Why is Retirement Planning Important?
As the nation’s average life expectancy continues to rise, planning for retirement is becoming increasingly important. The vast majority of individuals will rely on a pension to provide them with sufficient income after they retire. As the time spent in retirement increases, the value pension pots will also have to increase to accommodate this.
It is a common misconception that the government ‘State Pension’ will be able to provide you with enough income during your retirement. As of tax year 2020/21, the maximum State Pension will provide you with £175.20 per week (around £9,100. Per annum). For most people, this level of income is below their current living costs and in turn, must be supplemented with additional savings. As state benefits will inevitably be diluted within the retired population in the coming years, the real value of the state pension will fall over time. For retirees, the additional retirement income required will probably be supplied from personal pension funds.
Pension Tax Relief & Benefits
Whether you are self-employed, employed in a small business, a civil servant or an employee of a multinational company, it is now clear that it is down to you as an individual to fund for your retirement. Pensions offer a uniquely tax efficient method of saving for your retirement. There are a number of benefits to saving into a pension fund however, the most prominent benefits are:
Contributions paid into private pension can receive tax relief worth up to 100% of your annual earnings. Tax relief on pension contributions is offered at the same rates as the marginal income tax bands. i.e. If you currently pay 20% income tax on your earnings, you will be eligible to receive 20% tax relief on your pension contributions. Higher and additional rate tax payers can claim a further 20% & 25% on their contributions respectively, though this will have to be claimed on a self-assessment tax return.
In addition to pension contribution tax relief; investment growth within a pension fund is completely capital gains & income tax free, in a similar fashion to an ISA. This is hugely beneficial as it allows the funds held within the pension to ‘compound’ each year, which increases investment returns.
Up to 25% of the capital value of the fund can be taken cash free when you come to withdraw benefits. This is known as a, ‘Pension Commencement Lump Sum’ or PCLS.
How Does the Government Affect Pension Saving?
Despite the taxation advantages listed above, many people save very little towards their retirement. One of the common reasons for this, is that most people find pensions complex and difficult to understand. As an attempt to improve the general understanding of pensions and how to access your pension benefits, the government created the website, ‘Pension Wise’. This website offers free and impartial guidance about your pension options and even allows pension holders to book free appointments to discuss their queries. It is recommended to visit the website if you have any questions or general confusion regarding your options.
In order to encourage greater participation in pension planning, the government introduced Auto Enrolment legislation which came into effect in 2012. This legislation ensures that every eligible worker employed by a UK company (where an equivalent scheme does not already exist) will be automatically enrolled into a suitable pension scheme and both the employee and employer will have to make contributions into a personal pension funds.
Pension Flexibilities – A Wider Range Options
In April 2014 the government also announced the introduction of ‘pension flexibilities’ which increased the ways in which pension income may be purchased at retirement. These changes came into effect from 2015, and although this recent relaxation of the pension rules is welcome, there is now an even greater need for financial advice given the increased choice now available to pensioners.
As a result of ‘pension flexibilities’, when you finally come to claim your pension benefits, usually after you stop working, you now have a multitude of different ways to access your fund. Defined benefit (final salary) schemes offer a guaranteed income for life similar to a lifetime annuity however, as they are becoming increasingly rare, we will primarily focus on the options available to defined contribution (money purchase) and personal pension schemes. Your options for defined contribution & personal pensions include:
- Taking some or all of your pension pot as a lump sum. This is sometimes referred to as an ‘Uncrystallised Funds Pension Lump Sum’ or UFPLS for short.
- Purchase an annuity. This option well understood by most and effectively provides the annuity holder with a guaranteed income for life (as we mentioned above). Annuity rates have fallen rapidly over recent years and as a result they are becoming a less suitable option for retirement.
- Withdraw money directly from the fund, leaving the majority invested. This method is referred to as an ‘income drawdown’ and has certainly increased in popularity for pension holders since the ‘flexi-access drawdown’ option was introduced with pension flexibilities in 2015.
- A mixture of these options.
How Could Advice Help?
If these options seem confusing or complicated, you are not alone. Although not mandatory, many people seek advice from a professional financial adviser before taking pension benefits. An adviser can help to explain much of the jargon surrounding pensions, as well as advise you on both pension funding pre-retirement and pension income planning at retirement. In addition to standard retirement planning, an adviser at SIP Wealth Management can also help with more specialist areas of pension advice including:
- Auto Enrolment
- Self-Invested Personal Pensions (SIPP)
- Small Self-Administered Schemes (SSAS)
- Annuity Purchase
- Income Drawdown
- Lifetime Allowance Issues
- At Retirement Options
If you feel you would like to explore any of these options with us, please fill out an enquiry contact form to find out more.