view of what’s being paid. Some charges are unavoidable, while others relate to the choices you make about whether you try a self-managed service or whether you engage an advisor.
How can a financial advisor help with pensions?
We have only just scratched the surface about pensions in this conversation. They are incredibly complicated, but they are also the most tax efficient savings plan available in the UK.
They really can offer more than providing an income in retirement. I’ve had pension clients who’ve paid off mortgages, gone on a holiday of a lifetime, and people who’ve used them as a tax-efficient inheritance plan.
With something this complicated and important, I would strongly suggest that everyone take the time to sit down with an advisor. We’re here to help you understand what you’ve got, how it’s benefiting you and how it can help you plan for retirement and the future.
The value of pensions & investments and any income from them can fall as well as rise. You may not get back the amount originally invested.
