Your pension, explained

Marianne Curphey

Pensions are changing. We explain what your options are, where to find advice and how to avoid scams

According to a new survey by Mercer, the pensions experts, 50 per cent of people with pensions don’t understand their pension statement and don’t know what to do about their pension as they near retirement.

 

The new pensions freedoms

Thanks to new pensions freedoms, when you retire you can now use your fund in a more flexible way that suits your needs.

Anyone over 55 can access their pension fund and use the money as they wish, drawing down regular income, or even taking the whole amount as cash. While this gives you more control over the money that you’ve worked hard to accumulate and save, it does mean you have to make some important decisions about how you are going to use your fund. 

For many people, the biggest change is that they are no longer forced to turn their pension cash into a fixed income for life, known as an annuity. Instead they can dip into their pension fund and take out cash as and when they need it. In fact, they can take 100 per cent of their pension in cash should they wish to do so, although for most people this is not the best option because they will pay tax at their marginal rate on 75 per cent of the value of the fund.

Annuities have fallen out of fashion because they are seen as offering poor value in today’s low interest rate climate. However, they did have one important benefit. They ensured a fixed income for life, with no chance of running out of money. Today’s retirees will have to decide how best to use their fund in order to ensure that their pension money lasts for the rest of their life.

 

Why saving in a pension is a smart move

If you are a UK tax payer, you can currently receive up to 45 per cent tax relief on pension contributions. For example, a £1,000 investment for your retirement could cost just £550 of your net income. The more tax you pay, the more relief you will receive. 

“Money in a pension scheme can grow free of capital gains tax, as well as UK income tax,” says Austin Broad, group head of advice at AFH Wealth Management. “When it comes to retiring, you can usually withdraw up to 25 per cent of your savings tax free. The remaining funds, when drawn, will be treated as income and taxed at your marginal rate.”

What’s more, your savings are often free of inheritance tax, meaning any money left in your pension pot when you die can usually be passed on to your beneficiaries without the deduction for inheritance tax.

 

The choices you’ll need to make before you retire

Whether you are a member of a workplace pension scheme, or have your own personal pension, you’ll need to think about when you want to retire, and whether you plan to work part time or stop completely.

The new pensions freedoms offer great flexibility, but the choices can seem overwhelming. Although you may have saved carefully during your working life, when you get to retirement you’ll also need to make some decisions about how and where you money should stay invested, if you decide that an annuity is not right for you.

It’s important to think about the effects of inflation. While you don’t want to your pension fund to stay in high risk investments once you stop work, you will probably want some of it to be invested in shares and funds, because these offer from protection against inflation in a way that cash on deposit does not.

“Optimising money in retirement is as important as building up a savings pot, and while withdrawing cash early might be the right option for some, ultimately it will have an impact on their long-term retirement plan,” says Samantha Seaton, CEO of Moneyhub.

 

Retirement choices

When you reach retirement, you have a number of options: leave your fund untouched until you need it, buy an annuity, take cash in chunks while leaving the remainder of the fund invested, or cash in the whole pot. 

Although this choice can seem daunting, there is access to guidance over the phone or face-to-face via Pension Wise, a free and impartial service. You can also get more information from the Pensions Advisory Service.

It’s very important to think about how drawing down on your pension will affect the amount of tax you pay, and you may need to take professional advice. It’s not usually a good idea to cash in your entire pension pot, as you’ll only be able to access a quarter of it tax-free—the rest will be taxed at your marginal rate. Also, you may want to think about how drawing down extra income could push you into a higher tax bracket, and how best to structure your income stream in retirement.

 

Steering clear of scams

Your pension fund can be one of the most valuable assets you own. Sadly, there has also been an increase in the number of cold callers offering "free" advice on how to maximise the value of your fund. 

Don’t buy from cold callers and be wary of scam calls. Many of these schemes are worthless and charge high transfer fees. If the interest rates or investment growth seem too good to be true, or way above market rates, it is likely to be unsustainable.

 

More information

The Pensions Advisory Service gives free, independent information and guidance on pension matters, resolve problems with pensions, and shares insight with Government and industry to help develop future pensions policy.

Pension Wise is a government initiative which provides free appointments to help people understand their choices at retirement. Pension Wise can help if you are aged 50 or over, have a personal or workplace pension, and want to make sense of your options.