Why does pension advice have to be complicated and boring? After all the majority of people would probably prefer simple, fun, easy to follow help, a pension guide for dummies if you will, over complex jargon filled information.
Pensions and retirement planning are serious but by engaging you though a more down to earth viewpoint maybe we can improve your understanding on the matter and ultimately turn you into a wealthier, more financially secure version of yourself.
What is a Pension?
A legal, tax efficient way to save. It allows you to avoid or minimise paying taxes that would otherwise be due.
How much tax would I otherwise pay?
That depends on your circumstances but some of the taxes (UK rates) that you may be liable for include income tax (up to 45%), dividend tax (up to 30.5%), and capital gains tax (up to 28%).
Are there other advantages?
Yes, potentially you can also benefit from guarantees relating to the income received on retirement, matching contributions from your employer, and death benefits for your spouse or dependents.
What pension options are available?
Defined benefit vs defined contribution
Defined benefit pensions are only available through an employer. They provide a guaranteed level of income in retirement dependent upon your salary and the number of years accrued.
Defined contribution schemes are available through employers as well as privately. The income generated in retirement is down to underlying investment performance.
Of the two main categories above there are many variations available.
What is the best option?
A final salary pension scheme is typically the more generous offer due to the guarantees provided and the level of contributions made by an employer on your behalf.
When you leave an employer’s pension scheme, however, contributions made will cease and the level of benefits provided will be set in a defined benefit scheme. In a defined contribution plan your investments will continue to grow based on the underlying investment performance. When this happens it is termed a “frozen pension”.
Can a pension be transferred?
Pension transfers provide an opportunity to take advantage of the best pensions on the market. It is not only possible to consolidate all your pensions into one, allowing easier management, but it may also provide other benefits including reduced costs, increased flexibility and improved investment options for potentially higher future returns.
The benefits and drawbacks of a pension transfer are dependant on your particular circumstances. In general it usually unwise to transfer from either a company pension which you are still contributing to or a defined benefit scheme. However, a final salary pension transfer can be advantageous in the correct circumstances.
What pension transfer options are available?
Company to company: This occurs when you move employer and you have the opportunity to move your old pension to the new scheme on offer. This is likely to be a defined contribution (money purchase) scheme as, in the unlikely circumstance of being offered a defined benefit (final salary) scheme, you will probably not be able to buy added years – giving up a lump sum pension for a higher guaranteed final salary pension.
Company to private: This can either be a final salary pension transfer or a straight forward money purchase transfer. In either circumstance your new pension will depend on investment returns.
Private to private: This involves moving a pension to achieve more favourable conditions.
Under all circumstances it is critical to weigh up the pros and cons associated with the change of scheme.
For UK based residents transfers will normally be to UK based pensions schemes. Expatriates, on the contrary, may benefit from holding their pension abroad due to a change in law back in April 2006 (known as A-Day). It is now possible for expats to take advantage of a different country’s pension rules. The main pension option for expats are Qualified Recognised Overseas Pension Schemes (QROPS). The benefits and drawbacks of QROPS therefore differ to those offered by UK based pensions as highlighted by some of QROPS most frequently asked questions. Alternative overseas based pension options are International Self Invested Personal Pension Schemes (International SIPPS) and Qualified Overseas Non UK Pensions Schemes (QNUPS).
How simple can a pension transfer be?
For a light-hearted look at how easy making a pension transfer can be please view the diagram below. Alternatively, for further information please visit our articles on UK pension rules.
Pension saving benefits
The two main advantages of saving via a pension are their favourable tax treatment and the possibility of receiving matched contributions from an employer.
To highlight the benefit, let us consider a person who pays 20% income tax and has any pension premiums matched by their employer. For every £100 saved they would immediately have;
Saving via a bank account = £100 : Saving via a pension = £250
Breakdown: your £100 is matched by your employer = £200
You receive full tax relief of £50, which is added to the £200 = £250 (i.e. 20% income tax rate)
You are, however, liable to pay tax when you withdraw income at retirement. The reason for the increased tax efficiency is due to you benefitting from a tax free lump sum (25% in the UK) and the possibility that you are on a lower tax rate when you retire.
Continuing with the above example, after paying tax you would have £212.50 rather than £100.
(Tax due = £250 x 75% (taxable income) x 20% (tax rate) = £37.50).
For those who retire on a lower tax bracket pensions become even more favourable compared to other methods of saving even if there are no additional contributions from an employer. If the above person instead originally paid 40% tax and saved into a private pension (i.e. their premiums were not matched by an employer) then for every £100 saved;
Saving via a pension = £166.67 (£100 / 60% i.e. you pay 60% with the remaining 40% topped up by the government)
If when they retire their tax rate is only 20% then they would have £133.33 rather than £100.
Pension savings drawbacks
The main drawbacks of a pension centre around the inability to access your pension savings before the Normal Retirement Age (NRA). A lot of the previous disadvantages have been erased following UK rule changes started in the 2014 UK budget and subsequent alterations to general UK pension rules, defined benefit (final salary) pension rules, defined contribution (money purchase) pension rules, and pension death tax rates due to take effect from April 2015.
What is the Normal Retirement Age (NRA)?
The NRA is the set statutory age from when you can access your pension. This is currently set at 55 and will rise to 57 from 2028.
Can I access my pension before the Normal Retirement Age (NRA)?
In certain specific circumstances yes but on the whole no. Withdrawal prior to the normal retirement age, when not agreed by Her Majesty’s Revenue & Customs (HMRC), may become liable for substantial penalties and taxes. This is known as pension busting or pension liberation.
Pension investment returns
Pensions are tax efficient structures and do no have to limit your investment choices. They generally only positively effect the returns of any investment held through them. The choice of investments are vast ranging from low to high risk so since you control the investments you can dictate the expected returns you receive.
Fees and investment performance vary massively and it is therefore wise to seek out advice on this matter. As with anything there are good and bad versions. The latter could see your pension value languish.
Investing for retirement
There are multiple options on how to invest for retirement. With the increased flexibility offered by the new UK pension rules it is more important than ever to fully consider all investment options to retirement, the options available when you retire, as well as knowing what level of pension withdrawal rates are safe.
Pension advice received
You have two choices – either you can do all the research yourself or alternatively you can request professional advice. We help our expatriate clients find appropriate pension schemes and devise investment portfolios that are specifically tailored to thier individual risk & return requirements.
For further information on investing along with ways to reduce risks you take please visit our article on ways to benefit from risk.