Pensions

With the appointment of Rishi Sunak as Prime Minister, attention has turned to the potential tax increases and cost savings that may be needed to balance the books. The anticipated fiscal statement, which was first scheduled for 31^st October, has now been upgraded to a full Autumn Statement, to be delivered on Thursday. One of the possible contentious decisions to be reached by the Chancellor will be the level of increase in the State Pension from April 2023.

History of the Triple Lock

Since 2010, the annual increase to the State Pension has been subject to a “Triple Lock”. This is a guarantee that the annual increase would be calculated by the greater of the Consumer Price Index (CPI), average earnings, or 2.5%. This has ensured that the State Pension has kept up to date with rising prices since 2010, and the additional guarantees provided by the Triple Lock has given further protection in periods when inflation has been low. For example, in 2014-16, when annual CPI fell below the 2.5% level, the minimum lock at 2.5% provided an increase in the State Pension above the prevailing rate of inflation.

The rate of CPI inflation used to calculate the increase to the State Pension is the CPI annual rate as at the September preceding the date of the increase. For the increase due in April 2023, the September 2022 CPI figure of 10.1% will be used.

How State Pension is calculated

The amount of State Pension to which an individual is entitled depends on their National Insurance contribution record. This includes contributions made through work, and contributions added when an individual is unable to work. You need 35 qualifying years of National Insurance contributions to get the full amount, and a minimum of 10 qualifying years are needed to be entitled to any level of State Pension.

Credits earned before 6^th April 2016 are treated differently to those earned after this date. At the point at which an individual reaches State Pension age, a “starting amount” is calculated, which is the larger of the pension you would receive under the former State Pension system, or the new State Pension, which currently amounts to £185.15 per week. It is, therefore, possible that the entitlement under the former system provides a greater entitlement than the new State Pension, and this amount is protected, and paid on top of the new full State Pension.

How to check your State Pension entitlement

It is a good idea to obtain a State Pension forecast, which provides an indication of the likely State Pension to which you will be entitled. You can either obtain a forecast from the Government Gateway, or submit form BR19 to the Department for Work and Pensions. The forecast will also provides details of the qualifying years on your National Insurance record, from which you can identify any gaps in the record.

If there are any gaps, an individual can make voluntary National Insurance contributions, which can make up for years where a full contribution was not made. Individuals can make contributions to catch up any gaps in their record during the last six years, and the Government’s Future Pension Centre will be able to provide details of the cost of the voluntary contributions.

It is often the case that making voluntary contributions, where necessary, offers good value for money. However, each individual needs to consider their own position to determine whether it is worth making voluntary contributions.

Increasing retirement age

The age at which individuals are entitled to their State Pension remains under review, after a number of changes over recent years. Under the current legislation, State Pension age is currently 66 and this will gradually rise to 67 for those born on or after April 1960. A second increase is also scheduled, to age 68, between 2044 and 2046 for those born on or after April 1977; however, there have already been consultations, which have looked at bringing this date forward to between 2037 and 2039. A further announcement is due on the proposed changes by May 2023.

Build your own provision

Whilst the State Pension is available to all individuals with sufficient National Insurance contributions, relying on the State Pension alone is likely to lead to a very modest retirement. This is why we strongly recommend individuals look to make their own pension provision, to supplement the State pension payments. Most employees are now eligible to join auto-enrolment pension schemes, although it is important to ensure an adequate level of contribution is made, and your pension is invested in good performing funds.

Another reason to build personal pension provision is the increase in the State Pension age over coming years. Whilst average life expectancy has risen steadily over recent years, working right up to State Pension age may not be desirable or indeed practical. For example, depending on the nature of the job, ill health could force an early retirement, and by using the flexibility offered by personal pensions, it may be possible to look to draw a pension in the years leading up to State Pension age, allowing a reduction in hours or potentially an early retirement. Whether this is feasible depends on many factors, and this is where personalised financial advice can help you plan ahead for the future with confidence.

If you are interested in discussing the above further, 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.

When saving into a pension, the primary objective is to look to provide an income in retirement. In our experience, when first meeting clients, many have not considered what would happen to their pensions in the event of death.  It is quite normal for individuals to have built up pensions through different types of schemes and arrangements during their working life, which can add to the confusion, as different pensions may well be treated differently on the death of the pension holder. Taking the time to understand how the pension will be treated on death is an important step to successful planning, and this is an area where independent financial advice can add significant value.

Final Salary benefits

For those individuals holding Defined Benefit (i.e. Final Salary) pensions, the treatment on death will normally depend on the scheme rules. It is normal for the pension to provide an ongoing pension to a dependent on death of the pension holder, which is usually a surviving spouse, or potentially any children aged under 23. Often this will provide 50% of the annual pension to the dependent, although it is important to check the scheme carefully to determine the precise rules that apply to that scheme.

Pension Freedoms and Defined Contribution pensions

The death benefit rules for Defined Contribution pension arrangements changed significantly in 2015, with the age at which the pension holder dies being the determining factor as to how the pension is taxed in the hands of beneficiaries. Prior to 2015, whether money had been taken from the pension or not was used to determine how the pension benefits were taxed.

