Moneyfarm’s guide to pensions
A pension is essentially a long-term savings plan designed to help you save for life after work. The concept is rather simple, but the pensions landscape has evolved into something more complex. Add this complexity to the negative connotations associated with saving for retirement and it’s no wonder many are put off from making the most of their pension pot.
Moneyfarm’s complete guide to pensions will give you a comprehensive overview of your options when saving for retirement.
Table of contents
- Tax Benefits of a pension
- What is a good pension pot?
- How much should I pay into my pension?
- How much can you put into a pension?
- How to start a pension?
- Pension Transfer
- Pension Withdrawal
What is a pension?
Pensions come in many different shapes and sizes, and can provide you with a pot of money to see you through retirement. You can decide how to use this money, and whether you receive regular income or lump sums.
The Office of National Statistics estimates that around 45.6 million people in the UK were members of an occupational pension in 2018. This includes people who are actively contributing to a pension, people who have contributed in the past and will receive income in the future and current pensioners who are using the money they have saved and invested.
While this sounds like a large number of people, many aren’t planning sufficiently for retirement, or don’t even know how much they have saved.
An ITV poll in May 2019 found that 60% of people have no idea how much they’ve already set aside, whilst two-thirds don’t think they‘ll have enough money for retirement. Meanwhile, 60% of people struggle to save for a pension.
It’s clear there is confusion in the pensions landscape, and that a significant number of people in the UK could be doing more to ensure they reach their dream retirement income.
What are the different types of pension?
Once you hit state pension age, the government will pay you a regular income throughout your retirement – as long as you’ve built up the required number of years of National Insurance contributions.
How much is the state pension?
If you reached state pension age before 6 April 2016, the most you’ll get is £129.20 a week, which adds up to £6,718.40 a year.
If you reached retirement age after 6 April 2016, you should get the new state pension of £168.60 a week, which is £8,767.20 a year. You’ll have to build up 35 years of national insurance contributions to get the full amount, although you’ll still qualify for something if you have at least 10 qualifying years.
For more information on this, please read the government’s advice.
Experts suggest you’ll need two-thirds of your final salary to maintain your lifestyle in retirement, and the harsh reality is that you probably won’t be able to rely solely on the state pension.
The workplace pension is a pension scheme offered by employers to workers who are over 22 years of age (but below their state pension age) and earn at least £10,000 per year.
From April 2019, workplace pension schemes are required to pay at least 8% worth of a worker’s qualifying earnings into the pot – including the employer contribution (3%), the employee contribution (4%) and government tax relief (1%)
What is Auto-Enrolment?
While paying into a workplace pension isn’t compulsory, there have recently been some big changes in the industry to encourage more people to save for their retirement. Previously it was the responsibility of the employee to opt in to contributing to their workplace pension, but employers are now required to automatically enrol all qualifying employees, who can then choose to opt out.
Auto-enrolment has transformed the way Britons save for their pension, with over 10 million workers having been automatically enrolled onto a workplace pension scheme, while 11.5 million were already active members of one, according to research from The Pensions Regulator. Yet there is still more to do.
Defined Benefit Pension
A defined benefit pension scheme pays out a secure, regular income throughout your retirement.
The amount you get depends on a number of factors including the number of years you’ve been employed, your age and the scheme’s accrual rate – the percentage of your salary you’ll get as an annual retirement income.
Some schemes pay you in line with the final salary you earned before retirement, while some take an average of your career earnings. It is also possible to take the 25% tax-free lump sum on retirement.
Also known as a final salary pension scheme and associated with big organisations like the NHS and government, both you and your employer will pay into your pension plan throughout your career.
It’s up to your employer to ensure they have enough to pay your pension throughout your retirement. But these are expensive schemes that can put a lot of strain on companies, and many big high-street names have folded under the pressure of their pension deficit. This is why many firms no longer offer these.
Defined Contribution Pension
The most common pension scheme to save into today is a defined contribution pension. Both you and your employer pay into your pension pot throughout your working life, but unlike the defined benefit scheme, there is no guarantee to how much you get in retirement.
The amount you get depends on how much you and your employer put in, the performance of the investments in your pension, and the choices you make with your money when you retire. Unless you swap your pension pot for an annuity at retirement, you aren’t guaranteed a regular income.
There are benefits to keeping your money invested once you stop working, but you need to do your research before you do anything with your pension savings.
There are a number of important characteristics to a defined contribution pension. You can get generous tax relief on your pension contributions, and if you have a workplace pension, your employer can takes your contribution off your salary before you’re taxed.
