Pensions

Amongst the more impactful announcements within the Autumn Budget were the proposed changes to the treatment of death benefits paid from a registered pension scheme. From 6^th April 2027, most death benefits and unused pension funds held at date of death will form part of an individual’s estate for Inheritance Tax (IHT) purposes.

This is a significant change from the tax-advantaged position that currently applies. At present, unused pension funds, or remaining pension funds held in Flexi-Access Drawdown, can be passed to beneficiaries at the discretion of the pension trustees, outside of their estate for IHT purposes. This effectively allows unused pension funds to be cascaded through generations and is an effective estate planning tool.

Threat of double taxation

Not only could unused pension fund death benefits be subject to IHT, depending on the individual’s other assets, it appears that the existing tax rules for those drawing death benefits from a beneficiary’s drawdown pot will remain in place. If the pension holder dies before the age of 75, the beneficiary can draw down on the inherited pot without income tax applying to the payments, irrespective of whether the beneficiary draws ad hoc lump sums or a regular income. The situation is very different if an individual dies after the age of 75, where the beneficiary is taxed at their marginal rate of income tax on monies drawn from the pension. From April 2027, the value of the pension could potentially be subject to IHT at 40%, and funds drawn from the inherited pension could then also be subject to higher rate income tax (40%) or additional rate income tax (45%), once drawn, in the hands of the beneficiary. This could potentially lead to a total tax burden of 67% if the pension fund suffers IHT and the beneficiary drawing the pension is an additional rate (45%) taxpayer.

Spousal exemption remains

The position from April 2027 will remain unchanged when pension benefits are paid to a spouse or civil partner, as this will be covered by the IHT spousal exemption. Pensions left in favour of a surviving spouse will not be subject to IHT; however, just as is currently the case with assets other than pensions, the IHT liability will usually arise on the second of a married couple to pass.

Consultation process

It is important to note that the proposed changes do not come into force for another 2 years and 4 months. We therefore feel it would not be sensible to take knee-jerk decisions to adjust your financial plans.

The Government have launched a consultation with industry stakeholders, which will run until January 2025, to iron out how the new rules will work in practice. Any significant change to the proposals is unlikely; however, major logistical challenges remain on how the tax will be collected, and by whom. As the legislation seems to suggest that IHT on pensions will be due within six months of death, this will place considerable pressure on executors and pension scheme administrators to liaise and pay the right amount of tax due, to avoid interest being charged. Many legal experts are suggesting such changes may well introduce further delays to the probate process, meaning that beneficiaries have a longer wait before receiving funds from the estate.

The importance of holistic planning

Whilst no immediate action may be needed, it is important to begin to understand the implications of the new rules on unused pension funds and death benefits you hold. For those with unused pension funds, it will be important to review pension values to determine whether the change in rules alters the potential IHT liability on your estate.

There are a range of options that individuals who are holding unused pension funds could consider in order to mitigate a potential liability. These could include crystallising the pension and making gifts of the Tax-free Cash element, drawing additional income from a Flexi-Access Drawdown arrangement and making gifts out of surplus income or purchasing an annuity. You could also consider planning with other assets held outside of a pension, which could be invested to mitigate the potential IHT liability or look to protection policies.

It is clear that a holistic approach, which is tailored to the individual, will be key to effective planning, as the most appropriate option in each case will depend on the precise composition of assets held, family circumstances, financial objectives and attitude to risk.

The advisers at FAS always take a holistic approach to financial planning. We look at a wide range of aspects of an individual’s financial position, and as an independent firm, we can consider solutions from across the marketplace without restriction. If you have questions relating to the changes announced in the Budget, speak to one of our experienced advisers who will be happy to help.

Each major financial decision that we take throughout our lives will have some form of impact on our financial wellbeing. From the decision to purchase a property and take out a mortgage, to changing careers and other life events, such as divorce or receipt of an inheritance, the choices we make will have some impact on our financial future. Perhaps the most crucial decisions, however, need to be taken when we approach retirement, as actions taken at this time can have lifelong implications. This is where tailored and personal advice on the options open can prove highly beneficial in navigating the right course to take.

Pension Options

As we head towards the end of our working lives, thoughts inevitably turn to the level of income that we can look forward to in retirement, and pensions are likely to form a substantial part of your income when retired.

The full rate new State Pension is now £221.20 a week, although you will need to have accrued 35 years of qualifying National insurance Contributions to receive this amount. It is worth checking your State Pension record with the Department for Work and Pensions, as this can identify any gaps in your record that could be filled before reaching State Pension age. This is currently 66 but will rise to 67 for those born after April 1960, with a further increase to age 68 between 2044 and 2046.

Many individuals would prefer not to work until State Pension Age, and this is where careful planning at an early stage can help you assess your options and make best use of private and workplace pensions accrued during your lifetime, which could, in turn, make earlier retirement feasible.

Taking the time to review existing pension arrangements at an early stage can help identify poor performing investment funds, or recognise opportunities to increase pension saving, which could boost the end value of the pension plan as you reach retirement. It could also provide an opportunity to consolidate and rearrange plans, if appropriate, to benefit from cost savings or access the widest range of options when retired.

