There are 2 main types of pension contributions:
- defined contribution – a pension pot based on how much is paid in
- defined benefit – a pension pot based on your salary and how long you have worked for your employer
Defined Contribution Pension Schemes
These are usually either personal or stakeholder pensions – sometimes called ‘money purchase’ pension schemes.
- pensions arranged by your employer
- private pensions arranged by you
- The value of your pension pot can go up or down depending on how the investments perform
Defined Benefit Pension Schemes
These are sometimes called ‘final salary’ pension schemes. They are always workplace pensions arranged by your employer.
Changes to Occupational and Private Pensions (Flexi-Access)
Since April 2015 the rules around private and occupational pensions changed, if you are over the age of 55 you will have greater freedom in how you can access your pension pot.
If you have a defined contribution pension, you are no longer restricted to simply buying an annuity. Instead, you can withdraw some or all of your money as a lump sum.
Will the changes affect you?
The changes to private pensions will affect those on a defined contribution pension scheme. This is one where you build up savings (your ‘pension pot’) throughout your employment to fund your retirement.
These are some of Options you need to consider:
1. Take a Cash lump Sum
- You can either take it all as a single lump sum, or withdraw it in stages
- Only 25% of each withdrawal will be tax-free
- The remaining 75% will be taxed at your highest rate of tax
- Consider any impact this may have on any means-tested benefits you claim now or could be able to claim in the future
2. Buy an Annuity
It is no longer compulsory to buy one, although an annuity may still be the best option for you depending on your circumstances and your demands and needs. All personal pension plans include an Open Market Option. Which means you have the right to shop around for the best annuity deal for your money – remember it is your money!
Currently once an annuity is taken that is it, you could not change it or take advantage of products that may offer more attractive rates. However From April 2016, the government has announced that it will change the tax rules to allow those who are already receiving income from an annuity to sell that income to a third party, subject to agreement from their annuity provider.
3. Choose an Income Drawdown Scheme
In a draw-down scheme, you transfer your pension pot into a scheme which is then invested on the stock market. You can then take regular income from it to fund your retirement.
This can be an attractive option if you have a large pension pot, but the fees could be expensive, your income is not guaranteed amount, and your investment could reduce as well as increase, depending on the stock market. If you decide to with draw your income too quickly you could run out of money if you are not careful.
You will not be affected if:
- You have already accessed your pension savings, e.g. by buying an annuity
- You have a defined benefit pension scheme, also known as a ‘final salary’ pension. This gives you a retirement income based on your length of service and salary.
Until 6 April 2015, the amount you could take from a drawdown account was capped – unless your pension income already exceeds £12,000 a year. However, now everyone will be free to withdraw what they like.
From April your dependents will be able to inherit the unused part of your pension (although there may be an IHT liability.
How will the changes affect those who die before the age of 75?
From April 2015, anyone who inherits a pension fund will have no tax to pay – whether it is already being used or not. They will not be liable for income tax either. But there will still be a limit of £1.25m (£1m from 2016) on the amount of money anyone can have in their pension, unless they want to pay 55% tax on income from it.
How will the changes affect those who die after the age of 75?
From April 2015, all beneficiaries will only have to pay income tax. Depending on the rate of tax they pay – their marginal rate – they will have to pass 20% or 40% to the taxman.
What is the tax position?
Whether you buy an annuity or take a lump sum payment, the amount you receive (minus any tax-free amount) will be added to any other income you have, such as your State Pension.
If the total amount is over your personal allowance, you will have to pay tax on it. You may even be pushed into a higher than normal tax band, especially if you’re thinking about taking a large lump sum from your pension pot. You could go from paying no tax to being taxed at 40%.
Impact on state benefits If you’re currently claiming any means-tested benefits, you may find you are no longer eligible for them if your income and/or savings increase. Any benefits you could claim in the future may also be affected. Subject to your circumstances you may be unable to claim any means-tested benefits such as Pension Credit if the government believes an individual deliberately spent their money in order to claim these benefits. They could find themselves left only with their State Pension to live on.
Tax Relief on Pension Contributions
There is no limit on the amount of money you can save in a pension scheme or the number of pension schemes you can save in – although there are some limits on the amount of tax relief you can get.
The amount that can be saved in a pension tax-free each year – the annual allowance – has been set at £40,000 since April 2014. There will be changes to this system too.
At present, you can contribute up to £40,000 a year into a personal pension scheme. If you have a “defined contribution” employer scheme, the total of employer and employee contributions must not exceed £40,000.
The position is more complicated if you have a final salary scheme. Each year you are in the scheme, the value of the pension you will receive on retirement increases.
This increase must not be more than £40,000, or you have to pay tax on the excess.
However, if you have not used your annual allowances in previous years, you can carry forward the unused amounts from up to the last three years.
Under the new rules announced in the July 2015 Budget, this £40,000 allowance will be reduced for those whose total income is above £150,000.
In working out whether your income is above £150,000, you need to include the value of any pension contributions you make, any pension contributions made by your employer, and the increase in value of any final salary scheme over the tax year. This is called “adjusted income”.
For every £2 of adjusted income you have over £150,000, your annual allowance will be reduced by £1. The maximum reduction is £30,000, leaving an annual allowance of £10,000. So once your income is over £210,000, there is no further reduction.
When paying into your pension, you receive tax relief on any contributions that you make. This is at the highest rate of income tax that you pay, provided that the total gross pension contributions paid into your pension scheme, does not exceed:
- your annual earnings; and
- the annual allowance.
If you do not have earnings
If you do not have any earnings (for example, if you do not work) or earn less than £3,600 each year, you can make gross contributions of up to £3,600 each year to a personal pension, self-invested personal pension, or stakeholder pension receiving basic rate income tax relief at, currently, 20% on your contribution. You can pay in higher amounts than your maximum limit, but you don’t receive tax relief on the excess amounts.
It’s good to remember that you may have to repay any tax relief that you have received from HMRC on these excess contributions. You also don’t receive tax relief on any payments that your employer pays into your scheme. This includes contributions that you have elected to make through salary sacrifice.
Getting Further Help
You can visit the government’s Pension Wise website for free and impartial guidance.
You can also get help online, by telephoning Pensions Advisory Service or by face-to-face appointments at certain Citizens Advice Bureaux. You will not be provided with specific advice or recommendations.
At Bond Financial Ltd we will provide you with independent advice. Remember that you don’t have to rush into any decisions.
Before making any decisions, it’s important that you consider your options and the impact that your decision could have on your tax bill or benefit entitlements and at Bond Financial Ltd we will help you providing you with the options that are available to you so that you can make an informed decision having been presented with the facts.