Trust-based pensions are managed by a board of trustees who take all investment decisions on the pension – essentially all the assets of the pension schemes are held by the trust fund.
A pension trust fund will be separate to the company whose employees it serves. The reason for this is to protect the assets of the pension even if the company runs into financial problems. It’s rare for providers to offer these.
Private Pension (Personal Pension)
Also known as a personal pension, private pensions offer people more flexibility when saving for retirement and are popular with the self-employed or those who want to manage their pension themselves.
People might want to a private pension if they want to top-up their work place pension, self-employed and don’t have a workplace scheme, or if they are unemployed but can afford to pay into a scheme. These can also be popular with people who have a number of old workplace schemes but want to combine them into one put to make them cheaper and easier to manage.
The value of your pension pot will depend on how much you invest, how your investments perform and when you decide to access your savings.
As with most pension schemes, there are several ways to use your personal pension. You won’t be able to access your private pension until the age of 55. This minimum age is set to increase to 57 in 2028, and 58 after that.
What is a Self Invested Personal Pension (SIPP)?
SIPPs are popular with investors looking to reach their retirement dreams, as they give you more flexibility, transparency and control over your pension investments.
The value of your personal pension depends on how much you put in it, how long you’re invested for, how your investments perform, and how much you’re charged in management fees.
Both you and your employer can pay into your pension, and you can contribute if you’re self-employed. The flexibility of SIPPs allows you to maintain your savings plan if you change jobs or stop working.
What is the Moneyfarm Private Pension?
The Moneyfarm Private Pension is a personal pension plan designed to give you financial security throughout retirement.
We provide a unique blend of digital advice and human expertise to help people grow their wealth over time. When you sign-up, we’ll ask you some questions to match you with an investor profile, by understanding your financial goals and financial background.
We then look at your time horizon and risk appetite to find you an investment portfolio that’s specifically built by our team of experts to reflect your investor profile for as long as you invest with us. A target date product, Moneyfarm adjusts your pension investments as you get older to de-risk your portfolio as you get closer to retirement.
Our Investment Consultants provide investment guidance, retirement planning and support to help you reach your dream retirement income. Why not find out how much you should be saving using Moneyfarm’s our new widget or book a call with our Investment Consultants?
The Moneyfarm Pension allows you to transfer your old pensions for free and we will immediately pass on the benefits of the 20% government tax relief, if it applies. This means you’ll only have to pay £8,000 for a total £10,000 contribution.
If you pay a higher rate of tax, you’ll be in line for even more tax relief. Fill in your tax return form to reclaim your relief. You’ll receive your additional relief as either a rebate at the end of the tax year, a reduction in your tax liability, or HMRC will change your tax code.
When the time comes to retire, you’ll have flexible access to your pension pot.
Benefits of a pension
Tax relief on contributions
The government wants you to save for your future, that’s why there are a number of tax incentives available to those who invest in a pension. You may be eligible for tax benefits when you contribute to a pension and when you retire.
The government gives you tax relief on pension contributions relative to your income tax band. Basic rate taxpayers get 20% relief, higher taxpayers get 40% and additional rate taxpayers get 45% on their contributions.
If you’re charged the basic rate you’ll only need to pay in £8,000 for a £10,000 contribution – this is a 25% boost to your savings. At Moneyfarm the basic rate tax relief is automatically added to your pension investments.
If you’re a higher rate or additional rate taxpayer, you can claim back even more through your annual tax return.
Are retirement benefits taxable?
Once you reach the age of 55, you can take 25% of your pension pot tax free, with the remainder being used to provide you with an income throughout your retirement. You decide what to do with your tax-free lump sum, but it’s important you don’t waste it because once it’s gone, it’s gone.
The age you can access your personal pension savings will increase to 57 in 2028, and then 58 after that. It’s important to remember that the pension and tax rules can easily change, so it’s important you do what you can today to secure your financial future.
If you have no need for a big lump sum, you can choose to take your tax relief through your withdrawals instead. This is known as uncrystallised funds pension lump sum (UFPLS).
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Regardless the size of your pension, if you withdrew £10,000, £2,500 would be tax free. The remainder would be taxed at your marginal rate of income tax.
Taking your 25% tax-free lump sum won’t trigger your money purchase allowance, although taking an UFPLS will. This restricts the amount you can save into your pension each year to £4,000.