When taking a defined contribution pension, it is usually the case that 25% of the value will be available as Tax Free Cash. This is the first of many decisions that need to be reached. Some may decide to use the Tax Free Cash payment to cover existing debts or pay for discretionary expenditure. Some plans allow you to draw Tax Free Cash over a period of time, rather than in a single payment. Depending on the retirement strategy adopted, this could be an effective way of generating a tax-efficient “income” through regular Tax-Free Cash payments.

Deciding on how to draw an income in retirement is a key decision that many find daunting. Many choose a Drawdown approach, where the pension fund remains invested, and income is drawn flexibly to suit your needs and objectives. If funds remain invested after you die, these can normally be paid to a nominated beneficiary. The risk with drawdown is that the invested pension fund is fully depleted during your lifetime, and this is where regular reviews of the investment performance and amount of income drawn are important.

Purchasing an annuity, where the remaining pension is exchanged for a guaranteed income for life, is an option that some prefer, given that this provides a degree of certainty. The downside is that the purchase of a lifetime annuity cannot be reversed, and therefore careful consideration of the benefits and drawbacks need to be taken into account.

The final option is to take out the pension value as a single or series of lump sum payments. Taking this option is rarely sensible, as it will leave no ongoing pension income, and could potentially lead to adverse tax consequences.

Other Income sources

For many individuals, pension income is built from several sources, and whilst pensions form the majority of retirement income, other income streams can help support ongoing living expenses. Some may hold property that is rented out, which provides rental income, which may well be reliable, although such income is normally not tax efficient.

Many individuals hold existing investment accounts outside of a pension. Undertaking a review of such investment plans could prove beneficial in determining whether an income stream can be generated. Use of the annual Individual Savings Account (ISA) allowance can help ensure income is received free of tax.

Finally, some continue to work past their normal retirement age, or look to adopt a phased retirement approach of gradually reducing hours, whilst building up pension income slowly. This can be an effective way of managing income and leaving pensions in place to potentially benefit from further growth.

Watch out for tax

We are all taxed during our working lives, and many will continue to pay Income Tax on pension income throughout retirement. There are, however, steps you can take to look to reduce the tax burden in later life. For example, where income is generated in a flexible manner, the level of income can be tailored to meet your precise requirements without surplus income being generated, on which tax becomes payable.

Seek out personal advice

Planning for retirement is a point where important decisions need to be taken, and  seeking independent and tailored financial planning advice at an early stage is therefore advisable. Every individual’s circumstance, needs and objectives are different, and other variables, such as your attitude to investment risk and personal preferences, are key factors in reaching the right decision for you.

Speak to one of our experienced financial planners, who can help guide you through the retirement planning process.

A recent study published by the Pension and Lifetime Savings Association (PLSA) caught the attention of mainstream media, and turned the spotlight on the need to plan ahead to enjoy a comfortable retirement.

The PLSA have devised three Retirement Living Standards, which help illustrate the level of income needed to provide a Minimum, Moderate and Comfortable retirement. The PLSA suggests that the Minimum level of income covers essential spending in retirement, with limited funds left over for discretionary expenditure. At the other end of the scale, a Comfortable retirement income provides a greater level of financial freedom, and leaves sufficient surplus income to pay for some luxury items.

The reason that the update to the Standards caught the attention of the media is the significant increase in the level of income required at each Standard level over the last twelve months. For a single person, the PLSA research suggests an income of £31,300 is needed to provide a Moderate standard of living in retirement, whereas this jumps to £43,100 for a couple. These figures represent an increase of over £8,000 for a single retiree, or just over £9,000 for a retired couple, in just one year. The increased costs of living, including higher energy and food prices, have naturally fed in to the higher figures, although the PLSA also highlighted the increased cost of holidays, and the cost of providing financial assistance to family members, as contributory factors.

Increased focus on saving

The PLSA survey acts as a useful reminder of the need to plan ahead for the longer term, and to review whether your pension savings are on target to meet your needs in retirement.

Of course, personal pension savings will form part of any retirement strategy; however, the State Pension will also provide a proportion of the target income amount. The triple lock has led to a significant increase in the State Pension, with the hike of 10.1% last year being followed by an increase of 8.5% from April 2024. An individual who qualifies for the full flat rate State Pension will be entitled to £221.20 per week from April, or £11,502 per annum. This falls some way short of the Moderate Living Standards suggested by the PLSA, and highlights the need for individuals to focus on pension saving to meet the shortfall between State Pension provision, and a more comfortable retirement.

Another point to consider is that many individuals do not wish to work until their State Pension age, which is now 67 for those born after March 1961. Early retirement introduces an additional period of shortfall, as years when the State Pension is not payable will need a greater level of funding from other sources, such as personal pensions.

Since the advent of auto-enrolment, most UK employees are enrolled into a workplace pension scheme. Whilst the level of contribution made by employees has increased over time, the statutory minimum level of contribution, at 8% of qualifying earnings, is unlikely to be sufficient to bridge the gap. One worrying statistic highlighted by the PLSA survey is that 51% of those questioned believed the minimum auto-enrolment contributions will be sufficient to provide their required level of target income in retirement. This reinforces the need for individuals to start planning ahead and think realistically about the level of savings needed at retirement.