Under the new rules, if an individual dies after the age of 75, the fund can be paid to a beneficiary as a lump sum, annuity or a drawdown pension. Any funds drawn will be taxed at the marginal rate of the beneficiary. In other words, if the beneficiary is a basic rate taxpayer, assuming the pension income doesn’t push the beneficiary’s overall income above the higher rate threshold, the income will be paid net of 20% tax.

If the pension holder dies before the age of 75, the same options – lump sum, annuity or drawdown pension – remain; however, the main difference is that the payments will be made entirely tax-free.

For beneficiaries in receipt of pension death benefit rights, the options open can appear daunting, and we recommend beneficiaries look to take independent advice which is tailored to their specific circumstances. Often, the decisions could trigger unforeseen tax consequences, and there could therefore be a cost of not considering the various outcomes carefully before proceeding.

A final test

The Lifetime Allowance is the maximum permitted level of pension savings an individual can accrue before a tax charge applies, and currently stands at £1,073,100. If a pension holder dies before the age of 75, this triggers a test of the Lifetime Allowance and if the deceased pension holder breaches this Allowance, a tax charge will apply. How the beneficiary receives the pension has an impact on the level of tax charge that will be levied on the pension, and again this is a point that needs consideration by beneficiaries.

Make sure nominations are up to date to avoid death benefit pitfals

A very common misconception is the beneficiary of a Defined Contribution pension follows the wishes set out in an individual’s Will. This is not the case, and pension trustees will consider a Nomination or Expression of Wish completed by the pension member. The pension trustees have the ultimate discretion as to whom pension death benefits are paid; however in practice, assuming a Nomination has been made on the pension, the trustees will pay to the nominated beneficiary or beneficiaries, unless there is a good reason why they should consider someone else.

It is important to make sure that Nominations are up to date on a defined contribution pension arrangement, so that they continue to reflect an individual’s wishes. A new Nomination can be completed at any time that overwrites the existing Nomination held by the pension company.

Passing assets down the generations

Pensions have always proved to be a very tax efficient way of saving for retirement. In addition, they can also be a very effective method of passing assets to the next generation without a potential charge to Inheritance Tax applying to the value of the pension. As a result, pensions often play an important role in wider financial planning when estates could become liable to Inheritance Tax in the future.

The importance of advice

The rules around death benefits paid by pensions are complex. For Defined Contribution pensions, the introduction of the pension freedom rules in 2015 have led to a number of distinct opportunities to make tax efficient decisions that can have a significant impact on the level of income received by a beneficiary and the amount of Tax deducted from the pension payments. When beneficiary drawdown is selected, regular reviews of the rate of drawdown and investment strategy employed can maximise the potential for the pension to provide the beneficiary with income for the long term.

It is also important to tackle these issues shortly after the death of the pension holder, in particular if they died before the age of 75. Failure to take the appropriate action within two years of the scheme being notified of the death can lead to a potentially tax-free payment becoming taxable.

As we have demonstrated, there are many considerations in dealing with a pension in the event of the death of the pension holder. Taking practical steps to review existing arrangements can help you understand how the particular pensions will be treated.

If you would like to review your existing pension arrangements, then contact 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.

The pension freedom rules introduced in 2015 have been an undoubted success, allowing individuals to access their pensions in a far more flexible manner than ever before. However, drawing taxable income for the first time, or taking an ad-hoc single payment of income, from a plan held in Drawdown, can create a tax issue where H M Revenue & Customs deduct more Income Tax from the payment than is due, leading to a lower net payment than expected. For the unsuspecting pension holder, this can lead to complications, in particular if a net amount of funds withdrawn from a pension is needed for a specific purpose.

Holding the right Code

Unless the Pension provider holds an up to date Tax Code for the individual, the provider will need to tax the payment under a temporary Tax Code, which is known as an Emergency Tax Code. Under this Code, the amount being withdrawn is treated as if it will continue to be paid at the same amount each month, even if this is not the case. The provider will therefore apply 1/12th of the personal allowance (£12,570 in the current Tax Year) to the payment, and will assess the remaining payment against 1/12th of each of the income tax bands currently in force (i.e. Basic Rate at 20%, Higher Rate at 40% and Additional Rate at 45%).

For many this calculation will lead to an overpayment of Tax. Take the example of an individual who withdraws £20,000 from an uncrystallised pension as a lump sum. Their only other income is their State Pension of £12,570, which conveniently matches their Personal Allowance. The first £5,000 of the pension payment will be paid Tax Free (as this represents the 25% Tax Free Cash available on the amount crystallised) and the remainder of the payment should be taxed at Basic Rate Tax (i.e. 20%) which would lead to a total net payment after Tax of £17,000.

Instead of paying £3,000 in Income Tax, if the payment was taxed under an Emergency Tax Code, this could lead to a Tax charge of £5,025, resulting in a net payment after Income Tax of £14,975 – some £2,025 lower than if the correct amount of Income Tax had been deducted.

Doing the maths

It is important to point out that a refund of overpaid Tax is normally automatically paid at the end of the Tax Year. However, if you are seeking to withdraw a fixed amount from a Drawdown pension for a certain purpose, if Emergency Tax is applied then the net result could leave the withdrawal short of the amount required.

