Along with the State Pension from the government, there are 2 main types of pension:
Defined Benefit Scheme
This is a type of workplace pension based on your salary and length of time with your employer. It is also known as ‘final salary’ pension.
This type of scheme gives you a pension income based on your salary, length of service and a calculation made under the rules of your pension scheme.
Defined Contribution Scheme
This is a personal or workplace pension based on how much money has been paid into your pot. It is also known as ‘money purchase’ pension.
Defined contribution pensions include workplace, personal and stakeholder pension schemes.
You may also wish to set up a pension plan if you are self-employed or if you are not working but can afford to put aside money for retirement.
Pension plans are long term investments with the aim to build up a pot in a tax-efficient way to use for your retirement.
You can pay either a regular amount (usually monthly or annually) or a lump sum to the pension provider who will invest it on your behalf. You will receive tax relief on your contributions at your marginal rate of tax. The current Annual Allowance for pension contribution to any type of scheme is £40,000.00 p.a.
When you take money from a defined contribution pension, it comes from the money you (and sometimes your employer) saved into it over the years, plus any investment returns your money may have earned. There is no guaranteed minimum - you could get back less than the amount you paid in.
With defined contribution pensions, you can decide how you take your money out - with defined benefit pensions, your employer guarantees a certain amount each year when you retire.
Your Retirement Options
Once you reach 55 (or younger if you’re in poor health) you have now complete freedom over what to do with your pension pot. However, most people will want to continue building it up for some years after this so they have more money in retirement.
You no longer have to purchase an annuity at all if you do not wish to.
The first of the new options is “Flexi-Access Drawdown” which in essence places no limit on the amount of income you can take from your pension fund.
With this option you take up to 25% of your pension pot (or of the amount you allocate for drawdown as a tax-free lump sum), then re-invest the rest into funds designed to provide you with a regular taxable income. You set the income you want but, unlike a lifetime annuity, your income isn’t guaranteed for life.
Once you’ve taken your tax-free lump sum you can start taking the income right away or wait until a later date.
You can also move your pension pot gradually into income drawdown. You can take up to a quarter of each amount you move from your pot tax-free and place the rest into income drawdown. If you are dependent on your pension pot to support you through your lifetime you may need to consider taking a lower level of income to sustain you. Further, if you spend your pension fund in a way that could be seen as reckless, should you need State assistance in the future this may be declined under the deprivation of assets rule.
Pension Lump Sum
A new option has been introduced by the Government which is called the Uncrystallised Funds Pension Lump Sum (UFPLS). This option is for funds not already in drawdown.
You can use your existing pension pot to take cash as and when you need it and leave the rest untouched where it can continue to grow tax-free. For each cash withdrawal the first 25% is tax-free and the rest counts as taxable income.
You could also close your pension pot and take the whole amount as cash in one go if you wish. The first 25% will be tax-free and the rest will be taxed at your highest tax rate – by adding it to the rest of your income.
There are many risks associated with cashing in your whole pot. For example, it’s highly likely that you’ll be landed with a large tax bill.
New Death Benefit Rules
You can nominate whoever you choose to receive your death benefits. This can be your spouse, children, grandchildren or even someone unrelated to you. You can also leave some or all of your pension fund to charity.
The beneficiaries of your pension fund can elect to take the fund as a lump sum or leave it invested and take an income under the new Flexi-Access Drawdown rules.
If you die before your 75th birthday and your pension funds have been designated to your beneficiaries within two years they will be paid tax-free. They do not however need to take the money out within the two year period.
If you live beyond your 75th birthday, or if you die earlier but your pension funds are not designated within the two year period, then the death benefits will be taxed. The taxation that would normally be applied would be at the beneficiaries’ marginal rate of income tax. The only exception to this rule is that if they choose the lump sum option and this is paid before 6 April 2016, then it will be taxed at 45%.
If your beneficiary has not withdrawn the whole of the pension fund before their subsequent death then the pension funds can be passed on again so your beneficiary will be able to nominate anyone they want the funds to go to following their death.
It is possible to have unlimited successors, so in essence your pension fund could be passed on for generations if it is not all withdrawn.
Of course, you still have the option of purchasing an annuity, which for some people may still be the right choice.
You can choose to take up to 25% of your pot as a one-off tax-free lump sum then convert the rest into a taxable income for life. There are different lifetime annuity options and features to choose from that affect how much income you would get. You can also choose to provide an income for life for a dependant or other beneficiary after you die.
You don’t have to choose one of the above options when deciding how to access your pension – you can mix and match as you like, and take cash and income at different times to suit your needs. You can also keep saving into a pension if you wish, and get tax relief up to age 75.
For more information, please contact us and we will be happy to assist you.