It’s not just how much you save, performance matters

Whilst the amount that you pay into a defined contribution pension will have a major influence on the retirement income it could provide, it is important not to lose sight of the need to ensure that pension savings are invested in an appropriate manner. Pension savings could conceivably be in place for 40 years, and even longer if a drawdown approach is adopted, and this is a significant period of time over which good performing funds could make a significant difference to the overall pot value at retirement.

Take the example of an individual aged 57 with a pension pot of £100,000. They have 10 years left to retirement and contribute £200 per month gross into a pension. If consistent net investment returns of 4% per annum are achieved on the pension savings, the individual could expect to hold a final pension pot of around £178,000 at age 67; however, achieving consistent net returns of 6% per annum over the same time period could increase the pension pot to around £214,000, some £36,000 higher. Naturally, investment performance is never linear, and returns will fluctuate from year to year; however, this illustration highlights the difference performance can make to the overall pension pot value, and the importance of getting investment decisions right at the outset.

It is also important to review investment decisions regularly to ensure that the portfolio strategy adopted remains sensible, given the underlying economic and market conditions. It is also worth considering whether the investment approach needs to be adapted as you move closer to retirement.

The benefits of planning ahead

One key takeaway from the PLSA survey is that the level of pension income needed for a comfortable retirement is increasing.  Reviewing existing pension arrangements regularly can help ensure that your pension savings are on target to meet your goals, and that pension investments remain invested sensibly to maximise growth potential over the longer term. These are areas where holistic financial planning can add significant value, and help you achieve your objectives.

At FAS, our experienced financial planners can take an unbiased review of your existing pension savings, to advise whether the level of contributions you are making are sufficient, and review existing portfolio strategies to make sure that funds are invested appropriately. Our in-depth ongoing review service will review your pension savings at regular intervals so that you can make adjustments as necessary to help meet your retirement goals. Speak to one of our planners to discuss whether your retirement plans are on track.

Announced in the Spring Budget 2023, the Lifetime Allowance for pension savings will be abolished from April 2024. The Lifetime Allowance is the amount of pension savings an individual can accrue before a tax charge could apply. Transitional arrangements are in place for the current tax year, which means that the existing Lifetime Allowance charge is now set at zero.

The legislation that brings about the permanent abolition of the Lifetime Allowance will introduce a raft of changes to the way that lump sum pension benefits are taxed. As is often the case, the new rules are not straightforward, and present a number of planning opportunities for pension holders in a range of circumstances. We must stress that HMRC are still working with the industry to bring about the final framework for the new rules, and therefore the content in this article is based on our understanding of the rules as they stand currently.

Lump Sum Allowance

From 6^th April 2024, a new allowance, known as the Lump Sum Allowance, will place a limit on the amount of tax-free cash that can be taken from pension arrangements. The Allowance is set at £268,275, and is exactly 25% of the current Lifetime Allowance limit, which is  £1,073,100. Those with Lifetime Allowance protections will have a Lump Sum Allowance based on their protected Lifetime Allowance level.

From 6^th April 2024, whenever tax-free cash is taken from a pension, this reduces the available Lump Sum Allowance. To take account of payments of tax-free cash made before 6^th April 2024, 25% of the amount crystallised when taking benefits will be used. This produces a monetary amount that is deducted from the new Lump Sum Allowance. If the individual has used up 100% of their Lifetime Allowance, then they will be deemed to have no available Lump Sum Allowance remaining.

Further Tax Free Cash available?

The new rules may present an opportunity to draw further tax-free cash from a defined contribution pension scheme for individuals with specific circumstances. The starting point on the Lump Sum Allowance is to assume that everyone who took pension benefits prior to 6^th April 2024 received 25% of the value of their pension as tax-free cash. Whilst this applies to most individuals, there are situations when this may not have been the case.

Those with Defined Benefit (Final Salary) pensions may have received less than 25% of the value of the pension as tax-free cash, either due to the way the scheme is structured, or if they decided to take full pension income and not draw available tax-free cash. Further tax-free cash could be available; however this may only be useful if an individual is close to the Lump Sum Allowance, and would otherwise not be able to receive 25% of a further crystallisation as tax-free cash.

Those who could benefit from the new rules can apply for a Transitional Tax-free Amount Certificate from their existing pension provider. Pension holders will need to obtain evidence from the scheme where the additional allowance was created, to support their claim.

Lump Sum and Death Benefit Allowance

The other key part of the new pension regime is the new Lump Sum and Death Benefit Allowance (LSDBA). From the start of the new tax year, an individual will have a LSDBA of £1,073,100, although those holding transitional protections may have a higher allowance. This allowance is designed to cover lump sum payments made during an individual’s lifetime, and in addition, also covers lump sum payments paid on death of the individual. These payments include Defined Benefit lump sums and Uncrystallised lump sum death benefits. Any lump sum payments made during an individual’s lifetime, or to beneficiaries, above the LSDBA, will be taxable at the individual, or beneficiary’s, marginal rate of tax.

The important point to note here is that the rules apply to lump sums only. In the case of a Defined Benefit pension, or some Defined Contribution schemes, the only option open to beneficiaries is to receive a lump sum payment. This could potentially mean that beneficiaries become liable to tax if the LSDBA limit is breached.