When considering a withdrawal from a pension, it is therefore important to consider the tax implications of how the payment is to be treated. You can contact the Pension provider in advance and check the Tax Code that the provider holds for you prior to making a decision to withdraw, although it is important to note that the provider has no discretion as to which Code to apply and must use the Code supplied by H M Revenue & Customs.

An alternative is to withdraw a smaller amount from the pension first, upon which the Emergency Tax Code is applied, and then withdraw the remainder of the required amount once H M Revenue & Customs have supplied a new correct Tax Code, which will be triggered by the smaller pension payment. Whilst this is a sensible step in theory, there will inevitably be a delay until the new Code is issued, which may not be practical if funds are needed in the near future.

If a payment has been made with Emergency Tax Code applying, it can be a good idea to claim funds back quickly following the payment. If the pension withdrawal is made in April or May, for example, not taking any action to reclaim the overpayment of Tax could lead to a wait of 11 months or more for a refund. Conversely, taking a pension withdrawal for the first time, or a lump sum, in March, would normally mean a refund of overpaid Tax would arrive in a matter of weeks.

Claiming a refund

Given the number of individuals falling into the Emergency Tax trap, H M Revenue & Customs have a rapid refund system, which aims to pay back the overpayment quickly once the correct form has been submitted. These forms are relatively simple to complete and whilst the forms are an additional step that requires action on the part of the taxpayer, this process does at least provide the opportunity to make a claim for the overpayment of Tax quickly.

Let us guide you through the process

The complexities of the Tax treatment of pension withdrawals is one of a number of reasons why sound independent advice can add value for those using a drawdown pension to help fund their retirement. The pension freedoms have provided greater flexibility but also increased the responsibility of individuals to manage their accumulated pension savings appropriately and to their best advantage for the long term.

At FAS, we can provide impartial advice to those considering retirement, or reaching retirement age, on the benefits and drawbacks of a Drawdown approach, and on other options such as annuities. For those already holding a pension in Drawdown, we can review the overall strategy and investment options with the aim of managing the withdrawals effectively throughout retirement.

If you would like to discuss your requirements further then speak to one of our 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.

The Pension Freedom rules introduced in 2015 opened up many new possibilities for individuals to flexibly access their pension savings. The new-found freedoms have generally been popular, although the increased choice has been accompanied by added complexity, given the increased number of options now available. As a result, getting sound advice when nearing retirement has become even more crucial, as these key planning decisions may well have an impact on the income received for the remainder of your life.

To help those reaching this crucial planning phase, the government introduced the Pension Wise service alongside the new pension freedoms. Pension Wise is a government service that offers free, impartial pensions guidance in respect of defined contribution pension options. Users of the service can access a phone or face-to-face appointment at which guidance is provided in relation to the options available, how benefits will be taxed, and how to be aware of pension scams.

Pension trustees and providers have been obliged to make individuals aware of the Pension Wise service since the introduction of the new rules. From June 1^st, new legislation has been introduced which places greater emphasis on “nudging” individuals thinking about drawing or transferring flexible benefits, to seek guidance from Pension Wise. The new regulations require providers to offer to book an appointment for the member and the provider can block any action to draw benefits until an appointment has been attended or the individual opts out of the guidance process.

These new regulations do not apply to those individuals who have received regulated financial advice, as Pension Wise is designed primarily to help guide those who approach pension providers directly. Likewise, an individual is able to opt out of the Pension Wise guidance completely, although they will need to make a clear election to this effect.

Pension providers have indicated these additional steps may further slow the time taken to arrange transfers of pension benefits or lead to increased delays where individuals wish to access their pensions flexibly.

Guidance, not advice

Users of Pension Wise have generally felt the service is worthwhile, although there have been criticisms levelled at the service, with some users pointing out the sessions are little more than the representative setting out generic information about each of the options that are open at retirement. This is where the limitations of Pension Wise really become apparent, as it is a guidance service only, without the ability to offer advice that is tailored to an individual’s needs and objectives.

Reaching a decision to consider retirement is perhaps the single most important point at which financial advice should be sought. At this point, decisions reached and actions taken could have implications for the next 30 years or more, and it is therefore vitally important that the advice received takes into account all aspects of an individual’s financial circumstances.

One size doesn’t fit all

Pension Wise sessions may be helpful in providing a generic background and useful information, but if you consider the range of options provided by different pension schemes, it becomes clear that guidance is no substitute for tailored advice.

When meeting new clients for the first time, we often see the situation where a number of pensions have been accrued during their working life, and making sense of the total level of income that could be generated in retirement can be difficult. The ability to draw pensions flexibly – a key advantage of the new pension rules – is not always available through existing pension arrangements. Within some personal pensions, an internal transfer to a drawdown pension may be possible, where other pensions will require a transfer away to an alternative provider to be able to access the pension in a flexible manner.

We encounter many pensions that have enhanced benefits as a feature of the pension, which cannot be ignored. These include guaranteed annuity rates, which are often attractive, or a minimum fund value at retirement. Careful assessment of these factors is vital to ensure that a valuable benefit is not lost.

Seeing the bigger picture

Reaching retirement is a point at which much wider financial planning, in addition to bespoke advice on pension income, is required. Whilst the focus of advice pre-retirement is generally in relation to income production, there are a number of areas that need to be considered at the same time.

