As it’s Pension Awareness Week, we thought we’d share everything we think you need to know about pensions! This simple guide explores different types of pensions, allowances, and limits. We also explain the difference between drawdown and buying an annuity.
- How does a pension work?
A pension is a type of savings and investments scheme. You save money each month into a pension plan, and this is invested by the provider. There are different types of pensions, and each plan differs, especially in terms of attitude to risk and how funds are invested. The government provides 20% tax relief to pension payments. So, if you pay £80 per month into a pension, this will be made up to £100 in total contributions.
- What are the different pension allowances?
There are specific tax-related allowances that relate to pensions. Until April 2024, the lifetime allowance will apply for pensions, which is £1,073,100. There is also an annual allowance for pension income. Taxpayers earning less than £260,000 can pay £60,000 per year into their pension tax-free. If you have already started taking money from your pension, your tax-free annual allowance is £10,000 per year.
- What are the different types of pensions?
There are different categories of pension, which relate to who and how they are invested, for example, trust-based vs group pensions. But for most people, you would choose one of the following types of pension:
- State pension – When you reach state pension age, the Government will provide you with a pension, based on your National Insurance contributions (NICs). For guidance, please read our recent blog, Bridging the state pension gap.
- Auto-enrolment – If you are employed, then you’re likely to already be paying into an auto-enrolment workplace pension scheme. You and your employer make a monthly contribution, and at the time of writing, this is a minimum of 8% of your income. You would contribute 5% and your employer would contribute 3%. This is an easy way to ensure you receive some pension income on top of your state pension.
- Defined benefit pension – also known as a final salary pension, this is an increasingly rare type of workplace pension scheme. It provides a guaranteed income for life, based on your average or final salary.
- Private or personal – this type of pension is where you make payments, usually monthly, into a scheme and the money is then invested into a portfolio of funds. You should be able to choose a pension product that reflects your attitude to risk. You can agree when you can access the pension, as long as it’s over the minimum legislative age at the time. At present, this is 55 years, but this will rise to 57 years from 6 April 2028.
- SIPP – this stands for ‘self-invested personal pension’. As above, the money is invested into a portfolio of funds, but you have control over the type of investments.
- SSAS – a ‘small, self-administered pension scheme’ is a type of defined contribution workplace pension. It usually provides more flexibility for investment options.
- How much should you save into your pension?
Put simply, the money you receive from your pension will depend on the amount you have paid in over the years. This is entirely up to you, but as a general calculation, it is recommended to aim for between 10 – 15% of your income each month. The later you start paying into a pension, the more you will need to contribute. So, if you are only paying a small amount each month, your pension could fall short.
- Should you consolidate your pensions?
It’s quite common for people to find themselves with an extra small pension pot. This could be from a workplace pension scheme, for example, where you have left employment. There are different pros and cons for combining your pensions. This will depend on the type of pension, related benefits, and any penalties or transfer fees.If you can save on fees and will gain better access and visibility of your pension, then consolidation could be worth considering. You will need to check whether each pension is suited to your attitude to risk, whether there are any exit penalties, or whether you are likely to lose any valuable benefits. Always seek professional advice before consolidating your pensions in case of any financial pitfalls.
- How can you take money from your pension?
There are two main options for taking income from your pension:
- Drawdown – This allows you to withdraw money from your pension pot, and the remaining sum stays invested, which can go up and down in value. There are different rules that apply, and this will vary depending on your pension.
- Buy an annuity – On purchasing an annuity, you will usually receive a set income for life. Due to the current high-interest rates, this has become a more attractive option for some people.
If you haven’t had a pension review for some time, it’s worth checking whether you are happy with your current scheme. Our financial planners will advise you on how to plan for your retirement including tax-efficient strategies and financial planning solutions.
Get in touch to book a pension review with our financial planning team.