In this, the first instalment of our week-long series of blogs to mark Pension Awareness Week 2024, we’ll look at what a pension is and five important points – all explained in a no-nonsense and understandable way.
Later this week we’ll also look at compound growth and why it’s so important to your pension’s performance, and how to get your retirement fund on track if it’s not performing as hoped. So if you’re considering your retirement and what to learn more about pensions, read on to find out more.
A pension is a saving plan with tax advantages
A pension is a long-term saving plan that allows you to build a pot of money that you can then use as an income when you retire. Money placed into a pension is normally invested into different assets, which often include:
- shares
- cash
- Government bonds
- commercial property.
While there are many different types of pension products available, they broadly fall into one of three categories. These are:
Defined contribution (DC) schemes
Often referred to as money purchase schemes, these can be private or workplace pensions. The money that you (and your employer, if applicable) place into the pension is invested in different assets, which could include shares, cash and commercial property.
The income you receive will depend on, amongst other things, how much you’ve contributed to it and the performance of any investments held.
Defined benefit (DB) schemes
Otherwise known as final salary and career average schemes pensions. As these are funded by your employer and is usually calculated using:
- your length of service
- your salary
- the employer’s ‘accrual rate’.
This means the income you receive is not dependent on the performance of investments. While DB pensions are exposed to less risk, they may also be exposed to lower levels of growth potential when compared to DC schemes.
The State Pension
As long as you’re eligible, you can claim this benefit as soon as you reach State Pension Age. In 2024/25 this is 66 years for men and women, although it will increase to 68 by 2046. While the State Pension is not designed to provide a luxurious standard of living in retirement, it could provide a significant boost to your private and workplace pension.
In 2024/25, the State Pension is up to £221.20 a week, or £11,502.40 a year. The amount of State Pension you receive depends on how many years’ worth of ‘qualifying’ National Insurance Contributions you’ve paid during your career.
Now that we have looked at what a pension is, let’s look at five simple but important points you need to know.
1. £100 contributed into your pension could cost £80 or less
The government provides an incentive to save for your retirement through tax relief on the contributions you make. This means that it gives you back all or some of the Income Tax you pay on the money placed into a pension.
As such, every £100 you contribute costs you:
- £80 if you’re a 20% basic-rate taxpayer
- £60 if you’re a 40% higher-rate taxpayer
- £55 if you’re a 45% additional-rate taxpayer.
When you contribute to your pension scheme, HM Revenue & Customs (HMRC) returns the basic rate of 20% to your pension provider automatically. If on the other hand you’re a higher- or additional-rate taxpayer, you’ll need to submit a self-assessment to HMRC to claim the remaining 20% or 25%.
2. The level of tax-relief received is limited by the Annual Allowance
While you can normally contribute any amount to your pension pot, the amount of contributions that receives tax relief is typically limited to your Annual Allowance. In 2024/25, this is £60,000 or the amount you earn, whichever is the lower.
Should your contributions go above your allowance, the amount that exceeds the threshold will become liable to Income Tax. If you’re a high earner your Annual Allowance could be different under the tapered annual allowance rules.
It means that your allowance could drop to just £10,000 if you earn more than £260,000 (2024/25). That said, the tapering rules are complex, and a financial adviser will be able to confirm whether you’re subject to the rules.
3. You can’t access your pension until you reach a certain age
Normally, you cannot draw any money from your pension until you’re aged 55, although this is expected to rise to 57 as from 2028. That said, you may be able to access your retirement fund earlier if you’re:
- retiring early because of ill health
- you pension scheme allows it.
4. You might be able to take your workplace pension to a new employer
If you move to a new employer, they may agree to pay your contributions into your existing workplace pension, as long as it’s a DC scheme.
That said, you should check whether the scheme being offered by your new employer offers more or less benefits than your current one before deciding. If the new scheme provides greater benefits, you might want to join your new employer’s pension and consider merging your current workplace policy with others that you have.
This is known as ‘consolidation’ and could help to boost your pension’s growth potential and may also reduce the amount of charges you pay.
5. You could use ‘carry forward’ to contribute a significant lump sum
If you have a large sum of money, maybe from an inheritance or redundancy, you might want to place it into your pension using ‘carry forward’. If you’re eligible to use it, you can use unspent allowance from the previous three years to boost the size of your pension pot.
In 2024/25, you might be able to contribute up to £180,000 and still benefit from tax relief. As strict rules apply to carry forward, always speak to a financial adviser to ensure it’s the best option for you.
Get in touch
If you are looking to start a pension, or would like to discuss yours, please get in touch. We can help you understand whether your private or workplace pensions are on track to provide the standard of living you want when you retire, and if not, how to get them back on track.
If you would like to discuss how we could help you, please call us on 03330 100 008 or speak to one of our advisers, as we’d be happy to help.
Monday 9 September 2024