Deciding how best to use tax free cash is one such example where advice needs to be tailored to wider financial circumstances. For example, an individual may have outstanding borrowing on their property, which could be paid off by the tax free cash, or the lump sum could be invested to generate additional income in a tax-efficient manner. Alternatively, parents may see this as an opportunity of being able to help the next generation and decisions need to be reached as to how best to gift assets without potential tax consequences.

Inheritance tax planning is also sometimes a consideration, in particular where pensions do not need to be drawn to provide an income. Under the freedom rules, pensions can be very effective planning tools in a wider strategy to mitigate inheritance tax.

Tailored to your needs

Providing more information to those reaching retirement can only be a good thing, although Pension Wise appointments can only give guidance which is not tailored to the specific circumstances and requirements of the individual. In our experience, those nearing retirement are at a crucial point where bespoke financial planning can reap significant benefits in determining the way forward, potentially having an impact for 30 years or more. If you are approaching retirement, speak to one of our experienced financial planners to talk about the options open to you.

If you would like to discuss the above with one of our experienced financial planners, please get in touch 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 circumstances.

At FAS, we meet clients at various stages of life, from those who are working age and looking to plan for the future, through to clients who have already retired and need later life planning. Perhaps the biggest cohort of clients that approach us for advice are those where retirement is beginning to move into focus, and many ask a similar question – when can I afford to retire? Whilst the answer for each individual is different, we look at some of the common themes that anyone in this situation needs to consider.

The cost of early retirement

Under current legislation, the earliest you can access personal or workplace pensions is age 55 (which rises to age 57 from April 2028). For some individuals, it can be tempting to look to take pension income at the earliest opportunity. However, this is rarely a good option, irrespective of the type of pensions an individual holds.

For those that hold a Final Salary pension, the scheme will have rules as to when the pension can be accessed. Often this is set at age 65, although some schemes offer access at 60. Taking benefits early will usually lead to a reduction in benefits for each year the pension is taken early – typically this will be a reduction of around 5% per annum.

For individuals who hold Money Purchase or Defined Contribution Workplace pensions, an option may be given to either purchase an annuity or receive a scheme pension (both of which are progressively less attractive the earlier the pension is drawn, as they will, on average, need to be paid for a longer period of time) or generate a retirement income via Flexi-Access Drawdown. The same applies to personal pensions, and in the case of individuals selecting a Drawdown approach, drawing benefits early will mean that the retirement pot will need to fund retirement for a longer period of time, increasing the potential that the pot becomes exhausted.

Increasing life expectancy

Despite the coronavirus pandemic slowing the pace of increase in UK life expectancy over the last two years, the Office for National Statistics still expects longevity to increase over time. A female who is 40 now is expected to live until an average of 87.3 years, whereas a male at the same age now expected to live until an average of 84.2 years, though many will live for years beyond the expected average age. Along with increasing life expectancy, medical advances may enable people to stay healthier and active for longer, therefore pensions will need to potentially fund lifestyle choices for a greater number of years.

Relying on State Pension provision

The gradual increase in the age at which State Pension becomes payable leads many to consider whether they can afford to retire before they are entitled to their State Pension.

In 2018, the State Pension age for men and women was set at 65; however this has now jumped to 66 for anyone born between 6^th December 1953 and 5^th April 1960, 67 for anyone born between 6^th March 1961 and 5^th April 1977, and 68 for anyone born after 6^th April 1978. However, according to research undertaken by Moneyfarm, the average retirement age in the UK is lower than the current statutory age of 66, at 64 for women and 65.1 for men, which suggests that despite the increasing State Pension age, many will continue to take the opportunity of retiring earlier. Of course, this assumes that individuals are able to fund their lifestyle in the intervening period before they receive their State Pension.

Currently, the basic State Pension is £179.60 per week, for an individual with 35 or more qualifying years of National Insurance contributions, which rises to £185.15 per week from 6^th April 2022. State provision on its own is only going to provide a very basic standard of living in retirement, and may well prove insufficient,  particularly in the early stages of retirement, when many are active and want to enjoy the additional time at their disposal to enjoy hobbies, travel and leisure activities. That is why it is crucial to begin to make your own provision for retirement to make life more comfortable.

How to begin planning ahead

A good way to approach retirement is to start planning as early as you can. Firstly, look to establish a pension and fund this consistently through your working life. When you begin to consider your future plans, and how retirement may look, engage with an independent planner who can assist in looking at the options, seeing where improvements can be made to existing pension arrangements and reviewing investment performance to maximise returns on pension savings.

Individuals can also start considering the amount of income they will need during retirement, in today’s money, to begin to assess the feasibility of early retirement. All regular outgoings and costs need to be taken into account, such as household bills, groceries, transport costs and any outstanding loan or mortgage. In addition, a margin needs to be factored in for additional expenditure, which often arises after retirement. Holidays and travel expenditure, hobbies and leisure and home improvements need to be considered, together with the costs of replacing vehicles and household items over time.

Inflation is also an important consideration and one that is rarely out of the news at the moment. We have been living through a decade or more when inflation has been close to or below expectations; however, with the cost of energy, food and petrol rising substantially, individuals would be wise to place greater emphasis on the impact of increased costs when considering their ability to successfully fund retirement.

