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Some of the most common questions we’re asked are about pensions: “At what age can I take my pension?” and “How much money do I need to retire?” are typical. It’s understandable. Many people think pensions are complicated and involved – but while there are complex elements around them, fundamentally a pension is a simple financial product. So here we’ll try to answer a few of the more basic questions, and give you an idea of how your pension might work for you.
What types of pension are there?
At its heart, a pension is just a pot of cash that you – and in most cases your employer – can pay into to save for your retirement. Best of all, you get tax relief on your pension contributions; which means that, with your employer and the government adding to the pot it’s well worth having one.
There are many different pensions out there, but there are three basic types that cover most people’s retirement plans:
The State Pension – most people will qualify for a state pension, which is paid by the government and a secure income for life. How much you receive is based on the amount of National Insurance contributions you’ve made during your working life.
Defined benefit pensions – if you worked in the public sector or for a large company you might have one of these. They’re salary-related (either final salary or career average), and pay out a secure income for life.
Defined contribution pensions – also known as money purchase schemes, these build up a pension pot from which you draw your retirement income. The amount that builds up will depend on the charges you pay, how well your investment performs and how much you or your employer pay in.
Whichever type of pension scheme you have – defined benefit or defined contribution – the current rules mean you can usually start taking money from it from age 55 (the Government has said this will rise to 58 from 2028, which might affect your retirement plans). If you’re in poor health or in a profession where retirement is a lot earlier (such as a professional athlete), you may be able to start even earlier.
How much can I pay in?
Essentially, the more you can afford to pay in (and the earlier you can pay it), the more comfortable retirement you’ll have. Workplace pensions have minimum contribution levels, and there are rules on how much you can get tax relief on.
There are three limits to getting tax relief.
The earnings limit gives you relief on pension contributions up to the amount you earn each year; that may sound a lot, but if, for example, you’re a company director paid mainly in dividends rather than salary, it can be quite easy to reach that limit quickly.
The annual limit is aimed at higher earners, and offers tax relief up to your yearly allowance (currently £40,000) and any unused allowance from the previous three tax years. Since the 2020 budget, anyone whose total income, pension contributions and employer pension contributions are over £240,000 in a year will get a reduced allowance – for every £2 of ‘adjusted income’ that goes over £240,000, the annual allowance for that year reduces by £1. So if you earn a total income of £300,000 or more you’ll only get £4,000 tax relief annually.
The lifetime allowance is based on your total pension savings (including gains/interest), and if they exceed £1,078,900 you’ll face a tax charge.
Money contributed by someone else, such as your employer, counts towards all these allowances; you can always pay more into your pension too, but you’ll only get tax relief up to the maximum amounts shown.
Can I take money from my pension pot early?
As we said earlier, you can usually start taking your pension at 55, or in some cases earlier. You can also take an amount in tax-free cash, depending on what type of pension you have.
Defined benefits schemes generally allow you to take a pension and cash sum, both at the same time; a defined contribution scheme allows you to take some or all of your pension pot as a cash lump sum. As long as you don’t take more than 25% of your benefits or pot as cash, you won’t pay any tax; anything over that will be treated as income, and taxed accordingly.
You can also carry on working while you’re taking a pension, which can be useful in providing a quick cash boost to pay off a mortgage, clear debts or help cut your working hours, but taking money out of your pension early also reduces the amount of time it has to increase, which will reduce your future earnings, or it may even push you into a higher income tax band.
How much do I need to retire?
How quickly you can retire depends on how much you have in your pension pot, as you’ll be relying on it for the rest of your life – the more you have in, the more comfortable lifestyle you can have for longer, whether that’s through buying an annuity to provide an income or through managing your own investments.
In terms of how much that needs to be, a recent study by state-backed pension provider NEST (National Employment Savings Trust) found that to enjoy your later years in comfort you’ll need an annual income of around £15,000. Less than that may mean a fall in living standards, and above that will give you disposable income for trips away, meals out and so on.
If you’re planning your pension, a general rule of thumb is to aim to have up to 10 times your average working-life salary in your pension pot – so if your average salary is £30,000, your pot should be around £300,000 when you retire. That would mean saving about 12.5% of your monthly salary.
What help can I get in planning my pension?
With so many variables and tax rules to consider, it’s important that you have the right plan in place to cover what you’ll need in retirement, and make the most of the tax breaks on offer. That’s where a good Financial Adviser can help.
Seeking pension advice from someone like Slater Financial means you can find the latest, most cost-effective plans currently available, and you should review your pension arrangements every year to make sure you’re not paying too much in charges, or better performing funds. Or if you’re approaching retirement, Slater can help find the best way to secure the level of income you need from your pension pot.
Either way, getting the right advice as early as possible can make a difference of thousands to your pension pot – and give you the retirement you deserve.
Slater Financial will undertake a free 90-minute review of your current pension provisions and the options available, call us on 01298 212444 or email email@example.com to make an appointment.