Individuals holding modern Defined Contribution pensions should be able to avoid any adverse consequences of the LSDBA, if the pension arrangement offers Beneficiary Flexi-Access Drawdown. Payments made under beneficiary drawdown are not lump sums, and therefore benefits are not tested against the LSDBA.

Do you need to take action?

The final framework of the new pension rules is still in the process of being ironed out, and there could be further revision to the draft legislation before the end of the tax year. Our initial assessment of the draft framework is that the changes are likely to affect a relatively small number of individuals with specific circumstances.

Some pension holders could be entitled to additional tax-free cash, in particular if they have taken benefits from a Defined Benefit pension and did not draw the maximum available tax-free cash. Those with specific pension protection may also need to check to see whether the new rules carry any implications for existing defined contribution pension arrangements.

In addition, the new Lump Sum and Death Benefit Allowance could lead to more beneficiaries paying tax when receiving pension benefits following the death of the pension holder; however, this can normally be avoided by ensuring that Beneficiary Flexi-Access Drawdown is an option under the pension contract. It is important to note that not all pension arrangements offer Beneficiary Flexi-Access Drawdown and it is therefore worth checking that this is an option under an existing pension plan. If it is not an option, it may be worth considering whether the existing pension arrangement is appropriate, and if any action is needed to move the pension to an alternative plan.

It has always been important to complete an Expression of Wish declaration on a Defined Contribution pension, to guide the pension trustees on who you would like your pension benefits paid to. The new rules only strengthens the need to ensure a valid nomination is in place, so that the option to draw benefits under Beneficiary Flexi-Access Drawdown is available.

Speak to one of our experienced advisers to discuss the implications of the new rules on your pensions and whether you need to take any action.

It doesn’t matter the size of your pension pot, it’s important to review your personal pensions on a regular basis, to ensure everything is still on track to meet your objectives at retirement.

For most people, their personal pension is one of the biggest financial investments of their lifetime, second perhaps only to their investment in the family home. The contributions made to a pension over a lifetime can accumulate into a significant pension pot, which can help provide a pension income at retirement. Unlike a family home, however, where most people will undertake regular maintenance to ensure their home remains in good order, many people pay little attention to the progress of their pension plans as they go through their working life. The result is that underperforming pension funds could be left in place for an extended period of time, or excessive charges are allowed to eat away at the value of the pension.

Why is it important to regularly review existing pension plans?

We often come across clients who have held pension arrangements for 20 years or more, and it is important to recognise the significant changes that have occurred in the pension industry over this period. Pensions have become more sophisticated, more transparent, and far more competitively priced, and the most appropriate solution available on the market decades ago may well lack the features and efficiency of modern pension contracts.

The range of investment options available within a pension has increased dramatically in the last couple of decades. Most modern pension contracts offer a wide range of fund options, providing the scope to tailor an investment portfolio to your precise requirements. For example, this includes the ability to adapt a portfolio to meet ethical considerations, if preferred.

How you choose to take your pension benefits has also evolved, with the pension freedom rules introduced in 2015 now giving far more flexibility and greater choice. Many older pension contracts have a very limited menu of options open when taking benefits, whereas the new pension freedoms allow Tax Free Cash to be drawn as best suits the individual, and provide the ability to draw pension income flexibly to meet exact income requirements. This can also provide greater tax-efficiency and allow pension plans to adapt to a change in circumstances over time.

The price of inaction

Many older style pension contracts carry management fees that are expensive when compared to more modern pension plans that are available. These additional fees can mount up over the years a pension is in place and eat into potential returns.

The performance of pension funds in older style contracts may also not be up to scratch when compared to the performance of other funds with similar levels of risk, invested in a similar asset allocation. Insured funds, which formed the basis of many older pension contracts, often produce a poor performance when compared to actively managed modern investment funds, or look expensive when you consider the low-cost passive funds that are now available.

Whilst newer style pension plans are more competitively priced, pension providers have little incentive to lower the fees on older, uncompetitive pensions. They rely on the inertia from their customers, who don’t seek a better deal elsewhere. Holding an older pension contract over your working life could have a negative impact on the value of pension savings over time, and as a result, lead to a lower income when retired.

Is it best to switch pensions? Not necessarily…

When we consider existing pension contracts, we can often identify cost savings, better performing funds and greater flexibility in how pension benefits are drawn at retirement, as being potential reasons why it may be appropriate to consider moving the pension to another provider.

There are, however, reasons why it may be best to leave a pension arrangement in place and firmly underlines the importance of seeking impartial advice on existing pensions before taking action. Expert advice is particularly important when dealing with older pensions, which often come with lots of potential traps you could inadvertently fall into. We can do the work by analysing your pension carefully, to make sure you aren’t hit with costly exit penalties, or where transferring means you risk losing valuable benefits that would be lost on transfer, such as a guaranteed annuity rate. We can help to determine whether it is worth merging some or all of your older pension pots, and to find the right pension to suit your retirement plans and goals.

Arrange a review

Arranging a check-up on your existing pensions can be a sound investment. At FAS, we take the time to understand your existing pension arrangements, and can undertake comprehensive analysis of the performance of existing pension funds, together with a cost comparison against other pension contracts available. We also take the time to get “under the bonnet” to check carefully to see whether the existing pension has any special features, such as guaranteed annuity rates or exit penalties, which could affect our advice. As an independent Chartered firm, we can access competitive modern pension contracts from across the market place to find the most appropriate solution for your needs.