Take the first step

Every individual’s circumstances are unique and when it comes to planning for retirement, one size doesn’t fit all. At FAS, we take the time to fully understand your expectations, needs and objectives in retirement, with the aim of providing a plan of action designed to determine your likely income in retirement and whether you can afford to retire early. Speak to one of our experienced advisers to discuss your existing pension arrangements and plans for the future.

If you are interested in discussing the above with one of our experienced financial planners, please get in touch 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 circumstances.

For anyone approaching retirement, making the most of your pension annual allowance is a vital part of your pre-retirement planning. But you may be surprised to learn that individuals are allowed to take advantage of any unused pension allowances from the previous tax years. It’s called ‘carry forward’ and we think it’s a concept that more people need to be aware of.

But let’s take a step back. At FAS, we believe pensions are some of the most tax efficient investment vehicles available. For a start, payments made into a pension automatically qualify for income tax relief. In other words, the government pays you money to encourage you to put more into your pension! Income tax relief is paid at the basic rate of 20%, which means that for every £80 you put into your pension, the government will top this up with another £20. Higher and/or additional rate taxpayers can claim income tax relief at their marginal rate via their tax return, thus further increasing the value of pension planning.

But this generosity does have its limits. For example, pension rules state a person cannot pay more into their pension annually than they have earned. Additionally, to limit the amount of ‘free money’ the government gives to people paying into their pension, it has capped the annual amount an individual can pay in while still claiming income tax relief. For most people with a defined contribution pension, the ‘annual allowance’ places a limit of £40,000 (or 100% of earnings if lower) on the amount a person can place into a company pension (or self-invested personal pension – known as a SIPP) while still being able to claim tax relief. Any amount paid into the pension beyond this threshold is not eligible for relief.

What is the carry forward concept?

While the annual allowance means pension contributions eligible for income tax relief is capped at £40,000 in each tax year, the carry forward concept makes it possible for people to make use of any unused pension allowance not claimed in the previous three tax years. So, if you made pension contributions of £25,000 in each of the previous three tax years, you can carry forward the remaining £45,000 in unclaimed annual allowances (£15,000 x 3) on top of your current tax year allowance.

As you can imagine, this is a very valuable tax break, and one that appeals to individuals who may have sold a business, are close to retirement or hold large sums on deposit they would like to put into their pension. However, carry forward does come with a few conditions that must be met. For example:

• Carry forward can only be used where pension input amounts exceed the standard annual allowance for the relevant tax year.
• You must earn at least the amount you wish to pay into your pension in the tax year you are making the contribution for (so if you, for example, want to make total contributions of £100,000 you must earn at least £100,000 in that tax year). This doesn’t apply if your employer is making the contribution on your behalf.
• You must have been a member of a UK-registered pension scheme (not including the state pension) in each of the tax years from which you wish to carry forward from.
• You must use any unused annual allowance from the earliest year first (you can only go back three years) and can only use it once. This means carry forward cannot be used a second time.

Who fits the profile to use carry forward?

In our experience, carry forward is considered particularly useful for the self-employed, especially those whose earnings fluctuate from year to year, as well as individuals planning on making a large pension contribution before they reach retirement age. Here’s a theoretical example.

Case study: Meet Connor

Connor is self-employed and has been paying £2,000 a month into his personal pension for the last five years. Over the last 12 months, Connor has been working on a large contract. He expects to make a profit of £120,000 for the 2021/2022 tax year.

Connor knows that he can reduce his tax bill and increase his retirement pot by contributing more into his pension. On top of his monthly contributions, Connor wants to make a £40,000 lump sum payment into his pension.

As Connor is already making monthly contributions to a personal pension, the first step for him is to work out the total of these once tax relief has been applied. The easiest way to calculate this is to divide £2,000 by 20%, or £2,500. Connor’s gross annual pension contributions – including tax relief –  are therefore £30,000.

Connor wants to pay a further £40,000 lump sum payment into his pension. After applying basic rate tax relief (using the same principle shown above – £40,000 divided by 20%), Connor knows the total gross pension contribution is £50,000.

Given Connor’s annual allowance is £40,000, after deducting his total monthly pension contributions of £30,000, he has £10,000 available to use in the current tax year. Connor can use carry forward and use the unused allowances over each of the last three tax years (£10,000 x 3) on top of the £10,000 available in the current tax year, to pay his lump sum without exceeding the annual allowance and losing available tax relief.

How can we help?

The carry forward rules might seem complicated, and it’s important to understand their limitations. But here at FAS, we have considerable experience of helping individuals to make the best use of their available allowances, and help to get the full benefits from the carry forward rules. In the right circumstances, carry forward can really help to fund a pension before retirement.

If you are interested in discussing your defined contribution pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

Pensions remain one of the best ways to accumulate long-term wealth into retirement, but if you have accumulated pensions with several different employers down the years, it might be worth checking whether they are invested in default funds.

As the world of work has evolved, it’s become extremely rare for people to go through their career with the same employer. For most people, working for different companies down the years means they have accumulated several different pensions, arranged by their employers. If this sounds like you, then you might also have chosen the default pension fund suggested by the pension scheme or pension provider. If so, you’re not alone – according to research published by the Pensions Regulator, 95% of people who have defined contribution (DC) pensions arranged through their employer are invested in the scheme’s default fund.

