A comfortable retirement
Recently, the Government has introduced changes to greatly increase the choices available to people when it comes to using the money they have saved for retirement. However, if you want to make the most of these options, it is of course vital that you have put aside sufficient funds during your working life.
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.
Basic issues to consider
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 employer pension scheme?
- Are you self-employed?
- How much can you invest for your retirement?
- How much state pension will you receive?
The basic state pension in 2015/16 is £115.95 a week. For a full state pension, it is necessary to have made 30 years of national insurance contributions (NICs). You may also have an entitlement to some additional state pension. To receive a state pension forecast phone the Future Pension Centre on 0845 300 0168.
Individuals due to reach state pension age after 6 April 2016 will receive a flat-rate pension, worth no less than £148.40 per week. Those who reach state pension age before 6 April 2016 will continue to claim their basic state pension (plus any additional state pension that they may be entitled to). However, as this may be worth less than the new flat-rate pension, there will be an opportunity to make additional NICs - please ask us for details.
Employer pension schemes
There are two kinds of employer 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.
In order to encourage more people to save for their retirement, the Government has been gradually phasing in compulsory workplace pensions for eligible workers. Under the scheme, all employers will have to enrol automatically all eligible workers into a qualifying pension scheme.
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.
If you are not in a good employer scheme, you should make your own arrangements, since relying on the state pension will not be adequate for a comfortable retirement.
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. The annual allowance is normally £40,000 but due to changes to the annual allowance system from April 2016, some individuals may escape a tax charge if annual contributions in 2015/16 are below £80,000 and significant contributions were made before 9 July.
Where pension savings in any of the last three years' pension input periods (PIPs) were less than the annual allowance, 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.
From April 2016 the Government will introduce a taper to the annual allowance for those with adjusted annual incomes, including their own and employer's pension contributions, over £150,000. For every £2 of adjusted income over £150,000, an individual's annual allowance will be reduced by £1, down to a minimum of £10,000.
Jason has not made any contribution into his pension policy so far in 2015/16.
Jason has unused annual allowances of £30,000 from 2012/13, £5,000 from 2013/14 and £20,000 from 2014/15 (total £55,000).
Jason's maximum pension investment is therefore set at £95,000 (£40,000 plus £55,000) for his 2015/16 PIP. He needs to make a pension contribution of £70,000 (current year allowance £40,000 and £30,000 unused relief from 2012/13) in order to avoid the loss of the relief brought forward from 2012/13.
If contributions are paid in excess of the annual allowance, a charge - the annual allowance charge - is payable. The effect of the annual allowance charge is to 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.
Applying tax relief to personal pension policies
Premiums on personal pension policies are payable net of basic rate tax relief at source, with any appropriate higher or additional rate relief usually being claimed via the PAYE code or self assessment Tax Return.
Maya will earn £60,000 in 2015/16. She will invest £12,500 into her personal pension policy. She is entitled to the basic personal allowance and has no other income.
Maya 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 Maya is an employee, we can ask HMRC to give the relief through her PAYE code. Otherwise, we would claim in Maya's 2016 Tax Return. Thus the net cost to Maya of a £12,500 contribution to her pension policy is just £7,500.
The lifetime allowance
Where total 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)
Tax charge (excess paid as lump sum)
25% on excess value, then up to 45% on annuity
55% on excess value
Access to personal pension funds
The rules which apply to accessing personal pension funds have been amended from April 2015. These now allow for more flexibility. Taxpayers have always had the option of taking a tax-free lump sum of 25% of the fund value and purchasing an annuity with the remaining fund, or opting for income drawdown where limits generally applied.
An annuity is taxable income in the year of receipt. Similarly any monies received from the income drawdown fund are taxable income in the year of receipt.
From 6 April 2015, the ability to take a tax-free lump sum and a lifetime annuity remains but some of the previous restrictions on a lifetime annuity have been removed, allowing more choice on the type of annuity taken out.
The rules involving drawdown have been changed. There is now total freedom to access a pension fund from the age of 55. Access to the fund may be achieved in one of two ways:
- allocation of a pension fund (or part of a pension fund) into a 'flexi-access drawdown account' from which any amount can be taken over whatever period the person decides
- taking a single or series of lump sums from a pension fund (known as an 'uncrystallised funds pension lump sum').
When an allocation of funds into a flexi-access account is made the member typically will take the opportunity of taking a tax-free lump sum from the fund.
The person will then decide how much or how little to take from the flexi-access account. Any amounts that are taken will count as taxable income in the year of receipt.
Access to some or all of a pension fund without first allocating to a flexi-access account can be achieved by taking an uncrystallised funds pension lump sum.
The tax effect will be:
- 25% is tax-free
- the remainder is taxable as income.
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.
Next steps: contact us to discuss…
- Calculating how much you need to save to ensure you enjoy a comfortable retirement
- Tax-advantaged saving for your pension
- Saving in parallel to provide more readily accessible funds
- Saving in employer and personal pension schemes
- Using your business to help fund your retirement
- Releasing capital now tied up in your home to help fund your retirement