Contact one of our experienced financial planners at FAS to arrange a review of your existing pension arrangements.

Individuals reaching the point at which they want to access a defined contribution pension are now faced with a wider range of options as to how to draw a pension income. The Pension Freedom rules announced by George Osborne in 2014 certainly re-wrote the pension rulebook. From April 2015, those holding a defined contribution pension and aged over 55 have the option of using their pension to purchase an annuity, accessing their pension flexibly to move into Flexi-Access Drawdown or take lump sums. At the time, the new rules were revolutionary, but with the increased range of options, pension holders faced a more complex decision when deciding how best to access their pension.

Eight years on from the introduction of pension freedoms, deciding the best way to access a defined contribution pension remains a difficult decision, which can have far-reaching consequences. For this reason, seeking independent financial advice at this point can assist in reaching the right decision for your circumstances.

Tax Free Cash

It is usually the case that 25% of the value of a defined contribution pension will be available as Tax Free Cash. Many choose to take their Tax Free Cash in one lump sum, which can be used to pay off existing debts or pay for discretionary expenditure. The Tax Free Cash could also be invested, and generate further income from the lump sum payment. An alternative that may not be immediately apparent is the ability to draw Tax Free Cash over a period of time, rather than in a single payment. Depending on the overall retirement strategy, this could be an effective way of generating a tax-efficient “income” through regular Tax Free Cash payments.

Income options

Any amounts drawn above the available Tax Free Cash amount will be liable to Income Tax, and this is where careful consideration is needed in respect of the options available, to find the most appropriate method for your circumstances. For many, using a Drawdown approach can provide a flexible way of providing a retirement income. You can draw an income that suits your requirements, and this can be adjusted as your circumstances change. In addition, any funds remaining in Drawdown at death can normally be paid to your nominated beneficiaries, and the enhanced treatment of drawdown plans on death is one of the major benefits of a Drawdown approach.

Funds in Drawdown need to stay invested and this is both an opportunity and a risk. If pension investments perform well, you could potentially grow the value of your pension at a faster rate than the amount taken via Drawdown; however, if investments do not perform as expected, the pension pot could be depleted, and income payments could stop. These risks can be mitigated by selecting an appropriate rate of withdrawal that doesn’t place excessive pressure on the investment fund and ensuring that pension investments perform well.

The second option is to use the pension fund to purchase an annuity. This is where the remaining pension fund is swapped for a guaranteed income, usually for life. This guarantee provides certainty that the payments will continue no matter how long you live, or how markets are performing. Annuities provide a range of options that allow pension payments to increase each year, thus giving some protection against inflation, and potentially providing an ongoing pension for a surviving spouse in the event of death of the annuity holder. It is, however, important to understand that any additional options selected will reduce the initial payment amount.

The key drawback of an annuity is that once the payments start, you cannot cash in the annuity or alter the terms. This is a critical decision, as you will not be able to adapt your pension income to any change in circumstances. Furthermore, if annuity rates rise in the future, annuities in payment will not benefit from the increase.

Most annuities are arranged on a whole life basis, but there are options to arrange an annuity for a fixed period of time. Depending on the options selected, this can provide a return of capital at the end of the fixed term.

The third and final option is to take a lump sum payment. This is where part or the whole of a pension is drawn as a lump sum, with the first 25% of the payment being taken as Tax Free Cash and the remainder being liable to Income Tax. The major drawback of this approach is that drawing funds in a lump sum will provide no ongoing income, and in addition, the lump sum payment is made in a single Tax Year, which can have adverse Tax implications.

A further element to consider is that you do not have to adopt the same approach with the whole of a defined contribution pension. You can adopt one or more of the pension income options to find the right balance for your personal circumstances.

Which approach is right?

The short answer is that all of these options could be appropriate, depending on your needs, objectives and wider financial planning considerations. This is why seeking personalised, independent advice can help you work through the options and begin to establish a plan that works best for you. A further complication is that not all pensions provide access to every option available under the Pension Freedom rules. It may, therefore, be a wise decision to consolidate or transfer pensions prior to retirement in order to benefit from the whole range of options available, and also access a wider range of investment fund options and competitive terms.

Speak to one of our experienced advisers, to start a conversation about your existing pension arrangements, and the options open to you when deciding how to draw an income in retirement.

Amongst the announcements in the March Budget, was an overhaul in pension contribution allowances, which became effective from April. The new rules allow a higher level of contribution each tax year without incurring an excess tax charge and provide valuable planning opportunities for those wishing to boost their pension savings, and in turn improve their long-term financial security. Furthermore, the new rules also allow further accrual for those who have already accessed their pension flexibly.

The benefits of pension saving

It is worth revisiting why pension saving is such a crucial element of any long-term financial planning strategy. Firstly, your contributions receive a boost from tax relief. When you pay into a pension, you receive tax relief at your marginal rate on any regular or lump sum contributions you make. Secondly, in the case of a Defined Contribution pension, all growth within the plan is exempt from Capital Gains Tax and income received is also not liable to Income Tax or Dividend Tax. Finally, you usually have the option of taking up to 25% of the value of the pension savings as Tax Free Cash once you reach the age of 55 or above.

