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Date of publication: September 2012
The media is fond of reminding us that a destitute old age awaits those of us who haven't saved for retirement. We are forever being urged to sort out our pension planning. But how many of us really know what a pension is?
In essence, a pension is a long-term savings plan whose sole purpose is to provide you with a secure income in retirement. You pay in a little money each month throughout your working life and by the time you retire, this should have built into a tidy sum. That sum is then transferred to an annuity (we'll come on to those later) which pays you a fixed amount of income which should support you for the rest of your life.
What does this mean? Well, if you pay the current basic rate of tax (20%), then if we ignore national insurance for a moment, for every £100 you earn, you take home just £80. However, if you put that £80 back into a pension, the government give you back the other £20 so you actually get the full £100 invested. If you are a higher rate taxpayer (paying 40% tax), subject to maximum limits, you get £100 invested for laying out only £60.
There are two basic types of pension. A 'Personal Pension Plan' is started by you as an individual and can be run by your choice of provider – a bank, an insurance company, pension provider or other specialist firm. This will usually be funded solely by you, and the investment strategy is under your control throughout your life.
The second is an 'Occupational Scheme' and is organised by your employer. Here, the initial control at least rests with your employer – and in the case of defined benefit schemes, so does the investment strategy. However, they will also normally make some (or maybe even all) of the contributions for you. The benefits however, always remain with you, even if you leave that job.
A board of trustees run the assets for you, separate from any company, and this board is legally bound to appoint advisers, take any investment decisions which have not been otherwise delegated to yourself and also keep both the financial and member records up to date on your behalf.
Making small changes now can make a big difference to your income in retirement. We can help you plan ahead, to identify what pension income you would ideally like to receive in retirement, reviewing any existing planning you have in place and putting in place a plan of action to meet any shortfalls.
Remember the earlier you start the better, but don't assume you have left it too late.
When you reach retirement age you will have some important choices to make – the first being when that retirement age will be. The minimum age is now 55. Following recent announcements, the statutory retirement age for both men and women will be aligned and also increased to 67 by 2028.
As a general rule, it is better to hold off retirement for as long as possible. Deferring state, employment and/or personal pension benefits should ensure you receive a larger income as annuity rates tend to improve, the older you are. Equally, if you choose to downsize your career but can still earn some income after your chosen retirement date, you may be able to 'phase' your retirement, using only a portion of your pension fund to start with, leaving the remainder invested until a bit later.
However, the most important choice you will make will be over the actual annuity, or unsecured pension product, as this will determine your ultimate income. There is also the option of taking 25% as a tax-free lump sum, which could perhaps pay for a long holiday or be re-invested elsewhere to generate additional income. An annuity will provide you with an income stream for life, but this does mean you give up all right to the capital – and your descendants will not inherit anything if you die shortly after retirement. You therefore need to think carefully about whether you include guarantees in your annuity choice (thereby securing some of that fund value at least for the short term) and also the rate being offered to you, particularly if you smoke or have certain health conditions which could lead to an increase in the amount your receive.
With a drawdown pension arrangement, your fund basically remains invested and you draw an income directly from its value. This could be less or more than you might receive with an annuity, depending on your circumstances and requirements, but it does mean you preserve some of your pension fund.
These schemes do, however, leave your investment in the hands of the market so you risk the value going down as well as having the potential for it going up. There are, however, a wide range of underlying investment funds to choose from, so you can decide what risks, if any, you want to take. An adviser can help guide you through this process.
Finally, you could decide to take an annuity for part of your pension fund and then take some risk with the remainder. Such a combination could offer a decent half way house, so examine all your options carefully before making your move.
This guide does not contain a full statement of the law and it does not constitute legal advice. Please seek legal advice if you have any questions about the information set out above.