What is a default fund, and why do they exist?

Whenever you start a job, you are now opted into your employer’s pension scheme unless you explicitly tell your employer you don’t want to be. If you do participate, your future pension contributions will be placed in the standard ‘default’ investment fund, and will stay there unless you decide otherwise. Employers and pension scheme trustees have a regulatory duty to ensure their default fund remains appropriate for their scheme, which means pension schemes generally take a very similar “average” approach with their employees’ money. But that doesn’t mean default funds will be the best pension option, or offer the best value, for each contributor.

It is sensible for employers and pension fund providers to encourage most people to invest in a default fund as it is designed to suit the average employee. It keeps employees invested in a pension fund which is not too aggressive, and not too conservative, but somewhere in the middle in terms of the risk profile it adopts. Furthermore, it’s low maintenance – for the employer and the employee. A default fund takes the simplest and often the cheapest route to investing a person’s pension contributions, without asking anything of the employee apart from opting in, rather than opting out. A default fund ensures the employee’s contributions are invested from day one, without them having to do anything. The fund will carry on until the employee leaves the company, or until their retirement date. Without a default fund in place, the money would be held in cash, earning a rate of growth similar to a bank account (so close to 0%).

What are the disadvantages of a default pension fund?

The biggest disadvantage with staying in a default fund is that the investments within it have not been tailored to suit your individual needs. Instead, they have been chosen to meet the needs of the average scheme member. The result is that their performance tends to be disappointing for too many people. At FAS, we firmly believe investments should be built around a person’s specific needs, as well as their personal attitude towards risk and preferences, such as adopting a socially responsible investment policy.

Are some default funds better than others?

In our experience, most older default funds suffer from a lack of diversification and perhaps questionable asset allocation (the mix of assets the fund invests in). Often, the older-style default funds have an overreliance on UK asset classes, ignoring the growth potential available across other regions and global investment markets. They could also be a bit behind in terms of investing in alternative asset classes that can be valuable for diversification purposes. Default funds also traditionally don’t react to market events, and they have a fairly rigid asset allocation, which is intended to smooth returns, but can just as easily flatten them.

Additionally, if the pension scheme was set up before pension freedoms were introduced in 2015, the default fund may still be designed for purchasing an annuity that offers a guaranteed income at retirement, whereas you may be more interested in taking advantage of the freedoms to stay invested for longer.

Failing to take into account your time horizon

The other big drawback with default funds is that they don’t take into account the age of the employees joining the pension scheme. This means that an 18-year-old gets placed into the same default fund as someone with just a few years to retirement. Clearly this may not be ideal for either of these employees – the 18-year-old would be well advised to take on more risk with their pension investments as they build up their retirement savings over several decades, whereas the employee approaching retirement may be better off with a lower volatility pension fund that takes fewer risks with their capital in the final few years before taking their pension.

Talk to us if you have older pensions invested in default funds

We know from experience that people often build up a handful of pensions managed by former employers down the years, and there’s a strong likelihood that some of these pensions may be held in more traditional default funds. So, if you think this might apply to you, let us know.

We can review your current pension arrangements – especially those older pensions with past employers that you haven’t considered for a while – and work out whether you would be better off transferring those older pensions into a new pension vehicle designed specifically for you, and has been constructed based on when you plan to access your pension savings.

If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice. 

When “pension freedoms” were introduced, many saw it as a great way to access their pension well before retirement age. But the tax incentives with pensions can often prove too valuable to give up, and hasty decisions risk leaving some people worse-off in the long run.  

What is the Money Purchase Annual Allowance?

The Money Purchase Annual Allowance (MPAA) was introduced as part of a range of pension changes carried out by the government back in 2015. One of the changes that some have taken advantage of is the ability to take out up to 25% of your pension as a tax-free lump sum, with the remaining 75% still subject to tax. Back then, the rule changes were touted as being ‘pension freedoms’, although some of these freedoms do carry a bit of a sting in the tail.

Understanding pension allowances

Whenever you or your employer pays money into your pension, the government tops up your contribution with tax relief. For most people, the amount they can pay into their pension each tax year and get tax-relief on is limited to an annual contribution of £40,000. Also, when you make contributions to your pension, you benefit from being able to use the ‘carry forward’ rule, which means you can claim any tax relief you haven’t used for pension contributions made in the previous three tax years.

However, the government’s generosity when it comes to offering tax incentives while you accumulate your pension pot get swiftly taken away once you decide to access your pension. The MPAA is triggered once you’ve started to draw on the taxable part of your pension (this doesn’t include the tax-free lump sum you are entitled to) and from that point forward, the MPAA effectively limits the amount of tax relief you can receive on any future pension contributions.

Back in 2015, when the MPAA was first introduced, the annual contribution limit for those affected by the MPAA was set at £10,000, rather than the full £40,000 Annual Allowance. However, this limit has now shrunk significantly and, for the 2021/22 tax year, the MPAA is set at just £4,000. This means that if you’ve triggered the MPAA you can expect to pay tax on all future pension contributions above this amount, and the MPAA will be with you for life.

