Pensions

Personal pensions may be suitable if you're employed and not in a company pension scheme, or as an addition to a company pension.  A personal pension could be suitable if you are self-employed or if you are not working but can afford to put aside money for retirement. 

You can typically save into a pension plan in one of two ways:

• Regular instalments - The pension payment can be taken automatically each month by Direct Debit. Once you start making regular contributions in this way, and become accustomed to the regular payments going out of your account, you may find it easier to plan your monthly budget.

• One-off investments - Some people prefer the flexibility of making one-off investments at a time of their choosing, rather than commit to regular monthly contributions. Providers usually place minimum contribution amounts on single premium payments. This method can be useful where earnings/income for the tax year aren't known until closer to the end of the tax year.
  

• A combination of the above - This provides both the discipline of regular investments and enables one-off investments to also be made so that the best use of the available tax relief can be made.

The final value of your pension fund will depend on how much you have contributed and how well the fund's investments have performed. The companies that run these pensions charge you for starting up and running your pension. Charges are normally deducted from your fund in the form of fund management charges.

Tax relief is granted on pension contributions within allowable limits. Currently, the basic rate of tax is 20% and higher rate is 40%. The additional rate is 45%. 

For individuals contributing to a personal pension or stakeholder plan, the contribution is made net of basic rate tax. If you invest £80 into a personal pension, the provider will add the remaining £20 and invest £100 on your behalf (claiming the tax relief back themselves from HMRC).

If the investor pays tax at higher rates, it is possible to claim back the marginal rate on some or all of the contributions via a tax return (higher and additional rates) or via a tax code adjustment for higher rate relief.  In the example above, £100 is declared on the self-assessment tax return. The tax office will then credit you with the additional £20 of tax relief (so £20 of tax relief is paid into the pension plan and £20 is credited to the investor). 

Self-employed investors also receive 20% tax relief immediately and claim any higher rates of tax relief via their tax return.  As the income of a self employed person may be unclear until the tax year has ended, care should be taken to understand the effect on self-employed tax assessments when making pension contributions.

The total amount you (and your employer or other third parties) can save each year toward a pension, without suffering a tax charge, is limited to the 'annual allowance'. The annual allowance for the tax year 2024/25 is £60,000 for most people (but can be less for those with high income). You may be able to carry forward unused annual allowance from the previous three years (i.e.. back to 2021/2022 for 2024/25).

Your personal contributions that are eligible for tax relief are limited to 100% of your earnings, subject to the annual allowance cap, or £3,600. You can invest up to £3,600 per year gross in a personal pension (and still receive the 20% tax relief) even if you have no earnings. There is no tax relief on pension contributions after age 75. As the person making the contributions does not have to be the same as the person benefiting from the pension, this facility can be helpful in providing a pension for a non-working spouse - or for children and grandchildren as part of inheritance tax planning.

If you're subject to the higher tax rate of 40 per cent (up to 45% for additional rate taxpayers), you'll still get 40% or 45% per cent tax relief for any money you put into your pension that is matched by income in the higher or additional rate tax bands. But the way that the money is given back to you is different:

• You pay your contributions after deducting 20% tax relief and this 20 per cent tax relief is claimed back from HMRC by your pension scheme and added to your plan.

• It's up to you to claim back the other 20 per cent if you're a higher rate tax payer or 25 per cent if you're an additional rate tax payer on some or all of the contributions when you fill in your annual tax return (higher or additional rate), or by contacting your Tax Office (higher rate only). This tax relief is given to you rather than being added to your pension plan.

• Your pension fund will invest the money you save (including the basic rate tax relief amount) in your pension. Your pension fund will benefit from growth and income from its investments and these accumulate free from tax.

You can take a pension commencement lump sum of up to 25% of the value of your pension savings (or 25% of your remaining lifetime allowance if less), which is currently tax free, when you reach minimum pension age (currently age 55). The lifetime allowance for pension has now been abolished for pensions from 6th April 2023.

You then have two main options:

• Use the rest of the fund you have built up to buy an annuity (a regular taxable income payable for life) from a life insurance company. This does not have to be the same company that you have your pension plan with.
   
• Take a regular or ad hoc income (taxed at your normal Income Tax rate) from the remainder of your fund while it remains invested (known as flexi-access drawdown).

The first of the options is “flexi-access drawdown” which in essence places no limit on the amount of income you can take from your money purchase pension fund once you reach the minimum pension age, currently 55 changing to 57 in 2028. This means that it would be possible to take the whole of your pension fund in one go, however it may not be tax efficient to do so.

If you will be dependent on your pension fund to support you through your lifetime you may need to consider taking a lower level of income to sustain you.

You will be able to take 25% of your fund as a tax free lump sum if you have not previously used that fund for drawdown purposes with the remainder of the fund staying in your pension to provide you with an income.

It is important to remember that the amount of flexi-access fund withdrawn to provide you with an income will be taxed at your marginal rate of income tax therefore if you take too much income this may move you into the next tax bracket and result in you paying a higher rate of tax.

An option was introduced by the Government which is called the Uncrystallised Funds Pension Lump Sum (UFPLS).

This option is for funds not already in drawdown and allows you to take a one-off payment from your pension or a series of lump sums leaving the remainder of the fund in your pension invested, the first 25% of each UFPLS is tax free, with the balance being subject to tax.

Income Drawdown is a more flexible alternative to the traditional annuity route, offering greater choice and control for many people.

You can put off buying an annuity, and instead withdraw a regular income or take ad-hoc withdrawals from the pension fund while the remainder of the fund stays invested. While the fund remains invested, you could benefit from growth in the market - and from ongoing advice.

Anyone from the age of 55 (expected to rise to 57 from 2028 and then remain 10 years below state pension age) can set up a Drawdown contract. It could be suitable if you:

• want to vary your income over time, to reflect changes in your circumstances
• want your pension fund to continue benefitting from potential investment growth, and you’re prepared to accept the risk that the value of the fund may fall
• have other sources of income
• want to maximise the benefits your family receives upon your death, and also give more choice about how they receive these benefits
• are in ill health, and would like to pass on remaining assets to your estate
• want to control the time at which you buy an annuity
• want to maintain an active interest in managing your pension fund

As well as benefits, like most things, there are also some potential drawbacks.

• Income withdrawals from a flexi-access drawdown pension trigger the Money Purchase Annual Allowance (MPAA). This would reduce your maximum pension contribution to £10,000 gross per tax year.
• All of the payments above the Pension Commencement Lump Sum (PCLS) are taxable as the individual’s pension income via Pay as you earn (PAYE).
• Unused funds remain invested and therefore subject to investment risk.
• Sustainability – the possibility of the entire fund being depleted which would leave insufficient funds to live on in retirement.
• Income and lump sum benefits on death are taxable as the recipient’s pension income via PAYE on death where this occurs on or after on after 75th birthday.
• Where a lump sum death benefit is paid, this will form part of the beneficiary’s estate for Inheritance Tax (IHT) unless it is paid to a suitable trust.