Annual allowance increase

The annual allowance, which is the maximum amount an individual can contribute to a pension in a tax year before being subject to a tax charge, has been increased from £40,000 to £60,000, with the change being effective from 6^th April 2023.

The hike in the annual allowance significantly increases the scope for those working to make meaningful contributions each tax year. In the case of members of a Final Salary pension scheme who are higher earners, such as Doctors, Head Teachers and senior Civil Servants, this reduces the likelihood that their accrual in the scheme will breach the annual allowance.

For those with Defined Contribution arrangements, the new increased limit provides the opportunity to increase regular contributions, or boost pension savings through larger lump sum contributions. In addition to the new annual allowance of £60,000, the ability to carry forward unused pension allowances for the last three years remains. As a result, a contribution of up to £180,000 could potentially be made without being subject to a tax charge. This could prove very useful for a business owner or company director, who is looking to use pension contributions as a tax efficient method of drawing funds from their business, or individuals who receive a bonus or have lump sum savings.

Watch out for the tax traps

Whilst the annual allowance has been increased, the earnings cap remains. In other words, to get tax relief, your personal contributions cannot be any higher than your earnings in the tax year in question. The tapered annual allowance also remains in place, and higher earners need to beware of falling into this tax trap. This measure reduces the annual allowance from £60,000 to a minimum of £10,000, if an individual’s total income from all sources in the tax year exceeds £260,000. This is a complex area, and we always recommend that you speak to an adviser if you feel you are in danger of breaching the tapered annual allowance.

Help for retirees

In addition to the increase in the annual allowance, the money purchase annual allowance has also increased, from £4,000 to £10,000. Anyone who has accessed their pension savings flexibly is subject to the money purchase annual allowance for the remainder of their life. The previous limit of £4,000 was very restrictive and the more generous allowance now means that people who have flexibly drawn their pension can begin to accrue meaningful further pension savings.

This may be particularly useful for those who have taken early retirement and wish to return to employment, as they could potentially rejoin an auto-enrolment scheme or workplace pension provided by their employer, with less fear of breaching the money purchase annual allowance.

A tool for tax planning

As well as providing an income in retirement, pensions can also be a clever way of reducing the amount of income tax an individual pays in any one tax year. The bands at which Basic and Higher Rate tax are charged have been frozen since 2021, and the Additional Rate band, where income above this level is taxed at 45%, was reduced from £150,000 to £125,140 from April. Given that inflation is pushing wages higher, this creates an effect known as “fiscal drag”, where the exchequer receives more tax revenue due to the bands remaining static.

Personal pension contributions are a useful way of reducing the amount of income tax paid by an individual. The amount contributed has the effect of extending the tax bands, so that more of the income falls into a lower tax band. This is particularly important for those who fall into the tax trap where income is between £100,000 and £125,140. As the tax-free personal allowance (i.e. the amount an individual can earn before they pay income tax) is tapered above £100,000, the potential tax saving on pension contributions can be as high as 60%.

Always seek advice

The more generous allowances provided in the Budget earlier this year have increased the ability for individuals to save more into their pension, and in doing so, can help offset the impact of the frozen tax bands. There are, however, traps to catch the unwary, such as the tapered annual allowance and money purchase annual allowance, and we therefore always recommend individuals seek advice on the most appropriate way to contribute to a pension.

Please do get in touch here if you require pension planning advice from one of our experienced independent financial advisers.

When we first meet business owners, we often find that they view pension planning as a low priority, and we do come across business owners who have no pension provision at all. This is in contrast to those who are employed, where most are auto-enrolled into a workplace pension scheme, and therefore automatically accumulate savings towards their retirement. This is not the case for business owners, who need to take action to pay funds into a personal pension, and far too often this option is overlooked. There is, however, every reason for business owners to make pension contributions, as this is a tax-efficient way of drawing funds out of the business.

Salary or dividends

Directors of limited companies tend to draw income as a mix of a small salary, which is often somewhere between the level above the Lower Earnings Limit for National Insurance, but below the Personal Allowance above which Income Tax is paid, with the remainder drawn as dividends. In practice, this means that most Directors draw a salary between £6,396 and £12,570 in the current Tax Year. As pension contributions are limited by salary, this restricts the ability for a director to make meaningful personal pension contributions. It is important to note that dividends are not deemed “relevant earnings” and cannot be treated as income for the purposes of personal pension contributions.

Employer contributions

Whilst personal pension contributions are limited, a powerful tax break can be used that enables directors to receive contributions into their pension over and above the level of their salary. Directors of a limited company can benefit from their employer/employee relationship and opt to make contributions as an employer pension contribution, which is paid by the company from pre-tax company income. As the contributions are not made by the individual director and therefore are not limited by their salary, the full Annual Allowance is available. This is £40,000 in the current Tax Year, but will increase to £60,000 from 6^th April 2023, although the Annual Allowance can be reduced if an individual is a higher earner (and therefore subject to the Tapered Annual Allowance) or has previously accessed pensions flexibly (and is therefore subject to the Money Purchase Annual Allowance).