Who risks being caught in the MPAA trap?

The MPAA only affects those with defined contribution (DC) pensions, and who have chosen to access their pension flexibly, including self-invested personal pensions (SIPP). Money purchase restrictions do not affect defined benefit (DB) pensions.

Should you start to make use of pension freedoms to flexibly access your pension, you will trigger the MPAA, which means you will only then be able to contribute up to £4,000 to all your DC pensions each year. Also, you will not be able to make use of any unused pension contribution allowances (known as ‘carry forward’) from previous tax years.

We have heard examples of people who have taken out their tax-free lump sum, and then topped up this amount by drawing down a smaller amount from their taxable pension. Unfortunately, this is just the type of activity where the MPAA rules are catching people out.

What happens if you break the rules?

If you do happen to go over your annual contribution limits, then you should expect HMRC to catch up with you at some point. When they do, you will face a tax charge in line with the rate of tax you pay.

Example: Meet Victoria

Here’s a quick example of what can easily lead someone into falling foul of the rules. Victoria has £100,000 invested in her personal pension, and is also still a member of her employer’s pension scheme. Victoria would like to build a new conservatory, which costs £25,000, and would also like to draw down an extra £5,000 for a holiday. She instructs her pension provider to drawdown £30,000, knowing that she will pay tax on the £5,000 above the tax-free lump sum (25% of the pension) available.

Unfortunately, once Victoria takes out the £30,000, she has triggered the MPAA, because she has withdrawn more than the 25% tax-free element of her personal pension and is deemed by HMRC to have ‘flexibly accessed her pension’. Had Victoria chosen to get financial advice before contacting her SIPP provider, she would have been made aware of the dangers of triggering the MPAA and revised her plans accordingly. Instead, from now on, Victoria will only be able to contribute an annual maximum of £4,000 across all her pensions, which could well prove costly as any contributions above this level will attract a tax charge.

When does the MPAA not apply?

It’s definitely worth remembering that you won’t trigger the MPAA if you only withdraw from your pension an amount that doesn’t exceed your 25% tax-free lump entitlement. You also will not trigger the MPAA if you use your pension to purchase a lifetime annuity, or if the cash accumulated in your pension pot is valued at less than £10,000.

If anyone is considering accessing their pension, and taking advantage of ‘pension freedoms’, we suggest you talk to us first. We can help you to work out the most tax-efficient way of accessing your pension, without making any costly mistakes that could leave you worse off in the future.

If you are interested in discussing your current pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice. 

A few weeks ago, one of our articles highlighted how much young people are finding it difficult to set aside money for retirement. While pensions have always been a ‘hard sell’ to those who struggle to imagine themselves getting older and retiring, we recognise that flat wages, job uncertainty, high rents, and the increased cost of higher education are all contributing factors that understandably leave younger people with less savings to set aside. And we also realise that a lack of pension could potentially have a disastrous effect on their long-term wealth as they get older.

This struck a chord with our readers, particularly those who have sizeable retirement pots themselves, having paid into their own pensions over their lifetime, and perhaps benefitted from generous final salary schemes, as well as owning their own properties. So, it was encouraging to hear that so many of our clients are interested in helping their grandchildren with their finances and are considering setting up a pension on their behalf.

Setting up a pension for a grandchild

Pensions are considered individual investments and as such come with certain rules around how much can be invested and when. Most people are unaware of how the pension rules apply to family members, but in essence, a pension can be opened on a child’s behalf by their parent or legal guardian, and grandparents can then make lump sum contributions into the pension, quickly and easily as a “third party” contribution.

At present, the maximum amount you can invest into a child’s pension is £3,600, per tax year. But as qualifying contributions made to pensions are eligible for 20% basic rate tax relief, this means that the net contribution only needs to be £2,880, and the UK Government will top-up the rest. If you have several grandchildren, you can invest £2,880 annually for each of them. From a grandparent’s perspective, gifts could fall within the annual gift exemption of £3,000 or possibly be classed as gifts out of surplus income. Otherwise, anything above this level could be a Potentially Exempt Transfer, and therefore some thought would need to be given to the potential Inheritance Tax consequences of making contributions to a number of grandchildren in any one tax year.

As a reminder, investments held in a pension grow free from UK income tax and capital gains tax, making them a tax-efficient choice for longer-term saving.

The benefits of starting early

Once the pension contributions have been made, that money can then be invested to help it grow. Investing over several decades means it makes sense to invest in higher-risk/higher reward investments that can grow over time as well as riding out those periods of stock market volatility.

Also, investing over long periods ensures the growth is continually reinvested, meaning that the pension will benefit from the “magic” of compound interest. For example, if you started paying into a grandchild’s pension from the year they were born and for every year until they turned 18, their pension pot could have reached the £1 million mark by the time they reach 65.

Different pension options

If you are considering using a pension to invest for your grandchildren, there are two different pension options to choose from: a stakeholder pension and a personal pension. Stakeholder pensions allow you to pay low minimum contributions (from £20) up to the maximum annual amount, and you can usually pay either via lump sums or regular payments. However, most stakeholder pensions offer limited choice when it comes to the funds you can invest in.

