If there was ever any doubt about whether to save in a pension, there can be
none now. The Government says that saving for retirement is a “personal
responsibility”, which means that we can no longer rely on help from the
State in retirement.
The amount that we can expect to receive from the state or personal pensions
is set to change in April, when the Government alters personal tax
allowances and pension saving rules.
If you do not want to be swapping holidays in Tobago for Torquay when you
retire, but still don’t know the difference between a Sipp and a
stakeholder, then here are the basics you need to know.
What is a pension?
A pension is a pot of money you receive from the savings that you have built
up during your working life. Some of it will come from the Government in the
form of the state pension, the rest will be from personal and occupational
schemes.
People use pensions instead of regular savings accounts because pensions
attract tax relief. Regular long-term saving also enjoys the benefit of
compound interest. Julia Whittle, of Punter Southall, the independent
financial adviser (IFA), says: “There is no other investment that delivers
an immediate return of 40 per cent, and compound interest means that saving
regularly over a prolonged period cannot be beaten.”
Pension savers cannot claim the money until they are at least 50, rising to 55
from 2010. Savers usually receive some of their pension – about 25 per cent,
as a lump sum, with the remainder paid monthly.
What is tax relief, how much can I get and how do I get it?
At the moment, basic-rate taxpayers receive tax relief of 22 per cent, while
higher-rate taxpayers receive 40 per cent. So a pension pot of £10,000 would
be worth £12,820.51 for a basic-rate taxpayer and £15,128.20 for a
higher-rate taxpayer.
However, the amount of relief will drop from April, when the new basic rate of
income tax falls to 20 per cent. So on the same £10,000 pot, a basic-rate
taxpayer will receive £12,500, while a higher-rate taxpayer receives
£15,000. To obtain the relief, your pension company contacts the Government,
which then tops up your investment with the extra cash.
Investors with the capital to make a lump-sum pension investment can claim tax
relief early by writing to the Revenue, potentially saving almost £200 a
month on a £10,000 investment. Tom McPhail, of Hargreaves Lansdown, another
IFA, says: “If you have the capital to invest, then this is a very efficient
way to do it. You put the money away for your retirement, and you can make
an immediate claim to reduce your tax bill.”
Why do I need to save?
Very simply, the amount that you will receive from your state pension will not
be enough to live on comfortably. Single pensioners currently receive £87.30
a week, while couples share £139.60 a week.
How does the state pension work?
To receive a full state pension, you need to pay national insurance
contributions (NICs) while working. Workers earning more than £5,225 a year
must pay NICs. Men need to pay NICs for 44 years and women 39 years to be
eligible, although this will go down for those retiring from 2010 to 30
qualifying years. The age at which you can receive the state pension is 65
for men and 60 for women. The age for women born on or after April 6, 1950,
will rise to 65 between 2010 and 2020, with the age for both men and women
rising to 68 after 2020.
Workers who have not paid full NICs but have paid for a quarter of their full
qualifying years will be entitled to a weekly pension of between £21.83 and
£87.30 this tax year.
How do occupational schemes work?
Occupational pensions can be either defined benefit (final-salary schemes) or
defined contribution. Most are now defined contribution schemes, which means
that you and your employer put in a certain percentage of your salary, which
is then invested until retirement, usually in the stock market.
These schemes tend to offer a choice of investment funds with varying levels
of risk. Most experts recommend that the amount of risk is decreased as you
near retirement. You should receive an annual statement updating you on how
much money has been invested, the returns so far and projections of how much
you are likely to receive at retirement. The graphic on the facing page,
explains how to read a typical annual pension statement.
What sort of pension should I choose?
There are lots of different pensions on the market. Which you choose will
depend on your income level and whether you want to manage the investments
yourself or have someone else do it for you.
If you are in a company scheme, you should stay put because your employer is
topping up your own contributions. However, Dean McCarthy, head of pensions
at Cobalt Capital, the IFA, says that you should ask if you can increase
your contributions. “Not all allow this,” he says, “but if they do, they may
even match the additional payments you make.”
Of all the personal pensions on the market, the cheapest are stakeholders
because the charges are capped at 1.5 per cent. Transferring money from a
stakeholder is also free, as is stopping and starting your contributions.
However, the investment choice is limited and might not include some of the
top-performing investment funds.
Straightforward personal pensions offer access to a wider range of funds, but
they have higher charges. The more advice you receive, the higher the
charges. For people with large sums to invest, self-invested personal
pensions (Sipps) can be more lucrative. Mr McCarthy says: “Lots of people
want these, but they are suitable for only a few.”
Sipps allow investors to put shares of single companies in their pension and
to borrow an amount equal to 50 per cent of the value of the fund. They are
the most expensive because each transaction carries a charge.
How much should I invest?
As much as you can afford, but a good rule of thumb is to halve your age and
pay in that percentage of your salary. High earners attracted by the 40 per
cent relief are increasingly using all of the £225,000-a-year annual
contributions limit.
What are personal accounts and how will they work?
From April 2012, nearly all employees who are not in an employer’s scheme will
be enrolled automatically into their employer’s scheme or the new personal
accounts scheme.
The only employees not affected will be those younger than 22, older than
state pension age or earning less than £5,000 a year. Employees can opt out
of the personal account if they wish. Personal accounts will have a default
investment fund and a small range of alternative funds, including ethical
options.
Costly break for working women
Women who take time out of work to look after children risk losing millions of
pounds in pension benefits.
Julia Whittle, of Punter Southall, the independent financial adviser, says:
“It sounds a lot, but the figures back it up. Women do not just miss out on
the contributions, but also on the effects of compound interest on the
amount that they would have contributed. The amount they lose almost always
exceeds the cost of staying in work and paying for childcare.”
For instance, a woman in a final-salary scheme who starts work at 18 and stops
to have children at 30 on a salary of £38,000 would receive pension income
of only £7,500 if she does not resume contributions. Compare this with the
£50,000 a year she could have expected if she continued working.
Ms Whittle says: “If she lives to 85, this person would have lost a staggering
£1.3 million of pension income.”
Reducing contributions to an affordable level when not at work before raising
them again when you go back is the only real solution.