Tax savings

If a Director was to draw £10,000 from their business in additional dividends, this would be taxed at 8.75%, 33.75% or 39.35%, depending on the other income earned in the tax year in question. Arranging an Employer Pension Contribution would mean that the full £10,000 would be paid into a pension. A further tax saving should follow in the form of Corporation Tax relief on the amount contributed. Assuming the contributions are deemed as being exclusively in respect of your business trade, they can be classified as a legitimate business expense. This could mean a further saving of between 19% (the current rate of Corporation Tax) and 25% (the new highest rate of Corporation Tax in the next tax year).

What level of contribution?

The level of contribution made by a limited company on behalf of a director needs to pass a number of tests to ensure that the level of contribution is commensurate with the total remuneration, e.g. salary, dividends and benefits in kind, that are received by the director. This is where an Accountant can provide the necessary guidance that any employer pension contributions arranged would be deemed acceptable by HMRC.

Carry forward

Directors can also make use of the carry forward rules, to potentially make larger contributions than the Annual Allowance, by carrying forward any unused allowance not used in the preceding three tax years. This potentially means that a director could contribute up to £180,000 from 6^th April 2023, although there are two key caveats. Firstly, an individual would need to have held a qualifying pension in the tax year from which an allowance is carried forward and secondly, a contribution of this level may not be deemed acceptable under the “wholly and exclusively” rules. It could be the case that the tax relief would need to be spread over a number of tax years , rather than being relievable in the year that the contribution is made.

Investment options

Whilst employer pension contributions are a very tax efficient way for directors to draw funds from their business, how the pension contributions are invested will determine the level of growth achieved and ultimately be the major deciding factor as to the level of retirement income that can be enjoyed. This is where adopting an appropriate investment strategy and regularly reviewing the performance of investments put in place are both crucial elements of effective pension investment. As an alternative to pension investments, some directors use a Self Invested Personal Pension (SIPP) to invest in their commercial premises, which is a permitted investment for pensions.

Potential pitfalls and the need for advice

Whilst directors should make use of pensions as a very tax efficient method of extracting funds from their business, obtaining the right advice is key to avoiding the potential pitfalls, such as breaching the Annual Allowance, or arranging contributions that fail to attract Corporation Tax relief. As each company’s circumstances are different, obtaining individual and tailored advice can help maximise the tax advantages and avoid potential issues.

At FAS, we regularly provide advice to business owners and directors across Kent, London and the South East. Speak to one of our experienced Financial Planners here if you would like to review the options open to you and your business.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

The Pension Freedom rules, announced in the 2015 Budget, provided those with Defined Contribution pensions with much greater flexibility and choice as to how to draw their pension. Alongside the announcement of the new rules, the Government launched the Pension Wise service, which provides free and impartial guidance and information for those approaching retirement.

Pension Wise appointment

Anyone aged 50 or over, with a UK based Defined Contribution pension, can book an appointment through the Pension Wise service. The appointments last around 60 minutes and are carried out over the phone or face-to-face through Citizens Advice delivery centres. The purpose of the appointment is to go through the various ways you can access your pension savings and will also cover the tax implications of each option. It will also explain the ability for the pension holder to shop around, particularly in relation to the purchase of pension annuities, and help the user identify pension scams and avoid becoming a victim of what is sadly a growing trend.

Pension providers are now compelled to nudge consumers towards Pension Wise when they make direct contact with a provider to access their pension savings. Prior to June last year, pension providers were only compelled to signpost the Pension Wise service to those accessing their pension; however, the rules have been strengthened, so that the consumer who approaches a pension provider directly must be referred to the Pension Wise service prior to being able to access their pension.

What to do next

It is clear an appointment with Pension Wise may be a positive step and a way of arming yourself with information as to the options that are open to you. However, it is at this point that the crucial decisions need to be taken, where signposting and generic guidance won’t provide the answers.

The introduction of the Pension Freedom rules has undoubtedly been a success and put the control in the hands of individuals as to how they access their pension pot. However, the rules are now significantly more complex, and there are many variables to consider that a guidance service simply can’t take into account. Furthermore, depending on the action taken with the accumulated pensions, there may be no way of undoing a mistake which could prove costly over the long term. This is where independent and holistic advice can help you take the right decisions.

Looking to the long term

One of the first areas to consider is how your pensions are currently invested, and this is beyond the scope of a Pension Wise appointment. Flexi-Access Drawdown remains a very popular way of drawing benefits and this will mean that the pension remains invested for the long term. It is, therefore, crucial that the funds in which the pension pot is invested perform well and offer good levels of diversification. This is where a clear, defined investment strategy provides a significant advantage, although any investment strategy put in place should be reviewed regularly to ensure that the plan remains appropriate for your evolving needs and objectives.

Many people acquire a series of workplace pensions throughout their lifetime and holding multiple plans can make successful investment planning all the more difficult. One option is to combine plans into a single arrangement, and whilst this often provides advantages, it isn’t right for everyone. This is where taking tailored advice, rather than relying on guidance, can look at the specific options and advise on the right path to take.

