What is a pension?
Pensions are commonly misunderstood and often feared by savers! Pensions are, in fact, brilliant if used correctly.
It is true that the UK pensions regime is fairly complicated and in a seemingly constant state of flux. There are many different types of pension scheme, from employer sponsored schemes where the member has no say in the investment choice or how benefits are paid, to personal arrangements where the member has full control.
The State Pension offers relatively poor provision and faces an uncertain future.
The main reason a personal pension might be considered as a savings vehicle is quite simply the very generous tax incentives offered by the Government in a bid to get us all to save for retirement. There are four key tax breaks afforded to personal pensions:
1. Tax Relief
Contributions attract tax relief at the individual’s highest marginal rate*. For example, a higher rate tax payer earning £60,000 per annum can invest £15,000 into a pension and receive £6,000 (40%) back in income tax relief. This means that the £15,000 invested in the pension has cost this individual just £9,000!
2. Tax Free Growth
Investments held directly by an individual typically attract income tax and capital gains tax. Investments held in a pension however grow tax free. Benefiting from this ‘gross roll up’ means the funds can grow freely, not constantly hampered by ongoing taxation.
3. Tax Free Cash
From age 55, an individual may be able to take up to 25% of the total accumulated funds* as a tax free ‘Pension Commencement Lump Sum’ or ‘PCLS’. The remaining 75% can either: stay invested, be withdrawn as a lump sum or used to provide an annuity. Any income taken will be taxed at the investor’s highest marginal rate.
4. National Insurance Relief
With a little planning, member contributions to a pension can be routed via a willing employer’s payroll to enhance the total monthly investment amount through reduced National Insurance contributions.
*within certain limits
Advice and Investing
Thanks to recent innovations in pensions, certain personal pensions now available in the UK can now effectively be used to hold many different types of investments while benefitting from all the tax breaks outlined above. Many of our clients have exactly the same portfolio of funds in their pension as they do in their ISA.
A personal pension is also owned by the investor to serve as a savings plan to accumulate enough capital to spend during retirement – simple!
See Investments to investigate what can be done with the money paid in to a pension.