Pensions continue to present investors with a unique opportunity for growth, generous tax treatment and planning a legacy for dependants.
Despite this, they still have an image problem. Pensions are often portrayed as poor value for money, inflexible and fraught with complexity. Add to this the regular articles in popular press about low annuity rates and you have a recipe for a crisis in pension saving.
But we believe that pension savings are a real keystone to a great financial plan.
Here are a few of the features we think make pensions such an attractive way of saving:
Tax Relief
One of the major benefits of saving in to a pension of the tax relief you get on day one. If you are a basic or nil-rate tax payer, you will get 20% tax relief on your contributions in to a pension. For every £100 pension contribution made by a basic or nil rate tax payer, £125 goes in to your pension. Higher rate taxpayers can claim 40% tax relief on their contributions at present.
Your pension income is taxable when you come to take it but you will have had the benefit of the growth on the additional money in the meantime. In addition, you may not even be a taxpayer any longer. People who are higher rate taxpayers during their working lives are often basic rate taxpayers when they retire, this means that they will have claimed tax relief at 40% but only paid it back at 20%.
Estate Planning – passing on your retirement savings
In most circumstances your pension will not form part of your estate for inheritance tax purposes. When you take out a pension you will usually be asked who you would like to benefit from your pension, you can also change your expression of wish during the life of the policy.
If you die before age 75 Your pension can pass directly to whoever you have named completely tax free and they can take the money as an income or lump sum.
After 75, lump sums and income become taxable, income at the beneficiary’s marginal rate and lump sums are taxed at a flat 45%.
Your nominated beneficiary can also pass the pension on after their death if they choose.
You should always be sure that your pension provider knows you you wish your pension to go to in the event of your death. If you are unsure ask your adviser who will be able to find out for you.
Tax Free Lump Sum
No matter what kind of pension you have, you will be entitled to a tax free lump sum payment of a proportion of the pension value, usually this is 25% but can be higher or lower.
Considering that you will have already received tax relief on your contribution this is an extraordinarily generous tax treatment. Consider a basic rate tax payer who contributes £1000 in their pension, they will receive £1250 after tax relief. If they then retire as a basic rate tax payer they will be entitled to 25% tax free lump sum of £312.50 and be taxed at 20% on the rest, the total they will receive is £1062.50 after tax when they only contributed £1000 and this without any growth!
The lump sum is often accessed straight away when a person retires but this is not always the best option and an increasing number of pension providers allow plan holders to access their tax free entitlement more gradually.
Tax Efficient Growth
As well as getting tax relief on the way in and 25% tax fee cash on the way out, your pension fund also grows largely tax free when invested. This preferential tax treatment can make a big difference to your final pot when you come to retire.
Flexible Options at Retirement
Since the changes made in the 2015 Budget, savers with a money purchase pensions (private pensions that you or your employer have saved in to) rather than occupational defined benefit pension have been able to access their entire pension pot from age 55. As you would expect, 25% is your tax free cash and the rest will be taxed as income in the year you take it. In practice, most will find the ‘take it all’ approach to be inappropriate.
The real benefit is the flexibility to take whatever level of income you want from your pension from year to year, helping you to manage your pension to suit your changing needs.
Compounding Returns
The earlier you start saving for you pension, the better but it is never too late to make a difference. If a 50 year old were to start paying just £100 per month from your earned income until your 65th birthday, a 4% annual return plus the tax relief would add up to a 64%% return or an extra £11,530 over and above the money you put in, save for another 5 years and your return would be more than 83%!
Pound Cost Averaging
Investments are not guaranteed and values can go down as well as up. If you are saving regularly, your pound invested will automatically buy more when values and low and less when values are high. This effect, called pound-cost averaging means the longer you can save regularly in to your pension, the better are your chances of getting good value.
**All information in this article reflects our understanding of pension rules as of July 2017. This article is not a substitute for professional advice. Call us today to see how we could help you to plan for a better financial future.