Watch out for pitfalls

Different pension schemes and arrangements have varying rules, depending on the scheme. Some older style pensions, in particular, carry valuable benefits, such as enhanced Tax-Free Cash, guaranteed annuity rates or growth rates. This may not be immediately apparent from communications received from the pension provider and discovering the finer details of a pension arrangement is an important step to take before looking to draw benefits from a pension. Taking individual advice can discover all aspects of an arrangement and potentially avoid losing a valuable benefit by taking the wrong course of action.

The tax trap

The tax treatment of pension arrangements carries several traps, which the unadvised pension holder could easily fall down. For example, drawing a flexible income could mean that limits are imposed on making further contributions. Pension holders may also wish to access tax-free cash but taking an income may have an adverse impact on their tax position if they are still working. This is where a guidance service can only go so far and is no substitute for personalised advice.

Guidance is limited

Whilst a useful starting point for those approaching retirement, it is important to recognise that a Pension Wise appointment can only offer guidance on the options available. Pension Wise cannot provide advice, which is bespoke and takes into account your personal circumstances. This is where someone who has used the Pension Wise service may question their next steps and moving on to seek independent advice can help structure pension arrangements to suit the retirement you are aiming for.

Please speak to one of our experienced advisers who can provide the right advice tailored to your specific aims and objectives, here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

Using a pension is a highly tax-efficient way of saving for retirement. Whilst there is no limit to the amount of pension savings that can be built up by an individual, any pension benefits drawn above a stated level are liable to an additional charge to tax. This is known as the Lifetime Allowance, and the allowance currently stands at £1,073,100.

History of the Lifetime Allowance

The Lifetime Allowance was introduced in 2006, and prior to this date, there was no limit placed on the value of pension savings. When introduced, the allowance was initially set at £1.5m and as one might expect, with prices rising over time, the allowance increased to £1.8m in 2012. This was, however, the highest allowance provided, and the allowance was subject to a number of gradual reductions to stand at just £1m by 2016. The allowance slowly increased in line with inflation after this date but was frozen at the current level in 2020. The Budget in March 2022 confirmed this freeze would remain in place until the 2025/26 Tax Year, which will lead to a further real terms reduction in the allowance, when adjusted for inflation.

How to value a pension against the allowance

For those with Defined Contribution pensions, considering the current value of pension savings against the allowance is relatively easy. However, calculating the value of final salary (defined benefit) pensions for lifetime allowance purposes is not so straightforward. For this type of pension, the annual pension accrued is multiplied by 20, although if a separate lump sum is provided by the scheme at retirement, this also needs to be taken into account.

Testing against the allowance

The value of pension savings is tested against the Lifetime Allowance when you start drawing a pension. In the case of a Defined Benefit pension, this will be when the pension comes into payment. For Defined Contribution pensions, this is on each occasion that income, or a lump sum, is taken from the pension. The allowance is also tested if you reach the age of 75 and have pension savings that have not been drawn, or if an individual dies before the age of 75 and hasn’t drawn their pension savings before death.

What is the charge

If your pensions are collectively worth more than the Lifetime Allowance when drawn, you are likely to face an extra tax charge. What this charge will be, depends on how much you exceed the limit by, and also the method by which you draw your pension. If the amount above the allowance is taken as a lump sum, the tax charge on the excess is 55%, or if the excess is taken by way of pension income (for example via drawdown or an annuity) the tax charge is 25%, which is added to any income tax due on the pension income drawn.

Planning ahead

As pension values increase, it is important that individuals consider whether they are likely to face a Lifetime Allowance charge. This is where future planning can be helpful, as an estimate of the likely position at retirement can be calculated by considering an estimate of the likely contributions that will be made in the future, and what growth could be achieved (in the case of a Defined Contribution pension) on the value of the existing pension pot.

Protections exist that enable an individual to benefit from a higher Lifetime Allowance, although there are strict criteria that need to be adhered to in order that the individual benefits from the protection.

Criticisms of the Lifetime Allowance

As tax relief is provided on contributions into a pension, it is reasonable that legislation places certain restrictions to avoid the pension system becoming too generous and costly to the Exchequer. The Lifetime Allowance, however, has long been the subject of criticism, as being punitive and a disincentive to long term saving.

One reason is that the allowance can be considered as a tax on growth, as the value of the pension pot is measured against the allowance when benefits are drawn, with no reference to the amount contributed into the pension.

The Lifetime Allowance has also been cited as a major reason that highly experienced medical professionals are opting to take early retirement. Given that many will breach the Lifetime Allowance by the time they reach 55, highly paid professionals may look to reduce their hours, or leave the profession altogether.  This doesn’t only affect the NHS, it also has an impact on individuals working in other skilled professions, for example the judiciary.

Holistic planning can help

For those who are already affected or may become liable to a Lifetime Allowance charge in the future, there are a range of options that can be considered, including ceasing or restricting contributions or reducing hours (or potentially taking early retirement). For others, it is best to approach the situation by considering methods of mitigating the tax charge that will apply on taking benefits. The crucial point is that one size certainly does not fit all, and this is where independent, holistic advice – taking into account all aspects of an individual’s circumstances – can be beneficial.

It is also important not to leave planning too late, as this affords time to make appropriate decisions.

If you expect to be affected by the Lifetime Allowance or would like to review your existing pension arrangements, please speak to one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.