It could be beneficial in terms of inheritance tax if you refuse to take your tax-free lump sum. Inheritance tax is not charged on a pension, but if you withdraw your 25% tax-free lump sum this might be counted as part of your estate and could increase the amount of inheritance tax your loved ones would have to pay.
If you die before the age of 75, your pension will be passed on completely tax free to your beneficiaries. A lifetime allowance check will be made on uncrystallised funds. If you’re over 75 when you die, your beneficiary will be charged their marginal rate of income tax on your pension savings.
Whilst you may be eligible for higher rate tax relief whilst you’re contributing to your pension, you may be charged just the basic tax rate in retirement, which will give your savings an extra little boost.
Protection if you go bankrupt
Pensions often offer greater security in the event of bankruptcy than other investments. While some people see property as a better bet, your assets must be used to pay off your creditors in the unlikely event of you becoming bankrupt, meaning you would lose that future income.
With a pension, though, you cannot have your entire pot taken away. Even in the case of bankruptcy you will be left with at least enough money to support yourself and your family comfortably in retirement. However, you may still have to surrender a portion of your pot to pay off debts.
You and your employer must pay a percentage of your earnings towards your pension. How much you pay and what counts as earnings depend on the pension scheme your employer has chosen. In most schemes you’ll make contributions based on your total earnings between £6,136 and £50,000 a year before tax. Your total earnings include salary, bonuses, overtime, statutory sick pay and statutory maternity, paternity or adoption pay. You can find more information here.
Guaranteed income in retirement
Pension freedoms have unlocked new opportunities for savers looking forward to retirement, but you can still purchase an annuity with your pension pot. Buying an annuity used to be the only option for people in retirement. This is where you swap your pension pot for a guaranteed regular income, which can be a comfort with people living longer.
The income you get from your annuity is expressed as a percentage of the amount you transfer. For example, if you had £200,000 of savings and are offered an annuity rate of 5%, you’ll get £10,000 a year.
How much should you save in your pension pot?
It’s generally thought that you can maintain your standard of living when you retire with two-thirds of your final salary – you won’t have to pay for commuting, work clothes, you’ll probably have paid off the mortgage and your children will hopefully be independent by then.
That’s around £26,000 a year if you want to comfortably afford the essentials and a few luxuries along the way – you’ll be able to eat out and afford a European getaway every six months the research from consumer research group Which? shows.
If you want to have an income of £26,000 a year gross, and assuming you will have no state pension income, you’re going to need a pension pot worth a minimum of £520,000.
The logic behind this is that from a balanced and diversified portfolio, it’s reasonable to expect an average annualised return of around 5% over the long term. Assuming this is your return, if you withdraw up to the same 5% each year, you’ll never deplete the nominal value of your pension over time.
If you’ve been planning to travel more during your retirement and want to treat yourself to a new car every five years, you’re going to need around £39,000 a year. Remember, as you get older your priorities will change, and you’ll probably have to swap jet-setting for better life insurance.
For an annual income of £39,000, you’ll need at least £780,000 when you retire if you want to withdraw 5%. If you’re a bit more conservative over your expected returns and want to withdraw 4% a year, you’ll need a pension pot worth at least £973,500.
How much should I pay into my pension?
There are some simple tips to help you reach your goals of a comfortable retirement. The most important and effective thing to do is to start saving early.
The earlier you can start contributing into a pension, the longer you have to build up your pension pot.
A comfortable retirement
The Which? study showed UK households spend around £26,000 a year on average, and suggest this is around the budget most people will need for a comfortable life post-retirement.
Which? estimates that, to reach this goal, a couple in their 20s would need to save £259 a month, rising to £337 when that couple reaches their 30s, £487 when they’re in their 40s and £789 once they reach their 50s.
A luxurious retirement
Having said this, the amount you will need to save will depend on your personal circumstances. Whether you are planning on before 60, at 60 or even later, for instance, will obviously have a large bearing on how much you should be putting away each month.
To achieve a more luxurious retirement, a couple in their 20s will need to save £572 a month, going up to £744 when that couple reaches their 30s, £1,075 when they’re in their 40s and £1,741 once they reach their 50s.
It’s important you understand the charges of your pension provider, as fees eat into the income you’ll get during retirement.When you’re receiving a service, fees are a fact of life, but you don’t want these costs to mean you miss your dream retirement income or have to work longer to reach your goals. Fees can get complicated, with surprises charges for transferring old pensions, trading, or even additional fees for accessing your money in retirement.
