Pension & retirement

Pension planning

A pension is a long-term investment that helps you build up a pot of money to use for retirement. 

Pensions are a tax-efficient way to invest because HMRC adds basic rate (currently 20%) tax relief to your payments. 

For example, if you are a basic rate taxpayer and contribute £160, the taxman will add £40 so the total invested is £200. 

If you pay higher or additional rates of income tax, you can claim even more tax relief when you complete your annual self-assessment tax return, but this relief is not paid into your plan. 

You are limited to the amount you are able to pay into a pension each year. For most people, the annual contribution allowance is £60,000. Prior to April 2023, there was a limit to the amount you could save in a pension which was £1,073,100. Anything over this amount was taxed at up to 55%, however from April 2023, the Chancellor withdrew the lifetime allowance tax charges with a view to abolishing the lifetime allowance from April 2024. However, tax-free cash is limited to 25% of £1,073,100 or £268,275, unless you have lifetime allowance protection. There is also a limit on the amount of death benefits that can be paid tax-free, however, this is dependent on whether benefits are paid as income or a one off lump sum. 

As well as being able to claim tax relief on your pension contributions, pensions are generally not included in your estate for IHT purposes.  

We can assist with maximising contributions and tax benefits within your pension. 

Types of pension 

Most pensions are defined contribution schemes, which means that the amount you get back from the plan depends on how much the plan is worth. 

The final value of the plan is dependent on a number of factors, including: 

• how much you have paid in
• provider charges
• fund performance 

In simple terms, the earlier you start contributing and the more you pay in, the more you are likely to get back. 

Some people, mainly public sector employees, have defined benefit pensions. The benefits are based on a proportion of your salary rather than the size of the fund you have built up. 

Retirement options 

There are a number of different ways you can draw benefits from pensions when you reach retirement. 

Lifetime annuity 

An annuity is an insurer’s promise to pay an income for life for a set price. The annuity style is set at the outset and cannot be changed. You can build in a minimum period the income is paid for (guarantee period), spouses/dependents pension and escalation. The more options you include, the lower the income becomes. This is illustrated in the graph below:

Enhanced annuities are lifetime annuities that are available to people who have suffered health problems that are likely to have an impact on their lifespan. Generally, an enhanced annuity gives a higher income than a standard annuity. 

Investment-linked annuity 

The income from this type of annuity depends on the performance of investments. If the funds chosen do not perform well, then the income will reduce, and over time, there is a danger of the fund being exhausted. 

Fixed-term annuity 

A fixed-term annuity provides a guaranteed level of income for a set period of time. At the end of the term, you will get a set amount of money called a Guaranteed Maturity Amount which you can use to buy another pension product. Over time, the capital value of these products will reduce. 

Flexi-access drawdown 

Flexi-access drawdown allows you to take the maximum amount of tax-free cash when you start the plan and keep the rest invested. You can draw an income from the plan or decide to buy an annuity using the remaining value of the fund at any time.  

Phased drawdown allows you to use some of your tax-free cash to supplement your income. You only move the amount you need each month into drawdown, then take a withdrawal of income and tax-free cash each month. This can help you reduce the income tax you pay on your withdrawals. You also have the option to switch to full drawdown at a later date and draw the remaining tax-free cash from the pension fund. There is now a cap on the amount of tax-free cash you can take from pensions, so care needs to be taken with this planning. 

Although these plans offer the most flexibility, withdrawing too much money too soon could mean that the fund runs out during your lifetime.  

The remaining fund can be paid as a tax-free lump sum to your dependants or as a tax-free income if you die before 75. After 75, the fund is taxable at the recipient’s highest marginal rate whether taken as income or a lump sum. Generally, taking income would result in a lower tax charge. 

Auto enrolment 

All UK employers have to provide their employees with a workplace pension and make contributions. Workplace pensions are heavily regulated by the Pensions Regulator and the penalties for non-compliance can be expensive. Ongoing compliance with the rules can also be a major stumbling point for employers. We no longer set up new workplace pensions, but are happy to advise on existing schemes as part of your overall retirement planning.

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