Getting your pensions and retirement savings in order is key to making sure you get the most out of your retirement years.
But increasingly complex pension rules can leave some savers feeling bewildered. Not to mention that pensions have changed a lot over the years; the rules they have, the tax breaks you get, how and when you can get your money out, and much more.
It’s hard to be sure if what you know is still correct – here we try to help by considering some of the biggest myths – and what you need to know.
If you retire today in the UK you will receive the New State Pension, which currently pays £185.15 per week at the full amount, which works out at around £9,628 per year (for the 2022/23 tax year). This amount is unlikely to be able to provide much more than an extremely modest standard of living for a single person in the UK. And this is assuming you will receive the full amount of the New State Pension. Whether you will receive the full amount depends on your employment history, and you might find you only qualify for a reduced amount. It is a good idea to check your state pension entitlement with the Government’s state pension forecasting tool.
Since 2015 when the new Pension Freedoms were introduced, it has been possible to access pension pots flexibly with Income Drawdown. This has offered pension savers a more flexible approach to producing a retirement income and has become a popular way of accessing pension pots. At the same time interest in annuities has significantly declined, becoming unpopular for reasons such as limited flexibility and poor rates.
However, annuities can still have an important part to play in retirement planning by proving a risk free guaranteed income. Purchasing a guaranteed income for life in the form of an annuity could be invaluable for many people, even if it only provides part of a retirement solution, and should always be looked at when planning for retirement. There are many different versions of annuities with varying rates as a result, and may be more value for money than first realised.
The amount you can withdraw from your pension pot tax-free is often quoted as being 25%. However, some people with older-style company pension schemes may find that they have a greater amount of protected cash available. Yet many people in these occupational schemes don’t realise or forget that they are eligible for this.
It is always worth enquiring with your pension provider about your pension’s benefits, rather than assuming they are the same as other schemes (even those with the same employer). An adviser can help to clarify your situation and help ensure you don’t lose valuable benefits.
The Lifetime Allowance (currently £1,073,100 for 2022/23) is not, as some believe, an absolute limit on how much you can pay into or have in your pension pot. It is possible to have more than the Lifetime Allowance in a pension pot, but there is likely to be a tax charge when you come to withdraw anything over this limit. The lifetime limit is just in relation to the amount in your pot upon withdrawal, it does not limit how much you can put in.
The amount of tax you pay depends on how you draw the money out of your pension pot and can be 55% on the excess if you draw it as a lump sum or 25% if taken as an income. A good adviser will be able to work out a plan to create a tax-efficient drawdown strategy and possibly avoid the need to pay a Lifetime Allowance charge at all.
Taking benefits from your company pension scheme before the set retirement age may result in a penalty, but it could still be worth it. If you take your benefits early from a defined benefit (or ‘final salary’) scheme, there is often a reduction in the pension income that you receive. However, you would be receiving this lower payment for longer.
This could also have the effect of putting you in a lower tax bracket or bringing your total pension benefits below the lifetime allowance.
However, you may first want to consider what other savings you could access first, such as ISAs or other investments.
If you are planning to retire at your normal retirement age and looking to purchase an annuity then this may be the best option for you.
But, if you are planning to retire in a more flexible way, by working longer or taking a phased retirement, then looking at which default fund your pension is invested in is particularly important. Most default funds shift your money into cash and bonds the closer you get to retirement to avoid any sudden losses. However, this approach is unlikely to be appropriate if you are planning to use income drawdown and remain invested for some or all of your retirement.
With a Defined Benefit style pension, you may be limited to paying a survivor’s pension income to your dependant(s) only. However, with most other pensions you are able to leave your pot to beneficiaries of your choosing, and they do not have to be your partner or children. You should make sure your pension provider knows who you would like to leave your pension to by completing an expression of wishes form. You can name as many beneficiaries as you like, but be aware that the pension scheme trustees usually have ultimate discretion as to who receives your fund.
If you die before age 75, pension benefits can usually be passed on tax-free. Bear in mind that if you take your tax-free lump sum but do not use it before you die, it becomes part of your estate and your beneficiaries might pay inheritance tax on it.
For most people, simply enrolling in your company pension scheme will not be enough for a comfortable retirement. It is quite possible that someone could save for 40 years in work to fund 30 years in retirement, or even longer. So, the amount required by a basic workplace pension may well not be enough, and thought should be given to making sure that you have enough and how best to top your pension up.
Hopefully, this article will help clear up a few of the most common misconceptions around pensions. However, it is a complicated subject and the above list is far from exhaustive when it comes to the mistakes that can be made with pensions. And unfortunately many can be very expensive.
If you would like to discuss your situation with an expert, then many independent financial advisers, such as ourselves, are happy to chat through your situation for no charge or commitment. Seeking financial advice can clarify your retirement strategy, reduce tax liabilities, and ensure your plan is specifically tailored to your individual needs. This should help boost your retirement savings or possibly retire earlier than planned.