At Moneyfarm we believe you should know exactly what you’re expected to pay for your pension as this will impact your retirement income. We only charge a management fee at an account level, which means there are no surprise flat fees or charges for rebalancing, transferring or for meeting targets. The total cost of investing includes two further costs, the transaction cost (market spread) and fund fee, but these aren’t controlled by Moneyfarm or any provider.
How much can you put in a pension?
There are generous tax benefits to be had when you invest in a pension, but there are complicated rules, too. One is a limit to how much you can invest in your pension to receive tax relief from the government. There are two important allowances to be aware of: the annual and lifetime allowance.
There’s a cap on how much you can contribute to your pension to receive tax relief each year. This limit is either your annual salary or £40,000 ‒ whichever is lower. This includes contributions from you, your employer and tax relief.
The government applies a tax charge, called the annual allowance tax charge, if the total contributions to your pension savings for a given tax year exceed your annual allowance.
Your ‘total contributions’ include all your personal contributions, any income tax relief from the government and contributions paid by your employer.
You can keep putting money into your pension, you’ll just be charged a fee. The charge for exceeding your annual allowance is set at your income tax band. This acts as if the excess amount were added to your other earnings.
If you earn in excess of £240,000 a year, this allowance is tapered. Every £2 of additional income over £240,000 will reduce the annual allowance by £1. The lowest this can go to is £4,000.
Pensions also have a lifetime allowance, which is £1.055 million in the 2019/20 tax year.
If your total pension savings exceed the lifetime allowance when you decide to take benefits or a benefit crystallisation event, a tax charge applies, called the lifetime allowance charge.
The amount of the lifetime allowance charge depends on how you take the excess benefits from your pension.
If you take the excess as a lump sum, it will be subject to a 55% tax charge. If you decide to use the excess as income, it will immediately be subject to a 25% tax charge, and your income will then be subject to income tax.
If your savings exceeded the new lower limits when introduced, you may have been able to apply for a lifetime allowance protection scheme. If you’re unsure of your annual or lifetime allowance we recommend you seek financial advice.
Money Purchase Allowance
Once you start withdrawing from your pension, you might be subject to the Money Purchase Annual Allowance (MPAA). This restricts the amount you can contribute to your pension, before a tax charge is payable, to £4,000 a year.
Whilst taking your 25% tax-free lump sum won’t trigger your MPAA, there are a number of ‘trigger events’, also known as ‘accessing flexibility’. You may enter the MPAA in one of the following situations:
- Taking an UFPLS
- Entering flexi-access drawdown
- Going above capped drawdown income threshold
- Through existing flexible drawdown
- Taking a flexible annuity
How to start a pension?
These days, starting a pension of some description couldn’t be easier. Because of the rules on auto-enrolment, everybody between 22 years of age and the state pension age must be automatically entered into a workplace pension.
If you want to start paying into a personal pension, you will have to put in more research. It is important to establish what you want from your pension, as well as what you would like your funds to be invested in, how much you are prepared to pay in fees and how much you want to pay in. It takes a lot of time, money and skill to manage your pension portfolio yourself, which is why fully-managed providers like Moneyfarm are increasingly popular.
Management fees in particular can make some pensions very costly places to save your money. Unless you are confident making these decisions yourself, it is advisable to seek professional advice.
Pension transfers are becoming increasingly common amongst those saving for their retirement, as savers look for more simple ways to manage their pension pot and to save on fees.
By moving your pension from one provider to another, you can make your pensions easier to manage.
How to transfer a pension
With Moneyfarm transferring your pension is easy, free and efficient. Just fill out the required information on the transfer form and we’ll take it from there. We’ll talk to your existing provider and move your pensions over to your Moneyfarm account. This process should take three-four weeks, although this depends on your provider. For a transfer form, please get in touch with our Investment Consultants.
Should I transfer my pension?
If you’ve had more than one job, you’ve probably paid into more than one pension. As the average Brit has around 11 jobs in their career, they probably have 11 different pensions to go with it. If you’re not exactly sure what pensions you have, you can use the government pension tracing scheme set up by the Department for Work and Pensions.
There are a number of reasons why you might think about transferring your pension:
- You want a different pension service to the one your provider is offering
- You want to consolidate your old pensions to simplify your plan
- You want to pay less in fees
- You want a higher income
- You’re moving abroad and want a local scheme
- Some older schemes may not offer certain freedoms, like UFPLS
It can be difficult to keep on top of your pensions savings, having your pensions in a number of different places can make this more confusing. If you don’t know what you’ve got, it’s nearly impossible to understand whether you’re on track to reach your retirement goals.
