Do I Need Pensions Advice?

Planning for Retirement

Before you can achieve your retirement aspirations, you’ve got to do the hard part: working hard and saving to pay for it all!

In the UK, there are two broad types of pension schemes you might be saving into: defined contribution (money purchase) pensions and defined benefit pensions.

What is a Defined Contribution Pension?

As outlined briefly above, a defined contribution pension is one where the retirement income you receive is defined by the contributions you make during your working life and the underlying performance of the fund(s) you’re invested in, less any fees and charges.

Defined contribution pensions are the most common type of pension in the UK and within this category there are several different types of pension, with three commonly-used ones being:

• Stakeholder pensions
  Stakeholder pensions are perhaps the most flexible arrangement. They have low minimum savings thresholds and you can change how much and how frequently you pay in. Fees and charges are capped by legislation and, if you’re unsure about where you’d like to invest, they offer a ‘default’ fund designed to suit as many people as possible.
• Self-invested personal pensions (SIPPs)
  You get more control over your investments with a SIPP, as well as more choice in the investments you hold. Fees and charges are higher than for stakeholder pensions and a SIPP may have higher minimum savings thresholds and require larger and more regular contributions.
• Occupational / workplace pensions
  Since the arrival of auto-enrolment, most workers now must be enrolled in a workplace pension scheme that both they and their employer pay into. You can opt out if you wish, but you’d be missing out on valuable employer contributions that you won’t get if you’re just making contributions personally to a stakeholder pension or a SIPP.

What is a Defined Benefit Pension?

Defined benefit pensions used to be the most common UK pension scheme, but they’ve since been usurped by defined contribution schemes. While defined benefit pensions are seen as the ‘gold standard’ of pension savings, they’re expensive to provide.

This is because, unlike a defined contribution pension, where your retirement income is defined by the amount you save and the performance of your pension investments, a defined benefit pension is a promise from your employer’s pension fund to pay you an income for the rest of your life, no matter how long that might be.

There’s no ‘pot’ of money with your name on it with a defined benefit pension. While both employer and employee pay into the scheme, ultimately the onus falls on the scheme to pay the pension to the member with no investment risk for the pensioner.

Where Can I Get a Final Salary Pension?

The cost of providing defined benefit pension schemes has resulted in them being phased out; they’re now only really found among the largest private firms or in the public sector.

How Does a Final Salary Pension Work?

There are two types of defined benefit pension scheme:

• Final salary pensions
  A final salary pension is linked to your salary at retirement. You’ll receive an income based on a formula which uses the number of years you’ve been contributing to the scheme; your salary at retirement; and your pension scheme’s accrual rate (the proportion of your earnings you’ll receive for each year spent in the scheme, usually represented as a fraction, e.g. 1/80th)
• Career average pensions
  A career average pension uses the same formula, but rather than basing your pension income on your final salary, it uses an average of your salary across your entire career with the employer behind the pension scheme.

Increase Your Pension by Saving Earlier

The best advice for people wanting to improve their lot in retirement is to start saving as early as possible.

It’s never too early to save into a pension — thanks to the power of compound interest, contributions you make early on in your pension journey are almost more valuable than those you make later, even if the later contributions are larger because you’re earning more.

This is because pension savings you make early will have more time to potentially grow. Many people can also stand to take more pension risk when they’re younger, leading to the possibility of higher returns, because they have longer to make up any losses that tend to be more likely as a result of this riskier investment strategy.

Getting Pension Savings to Work for You…

While we’ve focused so far on the benefits of pensions after you retire, there are also benefits to be had during the accumulation phase also.

Pensions are probably the most tax-efficient savings vehicle out there for the working population. The government tops up your contributions with pension tax relief at your highest marginal rate, while pension investments grow free of capital gains tax and income tax.

Thanks to the pension wrapper that separates a pension from your estate, providing the pension remains invested it’s also free from inheritance tax if you die before taking it and want to pass it down to loved ones.

Furthermore, pension tax relief can reduce your tax bill while you’re still working depending on how you’re making contributions and your current tax position. High earners and company directors are particular beneficiaries of this, as laid out below.

Regain Your Lost Personal Allowance With Pension Contributions

Once you start to earn more than £100,000 per year, your personal allowance (the amount you can earn before having to pay income tax) is whittled down by £1 for every £2 you earn above £100,000.

