PENSIONS
From
5 April 2015 the pension situation in the UK is straightforward.
Pensions
are in essence a way of saving for your retirement in regular manner and in general
they are given a more tax efficient treatment which makes them attractive than
saving in deposit accounts. Contributions (sometimes called premiums) are paid
over a long period of time during which some sort of return is added (perhaps
interest or capital growth that is generally tax free) so that at a point in
the future there is a fund of assets available to finance retirement.
There
are essentially two type of pension scheme and the only difference is in what
benefits are guaranteed. The first is
known as a Defined Benefits (DB) scheme which is where there are specific
benefits guaranteed to be paid on retirement. Such schemes are normally set up
by larger employers and are quite common in the Public Sector but are not that
popular in the Private Sector since they are quite expensive to finance.
It
is a complicated calculation to work out how much needs to be put into a DB
scheme to ensure that there is enough money in the fund to provide the
guaranteed benefits in the future. The maths is done by actuaries who use the
members’ details (age, benefits entitled to, length of service left etc.) along
with assumptions (rate of return etc.) to come up with an amount that needs to
go into the scheme each year.
The
more common type of scheme in the Private Sector and for Personal Schemes is
the Defined Contributions (DC) scheme which is where there are no benefits
guaranteed. The fund available at retirement in this case is simply the product
of all the amounts contributed plus what return has been generated. There are
no limits on how much can be contributed into such scheme but there are limits
on how much of the contributions will attract tax relief.
From
the age of 55, benefits can be taken from the fund and there are essentially
two options. The first is to buy an annuity which is simply a regular amount
(annually or monthly) that someone is prepared to pay you for the rest of your
life in exchange for the capital in the fund. Clearly the younger you are when
you buy this annuity, the longer you are expected to live and hence the regular
amount will be lower each time.
The
advantage to this that you have are sure of what income you will get for the
rest of your life regardless of how long you live or changing financial
environments. The downside is that it stops when you die and you take the risk
that you won’t get back all of what the fund was worth. Clearly the older you
are when you start to take the annuity the more likely it is that you may not
recoup the full amount of what the fund was worth.
On
retirement there is the option to take 25% of the entire fund tax–free and only
use the balance to buy the annuity. The funds you get are therefor
part of your estate and it’s only the other 75% that you may not live to recoup
but the regular amount that you would receive clearly drops by 25% each time as
well.
You
can also build in options to the regular payments such as a guaranteed payment
period (say 3 or 5 years) which will ensure that you get paid for at least that
period even if you die in the interim. You can also choose to take a spouse
pension which will be paid to him/her after you die for the rest of their lives
(normally at ⅔ of the regular amount you would have got). You can also
opt to have the pension increase each year either by a set percentage or by
reference to a quoted index which will ensure that some account of inflation is
built in. However all these option come at a cost so the regular amount that
you get decreases with each additional option you buy.
There
are many providers of annuities in the marketplace and it is important that you
shop around to get the best deal for you.
The
second alternative is not to buy and annuity but to take withdrawals from the
fund as and when you want. The first 25% of the fund is still tax free. The
advantage to this option is that the undrawn part of the fund will still be
generating income and you can change the amounts you draw down each year to
suit your circumstances. It will also remain as part of your estate on your
death. On the other hand there is no guarantee that there will be sufficient
funds for the remainder of your life and the fund could run out before your
death.
It
is possible to take the entire pension fund in one lump sum with the first 25%
being tax free and the remainder subject to income tax at your highest rate.
In
the event of your death any undrawn funds in your pension fund can generally be
drawn either as a lump sum or as regular income. If you were over 75 at the
date of death the amounts will be subject to tax.
Annuities
are subject to income tax (but not to national insurance) which will be
deducted at source by the provider after allowing for any unused part of your
annual tax allowance. Depending on your overall income in the year there could
be a higher rate tax liability (see Income Tax).
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