Consolidating your pensions into one place makes it easier to see how your investments are performing and know exactly what you’re paying in fees at any time.
If you’re consolidating your old plans into a personal pension, make sure your portfolio is suitable for your investor profile and time horizon. This will put your money in the best position to grow for the retirement income you need. And if you’re not on track to get the retirement income you were hoping for, you can also easily identify and make the necessary adjustments you need to get there.
It will be a comfort for savers to know that pension funds are well protected in the UK.
In the unlikely scenario that your pension provider will not be able to pay you what’s in your pot, the Financial Services Compensation Scheme (FSCS) could compensate you up to 100% of your pot, as long as your scheme was Financial Conduct Authority (FCA) approved.
If your defined benefit scheme cannot be paid out, there is a specialist fund which can help – the Payment Protection Fund (PPF). If the scheme you paid into was FCA approved, the PPF can compensate you for all of your losses if you’ve reached retirement age, or 90% of a capped amount dependent on your age.
How to withdraw money from a pension fund
You can take your 25% tax-free lump sum, and pay income tax on the rest. If you have no need for a big lump sum, you can choose to take your tax-relief through your withdrawals, known as an uncrystallised funds pension lump sum (UFPLS).
By keeping more of your money invested to grow in the market, you can end up taking more of your money tax free over the long-term. It can also be more beneficial for inheritance tax reasons. If you die before the age of 75, your family can inherit your pension tax free. Thanks to pension freedoms, you now have more flexibility with how you choose to use your personal pension savings in retirement. You can take out an annuity, opt for income drawdown, or even keep all of your money in cash – although few would advise the latter.
Although there are many schools of thought over whether annuities or income drawdown are best for retirement income, both play an important role in reliable financial planning for retirement. Historically, you could only swap your pension for an annuity, which guaranteed you a regular income for the duration of your retirement, expressed as a percentage of the amount you transfer.
As annuity rates are closely linked to interest rates, the returns offered by annuity providers have been low for the last decade. You also only get one chance to buy an annuity, unless you opt for a shorter-term guarantee. Income drawdown gives you a more flexible approach to your income during retirement. By keeping your savings invested in the market, you can dip into your money as you like. You can still take your 25% tax‐free lump sum from the age of 55, paying usual rates of income tax on the remainder.
By keeping your pension invested, you’re hoping your money will continue to grow in value to help offset the impact of inflation – although it can fall in value too. If you’ve got a number of different pensions, you might want to consolidate your savings into one place to lower costs and make your retirement income easier to manage.With a drawdown pension, your savings stay invested until you use them. You decide when and how much you want to withdraw, and are charged income tax on these withdrawals. Your tax charge will be based on the level of your income together with your other taxable income. There’s no minimum or maximum amount you need to withdraw.
Brits deserve flexibility and choice when it comes to their pension, but it’s important that savers fully understand the risks of pension drawdown. You’ll need to work out how much you need to afford the retirement lifestyle you’ve been dreaming of. Once you’ve spent your money, that’s it – you’re not guaranteed an income and will have to rely on the state pension. Income drawdown does allow you to have more control over how you plan to live your retirement, and gives you the option to dip into your funds in an emergency. But it’s important you remember that your pension needs to last as long as you do – retirement can last over three decades depending on how long you live.
There are different charges and you should always shop around to make sure you get the best deal for you and your family.
When can you access your pension?
You can access your pension from the age of 55, although you aren’t required to start withdrawing from your pension at that age. You can even start taking some benefits if you haven’t finished work, which can be helpful if you’ve had to reduce your hours and need some extra income.
Is it possible to withdraw money early?
It is possible to withdraw your pension early, but only for exceptional circumstances. If you have a terminal illness, you may be able to access your funds early depending on the rules of your scheme. If you have less than a year to live and your pension is within the lifetime allowance, then you will be permitted to take the whole pot tax-free, even if you are under 55.
If neither of these situations apply to you, you should not withdraw your pension early. It is possible, but you will be heavily taxed on everything you withdraw – up to 55% in some cases – and you could lose a large proportion of what you have saved.
Tax on pension withdrawal
Aside from your 25% tax-free lump sum, you will be charged on the rest of your pension withdrawal. Tax on your pension works just like tax on earnings – you have a tax-free allowance up to £12,500 a year, and whatever you withdraw or receive on top of that is taxed according to how much you have coming in. In some cases, it is wise to withdraw smaller amounts each year to avoid being taxed at a higher rate.