For the 2019/20 tax year, the personal allowance stands at £12,500 so once you’re earning £125,000 or more you have no personal allowance left and must therefore pay income tax on everything you earn.

It’s here you start to pay a significant amount of tax — almost 60%!

One approved way to reduce your income to below £100,000 is to make pension contributions as these attract tax relief. So for the person earning £126,000 above, if they made a £26,000 pension contribution their tax liability would fall notably because they’d have regained their entire personal allowance.

Company Director? Cut Corporation Tax With Pension Contributions…

If you’re a company director working through your limited company, another way you could potentially save tax is by making contributions via your business and writing them off against your corporation tax bill.

Pension contributions are an allowable business expense for company directors, providing you can meet HMRC’s ‘wholly and exclusively’ test. This means pension contributions can reduce your corporation tax bill, as well as saving on employer’s National Insurance contributions if you make pension contributions in lieu of your normal remuneration.

Most company directors benefit greatly from pension contributions via their limited company because they only tend to pay themselves a small PAYE salary and top up their earnings with dividends for maximum tax efficiency on their income.

You can only pay into your pension each year £40,000 or 100% of qualifying earnings, whichever is lower. This is problematic because dividends don’t count as ‘qualifying earnings’ and so you’re limited in terms of the size of the personal contributions you can make by the size of your PAYE salary.

There’s no such restriction of 100% of qualifying earnings on contributions made through your limited company (although you’re still limited to £40,000 per year), so you can save significantly more into your pension and still receive tax relief by making contributions this way.

Tracking Down Lost Pensions

When it comes to retirement planning, every little helps. That’s why it’s important to know where all of your savings are.

This was easier in the past when the ‘job for life’ was the norm and a person rarely changed jobs during their working life. However, in today’s economy, people have many more jobs over the span of their career and so many of us have multiple pensions in our pasts to consider.

Ask yourself:

• Where are my old pensions?
• How are they performing?
• What am I being charged for them (looking in particular for ‘inactivity fees’ some providers levy if you stop paying in)?
• Are old pensions invested based on my current appetite for risk?

If you’re not sure about the answers to these questions, then it’s time to take a closer look at your old pension schemes to make sure they’re pulling their weight when it comes to getting you the retirement you’re aiming for.

Firstly, you need to find them all. While you can employ an adviser to do this for you, there’s actually a free government pension tracing service you can use for this very purpose.

Once you’ve found all your old pensions, you have a number of different options to consider, such as deciding which pensions to leave alone and which might be ripe for consolidation or transfer.

Pension Consolidation and Pension Transfers

While it’s fairly easy to trace lost pensions from previous jobs yourself, deciding what to do with them is another matter.

Pension Consolidation

Which pensions are worth consolidating into a larger fund that offers you better control, access and ease of management? Which pensions are best left where they are, perhaps because they come with valuable guarantees?

Don’t rush to consolidate all of your pensions into one ‘super pot’.

Some may come with promises such as a guaranteed annuity rate that’s much higher than annuity rates on the market today, or a protected early retirement age, which allows you to retire earlier than most other people.

John Spink
Head of Financial Planning at Drewberry

Another common mistake people make with pension consolidation is automatically transferring smaller pensions into larger ones, simply because the larger ones have a bigger balance. The reality may be that the smaller pension pot has more favourable fees, charges and other terms and so consolidating from a larger pension fund to a smaller one may make more sense.

Pension Transfers

While final salary pensions are rarer today than they once were, there are still many people in the UK who do have one of these pensions. For most people, what will make most sense is leaving their pension where it is so they can enjoy a guaranteed income for the rest of their life without having to take on any investment risk themselves.

A small number of people, however, may benefit from a final salary pension transfer, which sees you give up your final salary pension and all of its guarantees for a lump sum invested in a defined contribution pension instead.

This lump sum is know as a cash equivalent transfer value because it’s the equivalent amount of cash your scheme estimates will be necessary to purchase the same income the scheme would have provided on the open market.

Investment Strategy

As part of our service we’ll devise an investment strategy that works for you.

Everyone needs a personalised investment strategy — you’re very different from your next door neighbour, so it’s no use picking a generic solution off the shelf in the hope it suits you both!

We want to understand your appetite for risk and then mould a solution to you accordingly.

This will take into account your attitude towards risk, your stage of life and your retirement goals and aspirations, ultimately with an aim of achieving those goals without taking too much or too little investment risk for your personal tastes.