With a personal pension, you get to choose from a wider range of investments but could pay more in terms of fund charges and annual fees.

Worth remembering

As with any pension, one of the biggest drawbacks is that the money invested cannot be accessed until the grandchild reaches the age of 55 at the earliest, and this is likely to rise to 57 or 58 depending on the timing of increases in the State Pension age. There is also a good chance that the pension rules will have changed by the time your grandchildren reach retirement. However, to give you a real-life example, retired long-standing clients of ours who are now enjoying retirement, started investing in pensions for their six grandchildren some 20 years ago. Their eldest grandchild has just graduated from university with her own pension fund worth in the region of £150,000. She thanked her grandparents for their foresight and generosity and could well retire at age 60 with a million pounds pension pot, without ever paying a penny into it herself!

If you are planning on leaving your grandchildren with enough money to use as a deposit to buy their first home, then you might want to consider alternative investment arrangements, such as a Junior ISA, where the money can be accessed when the grandchild turns 18. For grandchildren over the age of 18, a Lifetime ISA, where the money can be used for retirement savings, or as a deposit for their first home, could be an appropriate option to consider.

If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

Within many pension schemes, default investment strategies now employ a process known as lifestyling, which claims to do the hard work of managing your pension assets for you as you get closer to retirement. However, adopting such lifestyle approach may well not be suitable for everyone.

What is a lifestyle pension strategy?

Lifestyle strategies are designed to effectively ‘lock in’ the investment growth built up in your retirement pot as you get closer to your designated retirement date. A lifestyle pension will start by investing a larger proportion of your retirement pot in equities, which offer the best potential for growth, with higher levels of risk. As you get older, and closer to your retirement date (typically 5-10 years before retirement), your pension will automatically start switching into lower-risk holdings, such as cash and bonds. The aim is that when you retire, and want to begin drawing your retirement benefits, you have a pot that is invested largely in a mix of cash and bonds and is less exposed to stock market volatility.

Pension providers like to talk about lifestyle strategies as offering a ‘glide path’, and there is a very good reason for doing it this way. After all, the last thing anyone just days from retirement would want to happen is to learn that stock markets have crashed, and a huge amount of their pension has suddenly been wiped out. A lifestyle pension takes away this risk because the pension has already been moving away from higher-risk assets into more low-risk investments over a number of years.

What are some of the advantages/disadvantages?

In theory, lifestyle pension strategies are a good idea, and certainly provide more certainty to individuals who do not wish to make investment decisions within their pension funds. That being said, lifestyle pension strategies still have a few drawbacks that anyone with a company pension would do well to be aware of.

Times have changed

Perhaps the biggest irony with lifestyle pensions is that they do not quite fit with the lives of today’s retirees. Retirement needs have changed considerably in the last few years. Some people are now choosing to retire later, either because they need to keep working or they don’t want to retire just yet. Others may want to reduce hours prior to retirement and begin taking pension income a little earlier.

Also, lifestyle pensions were introduced back when it was compulsory for UK retirees to purchase an annuity in exchange for a guaranteed pension income for the rest of their life. But since compulsory annuities were scrapped back in 2015, it’s no longer a requirement to have a large pot of cash ready to buy an annuity when you hit retirement age. In recent years, using income drawdown has become a more effective way of receiving an income during retirement, as this avoids locking into the low annuity rates that we have currently.

Lifestyle strategies may not deliver the retirement flexibility you need

Another important factor associated with lifestyle pensions is their relative rigidity. When you start your lifestyle pension, you are expected to name your retirement date. Lifestyle pensions will focus on ‘growth assets’ in your early and middle years and, based on your ‘glide path’, will phase-in less volatile investments as your retirement date approaches. However, the timing of this shift from risky to less risky assets can make a huge difference to the overall size of the pension pot.

If your pension starts switching someone out of equities on your 45th birthday, because you told your company you planned to retire at 55, you could be missing out on a decade or more of investment growth, seriously limiting the final value of your retirement pot.

Switching from equities to bonds may not be the best investment strategy

Although owners of lifestyle pensions have done very well in investment terms over the last decade, this has been partly due to the strong performance of bond markets. This may not necessarily be the case over the next decade. The problem with a lifestyle pension is that it will make the switch based on the retirement date, rather than the conditions within investment markets at the time. At a time when everyone in retirement wants their money to go further, giving up ten years of investment growth may not be the right decision.

One size does not fit all

Lifestyle pensions became the default choice for company pensions because they offered a very straightforward method of pension planning – build up a pension pot and then purchase an annuity once you retire. But once you take annuities out of the equation, and make the retirement date a moving target, the simplicity of the lifestyle approach becomes less of a solution and much more of a problem. Based on the current economic climate and modern retirement patterns, there is an even stronger case to be made for keeping pension pots invested in growth assets well into retirement, choosing instead to take income via drawdown.

Have a conversation about your pension

If you have a company pension invested in a lifestyle pension strategy, it might be a good idea to discuss the details with us. We can ‘look under the bonnet’ of your current pension, and can help to determine whether it is set up to support your retirement plans. You only get to retire once, and an overly cautious investment strategy can be just as dangerous as an overly risky one. So, let us help make sure your lifestyle pension is really capable of delivering the lifestyle you want.

If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.