A financially secure future
Recent years have witnessed growing concerns over the number of individuals who are failing to save sufficiently to be able to retire when they would like to. Changes proposed from 6 April 2015 intend to bring flexibility to the options available at retirement. However, with the UK facing ongoing economic challenges, and many pension schemes remaining underfunded, it is essential to ensure that you take appropriate action ahead of time.
While retirement may not currently be high on your priority list, you should take steps now to ensure that you will have the freedom and the means to achieve a comfortable retirement when the time comes. You could spend a third of your life as a retired person, and by taking action now, you can help to make this period as financially secure as possible.
A strategy for retirement
Your retirement planning strategy will be determined by a number of factors, including your age and the number of years before retirement. However, there are some other key issues to consider:
- Do you have a company pension scheme?
- Are you self-employed?
- How much can you invest for your retirement?
- How much state pension will you receive?
You can request a State Pension statement (formerly known as a State Pension forecast) by logging on to the Gov UK website: www.gov.uk/browse/working/state-pension.
The basic state pension is worth £5,881 a year for a single person in 2014/15 and double this amount if you're married, and both you and your partner have built up State Pension.
The overall lifetime limit on tax-advantaged pension funds is £1.25m. There is a tax charge for fund values in excess of the 'lifetime allowance' at retirement, and for excess contributions or increases (set at £40,000 in a pension input period (PIP) ending in 2014/15).
Company pension schemes
There are two kinds of company pension scheme, into which you and your employer may make contributions. A defined benefit scheme pays a retirement income related to the amount of your earnings, while a defined contribution scheme instead reflects the amount invested and the underlying investment fund performance. In both cases, you will have access to tax-free cash as well as to the actual pension.
The impact of the early-noughties stock market downturn was one key factor that resulted in many final salary schemes being underfunded and a decision was taken by many firms to close such defined benefit schemes. Many experts consider that this type of scheme will cease to exist over the next few years, as a result of the current situation. Where companies do provide company pensions these are now almost always defined contribution schemes.
The amount of personal contributions that can qualify for tax relief is limited to the greater of £3,600 and total UK relevant earnings, subject to scheme rules.
The new pensions auto-enrolment regime
In order to encourage more people to save for their retirement, the Government is introducing compulsory workplace pensions for eligible workers. The changes are being phased in.
All employers will have to enrol automatically all eligible workers into a qualifying pension scheme or NEST (National Employment Savings Trust), a simple low-cost, opt-out pension scheme that is being introduced by the Government.
There will ultimately be a minimum overall contribution rate of 8% of each employee's qualifying earnings, of which at least 3% must come from the employer. The balance is made up of employees' contributions and associated tax relief.
Those employees with, or considering, lifetime allowance protection may wish to think about opting out of auto-enrolment to avoid the protection being invalidated by further pension contributions.
If you are not in a company scheme, you should make your own arrangements, since relying on the state pension is already questionable and will become more so with each passing year.
In response to poor performances from pension fund managers, some retirement savers have switched their pension savings into Self Invested Personal Pension policies (SIPPs) - a form of personal pension plan which gives the investor more control over how the funds are invested.
To qualify for income tax relief, investments in personal pensions are limited to the greater of £3,600 and the amount of your UK relevant earnings, but subject also to the annual allowance (£40,000 for 2014/15) in all years. The annual allowance was £50,000 for 2013/14 and earlier years.
Where pension savings in any of the last three years' PIPs were less than £50,000, the 'unused relief' is brought forward, but you must have been a pension scheme member during a tax year to bring forward unused relief from that year. The unused relief for any particular year must be used within three years.
Case Study 1
Steve invested £20,000 in his pension policy in the PIP ending in 2011/12, £45,000 in the 2012/13 PIP and £20,000 in the 2013/14 PIP.
He can carry forward to 2014/15 £30,000 of unused relief from 2011/12, £5,000 from 2012/13 and £30,000 from 2013/14 (total £65,000).
Steve's maximum pension investment is therefore set at £105,000 (£40,000 plus £65,000) for his 2014/15 PIP. He needs to make a pension contribution of £70,000 (current year allowance £40,000 and £30,000 unused relief from 2011/12) in order to avoid the loss of the relief brought forward from 2011/12.
Note that the effect of the annual allowance charge will claw back all tax relief on premiums in excess of the maximum. Where the charge exceeds £2,000, arrangements can be made for the charge to be paid by the pension trustees and recovered by adjustment to policy benefits.
Where pension savings exceed the £1.25m lifetime allowance at retirement (and fixed, primary or enhanced protection is not available) a tax charge arises:
- Tax charge (excess paid as annuity) - 25% on excess value, then up to 45% on annuity
- Tax charge (excess paid as lump sum) - 55% on excess value
Case Study 2
Becky will earn £60,000 in 2014/15. She will invest £12,500 into her personal pension policy. She is entitled to the basic personal allowance and has no other income.
Becky will pay her pension provider a premium, net of basic rate tax relief of £10,000. She is also entitled to higher rate tax relief on the gross premium, amounting to £2,500.
As Becky is an employee, we can ask HMRC to give the relief through her PAYE code. Otherwise, we would claim in Becky's 2015 Tax Return. Thus the net cost to Becky of a £12,500 contribution to her pension policy is just £7,500.
Stakeholder pension policy providers are required to accept premiums of a minimum of £20 per month, although some will accept less.
Providers must meet a number of 'standards', including a cap on charges - for new policies of 1.5% per annum for the first ten years, then 1%. Additional premiums are subject to the same rules as for personal pension policies. Stakeholder premiums can be paid on behalf of another person - for example, by a grandparent for an infant grandchild.
Unlike personal pension providers, most retirement annuity providers - personal pension schemes set up before July 1988 - do not offer a 'relief at source' scheme and they claim back tax at the basic rate.
Instead we claim the tax relief you are due through your self assessment Tax Return, or if you do not complete a Tax Return by contacting HMRC on your behalf.
Some alternative options
Although they might not suit everyone, there are at least two ways to boost your retirement finances, through your home. The first option is down-sizing - selling your current home and buying something cheaper, to release value tied up in your property for other purposes. 'Equity release' might be an alternative approach. However, you should discuss all of the implications with us and your other financial advisers before deciding whether this is a suitable avenue to take.