Pension Pot Calculator

How much will your pension be worth at retirement?

It’s worth calculating because the final figure may leave a lot to be desired, and the sooner you know about any potential shortfall the better as you can go about boosting contributions.

On the flipside, the calculator can also warn you if you’re going to breach the pension lifetime allowance before retirement, which could result in a hefty tax charge.

The calculator below takes the value of your pension now, your current contribution levels and provides a rough estimate of what your pension might be worth at retirement based on a growth rate of 2%, 4% or 6% per annum.

Your Retirement Options

For most people, a defined benefit pension will be best left where it is, so at retirement your option will be to receive a guaranteed income from the scheme for the rest of your life. This will rise each year in line with inflation and then provide a reduced pension for your spouse / civil partner if you predecease them. All this will happen without you having to take any investment risk.

If you’ve transferred your final salary pension to a defined contribution scheme, or had a defined contribution scheme to start with, your retirement options are different thanks to the pension freedoms. You have two main choices: buying an annuity or entering income drawdown.

What is an Annuity?

An annuity is a guaranteed income for life. You swap all or some of your defined contribution pension savings for this lifelong income.

The main advantage of an annuity is that your pension fund cannot run out. As well as being guaranteed for the rest of your life, it’s 100% backed by the Financial Services Compensation Scheme so if your annuity company goes bust you’ll still receive an income.

There’s no investment risk to you as an individual with an annuity. No matter how the markets perform, your income is secure.

However, annuity rates have been low in recent years thanks to poor yields on government bonds, rising longevity and various other socioeconomic factors. It therefore costs a lot more to buy the same annuity income today than it would have done 20 years ago.

There are many different types of annuity to consider — which one is right for you will depend on your circumstances.

What is Pension Drawdown?

Pension drawdown is a way of drawing on your pension that leaves it invested in the markets, allowing for the possibility of future growth during your retirement.

After the 2015 pension freedoms, legislation made fully flexible drawdown — known from 2015 as flexi-access drawdown to reflect the difference from what came before — available to anyone who wished to use it. Everyone now has access to drawdown and the full range of associated flexibilities that come with it.

You can use your drawdown pension to invest, generating an income to live off. Alternatively, you can create your own programme of lump sum payments as you see fit, or take a mixture of these two approaches.

You’re typically entitled to take up to 25% of your pension pot upfront as a tax-free lump sum, known in the jargon as a pension commencement lump sum (PCLS).

You can take the 25% tax-free cash in one go if you decide to designate your whole pension to drawdown. In which case, 25% of the entire pension pot can be withdrawn as tax-free cash. Alternatively, you can opt to move your pension to drawdown gradually, in which case 25% of each sum you move to drawdown will be tax-free.

Once all or part of your pension pot is in drawdown, you can choose how and when to take a retirement income from the pot.

What’s the Difference Between an Annuity and Drawdown?

Perhaps the biggest difference between pension drawdown and an annuity is the fact that an annuity is guaranteed whereas pension drawdown isn’t.

Your income could run out with drawdown if you take too much, too soon, your investments underperform, you live longer than expected or a combination of any or all of the above occurs. An annuity, on the other hand, will keep paying out regardless for however long you live.

Some people prefer the security of a guaranteed income an annuity provides and want to be safe in the knowledge that their pension will never run out.

Meanwhile, others will be keen for potential investment growth in retirement and want it to be easier to pass down their pension pot to their loved ones. For such people, drawdown may be a better option.

Pension Drawdown Calculator

Use our Pension Income Drawdown Calculator below to work out how long your pension might last in drawdown based on its size at retirement and your desired monthly income. Alternatively, you can use the calculator to work out how much you can take in income each month if you want your pension to last to a certain age.

Pension Legacy Planning: Can I Inherit a Pension?

What happens to your pension when you die is one of the most common questions we get here at Drewberry. Your loved ones can inherit your pension in certain circumstances, although ultimately this depends on whether you’ve started taking your pension (and, if so, how you chose to take it) and your age when you passed way.

What Happens to My Annuity When I Die?

If you bought a single life annuity, one that is based on just your life, then this usually dies with you and your family receive no further benefit from it, even if you haven’t yet received back in income all the money you used to secure the annuity in the first place.

This is unless you bought an annuity with a guarantee period, which will enable your loved ones continue to receive income from your annuity if you die within a set period.

