Pension Saving – what’s next?

Approaching retirement? Do things seem more complex than when your parents retired? In short, they are.

Historically, many people worked for the same employer throughout their career and at retirement their employer’s pension scheme paid a pension for life, supplemented by the state pension kicking in at 60 for women and 65 for men.

Today, traditional schemes, known as Defined Benefit (or Final Salary) pensions are becoming rarer with Defined Contribution (or Money Purchase) pensions (where funds are invested over time and converted to an income at retirement) becoming commonplace.

You may have had a varied career, involving membership of several pension schemes, perhaps including a combination of schemes, resulting in several different pensions with different retirement dates from different providers in different locations.

And this is where things can get tricky.

Consolidation

If you have multiple pensions, you may consider consolidation (i.e. transferring them all into a single scheme such as a self-invested personal pension ‘SIPP’). Put simply, consolidation can make it much easier for you to monitor your pension, reduce the charges you pay and potentially increase your return on investments. Importantly, it also means one phone call for your spouse (or beneficiaries), should the worst happen. In reality, consolidation can be much more complicated than this – particularly if you have different types of pensions in different places. Consequently, qualified financial advice should always be sought to ensure it is the right option for you.

Taking your pension

There are two main options with a pension fund: Annuity or Drawdown.

An Annuity involves exchanging your pension fund with an insurance company for an income for life. This may sound straightforward but there are a multitude of options. Do you want your pension to increase each year to help counter inflation? Do you want a pension to be payable to your spouse if you die before them? What you choose will determine how much income you will receive and once a choice has been made, it cannot be changed.

To give you an idea, a 60-year-old with a £200,000 pension fund could receive £12,036p.a. for a non-increasing pension that provides nothing to the spouse on death or £7,480p.a. for one that increases by 5%p.a. and provides 50% to the spouse on death. (These figures are based on UK ‘best buy’ figures, but the actual amount offered may be considerably less.

A concept called ‘Drawdown’ is becoming more common place. This is where your pension fund remains invested, and you withdraw an amount each year as income. Any money left after your death is distributed to your beneficiaries.

The question of how much you take out each year to ensure there will be enough to last your lifetime is almost impossible to answer without knowing your life expectancy, future inflation, and future investment growth. However, an actuarial calculation which considers your age, expected life expectancy, current pension fund value and expected investment returns can suggest a starting income amount. This is revisited every three years and a new income figure suggested if required.

The choice of annuity (guaranteed income but inflexible) or drawdown (no guarantees but flexible) will depend on your circumstances and income requirements, and qualified independent financial advice is always advised.

Pension as a savings plan – an alternative way to think about your pension

Plans for a special holiday, a big life event or a new car?

When it comes to saving for something special later in life (after age 55), the advent of PFS, and the ability to fully encash your pension fund, makes for a tax efficient way of saving for retirement. As an example:

£5,000 per year saved into a PFS pension will attract tax relief at the highest rate (let’s assume 20%). This means an actual cost of only £4,000 (thanks to £1,000 tax relief). After five years, a total of £25,000 is saved, at a cost (after tax relief) of £20,000. Assuming no charges (for the purposes of this example) and ignoring any fund growth (which will be tax free), this can be cashed in after age 55. Of the £25,000, 40% (£10,000) will be tax free. The balance will be taxed at highest rate (assume 20%). The tax charge would be £3,000, meaning a nett return of £22,000: 10% more than was paid in.

So, in short, you get tax relief on the way in, the fund grows tax free (because it’s a pension), and your 40% is tax free on the way out. Something to think about.

Start thinking now

If retirement is on the horizon, it is worth gathering the information on your pensions now, looking at your options and working out your priorities.

Retirement can be considered as the longest holiday of your life. Think about the time you would take to plan a fortnight’s holiday, multiply this by the years you hope to enjoy in retirement, and this will give you an idea of the time you should perhaps spend planning.

Taking early advice can make sure that things are in place as and when needed.

The examples used in the above article are for illustrative purposes only. Pensions will have charges, and investments can go down as well as up. Always seek professional advice.

Source: Hargreaves Lansdowne annuity best buys. 12th April 2023