So if you had a 5 year guarantee period and died 3 years into receiving your annuity, your beneficiaries will continue to receive your income for another 2 years, until your guarantee period is over.

If you bought a joint annuity, then your income will be tied to the life of you and another individual, typically your spouse / civil partner. It will pay out for the rest of your life and then, if you predecease your spouse, will pay out for the rest of their life also.

Note that joint annuities typically come with a lower income than a single annuity because with a joint annuity the annuity company anticipates paying out for longer.

What Happens to My Final Salary Pension When I Die?

With a final salary pension, your options are limited as to who can inherit it when you pass away. This is because there’s no ‘pot’ of money with your name on it in a final salary scheme — the pension represents a promise from your employer’s pension scheme to pay you for the rest of your life only.

There is typically a widow’s / survivor’s pension for a surviving spouse / civil partner if you predecease them, which will usually be paid as a proportion of your annual income from the scheme (e.g. 50%). However, besides this, there’s little way to leave your final salary scheme to your loved ones, such as any children you may have.

What Happens to My Drawdown Pension When I Die?

If you have a drawdown pension, then you have more discretion over whom you leave your pot to than with an annuity or a final salary scheme. The way your pension pot will be treated when you die depends largely on the age you are at your death.

Do I Pay Inheritance Tax on an Inherited Pension?

No, you don’t have to pay inheritance tax on pensions in most instances. This is because pensions are usually treated as outside your estate and so aren’t added in with the rest of your assets when your estate is valued for inheritance tax (providing the pension remains in the pension wrapper and hasn’t been withdrawn to a taxable vehicle, such as a bank account).

Do I Pay Income Tax on an Inherited Pension?

If you die before the age of 75, your beneficiaries won’t usually have to pay any tax on an inherited drawdown pension fund regardless of how they choose to take the money.

Your beneficiaries can take the money as one lump sum, continue with drawdown income or buy an annuity — all options will be tax-free providing they do so within 2 years of your death. They don’t have to reach 55, the age at which you get access to your own defined contribution pension, before they start taking it.

If the original pensioner dies after the age of 75, there is tax to pay on an inherited pension drawdown arrangement. Your beneficiaries can still choose to take the drawdown fund as a lump sum, take flexi-access drawdown income or buy an annuity, but each option will be taxed as income at their highest marginal rate.

Pensions Advice and Your Financial Plan

We take a holistic approach and look at your finances in the round. We know that — whatever you might read — there are no shortcuts to building wealth.

Creating financial security takes time and discipline. It also means getting the simple things right, year in and year out. This is the essence of our approach at Drewberry and it’s why we think our fees pay for themselves over time.

If you need personal pension advice please do not hesitate to contact us on 02084327333 or email wealth@drewberry.co.uk.

Your Financial Plan: Build A Better Future

A good financial plan can help you make the right decisions when it comes to your finances. Make the right decisions today to build a more prosperous future.

Good financial planning with clear goals can increase your retirement income by as much as 53%. Old Mutual Redefining Retirement Survey

Why Speak to Us…

We started Drewberry because we were tired of being treated like a number and not getting the service we all deserve when it comes to things as important as planning our finances. Below are just a few reasons why it makes sense to let us help.

• See your financial future
  We use sophisticated financial modelling technology to visually show you your financial future. A living financial plan where you can clearly see what you can achieve depending on the decisions you make — read more
• Achieve the retirement you deserve
  Can afford that dream round-the-world trip? Can you help your children onto the property ladder? We’ll model your goals and build your financial plan to help you achieve them.
• Our expertise saves you time and provides peace of mind
  Organising your pensions, investing your assets, managing risk and making the most of your tax allowances is all taken care of as part of your financial plan.
• We’ve got bargaining power on our side
  This allows us to negotiate better rates for you than dealing with providers yourself.
• You’ll speak to a dedicated expert from start to finish
  You will speak to a named expert with a direct telephone and email. No more automated machines and no more being sent from pillar to post – you’ll have someone to speak to who knows you.
• Benefit from our 5-star service
  We pride ourselves on providing a 5-star service, as can be seen from our 3900 and growing independent client reviews rating us at 4.92 / 5.
• Gain the protection of regulated advice
  You are protected. Where we provide a regulated advice service we are responsible for the decisions we help you make. Doing it yourself or going direct to a provider won’t provide this protection, so you won’t benefit from these securities.