Pensions – a simple guide

Posted on By admin
A young biracial woman is reading a paper and looking at a laptop in a kitchen

Pensions are far more than a way to save for your retirement. This article aims to explain the basics of pensions and what you need to consider about your own pensions.  

Types of pensions

Apart from the State Pension, there are two main types:

  1. Defined contribution (DC) schemes, which are also known as ‘money purchase’ schemes. These include personal pension plans, self-invested personal pensions (SIPPs) and workplace pensions.
  2. Defined benefit (DB) schemes, which are also known as ‘final salary’ schemes. These include NHS, teacher and government pension schemes.

A bit about tax

Pensions are a very tax efficient way to save. As long as you remain within the maximum limit, you receive tax relief on contributions paid into your pension.

Also, investment growth and income in your pension fund is tax free. When you take money out of your pension, you can take part of the fund as a lump sum, tax free.

How much can you pay into a pension?

You can make contributions that qualify for tax relief by whichever is the lowest amount of either:

  • 100% of your ‘UK Relevant Earnings’ (Tool Tip: For most people, this includes salary and bonuses. They exclude dividends, rent and some other payments, such as withdrawals from investment bonds) or the
  • Annual allowance, which is currently £60,000 (2023/24).

If you earn more than the annual allowance, you may still be able contribute more by using unused allowances from previous years. Also, someone under 75 with no earnings can contribute £2,880 (net) or £3,600 (gross) which includes children! If a child contributes to a pension, their parent or legal guardian looks after it until they are 18.

What happens when you die?

In most cases, if you die leaving a ‘residual’ pension fund, your nominated beneficiaries receive it, inheritance tax (IHT) free. The residual fund is the amount left in the fund when the person dies.

However, it is important that you set up either a ‘nomination’ or an ‘expression of wishes’ to explain who you want to receive your pension. This can be a family member, charity, friend or a trust. You can change your nomination at any stage. It is a good idea to review it periodically.

The death benefits on most pensions are held under a discretionary trust. Find out more about what a discretionary trust is.

The people who run the trust will usually only deviate from your stated wishes if significant circumstances come to light. For example, they might do so if you had got divorced and remarried many years after setting up your nomination, but not updated it.

If you die before you turn 75, the people you choose to receive your remaining pension fund will get it without having to pay any income tax. However, if you die after reaching 75, the recipients will have to pay income tax based on their own tax rates. This applies whether they take the money as a lump sum or regular payments.

You also have the option to nominate a ‘bypass’ trust to receive your pension fund when you die. However, if you choose this option and die after 75, a 45% tax charge will be applied to the amount paid out from your pension fund. This tax charge will be deducted directly by your pension scheme administrator and paid to HMRC.

This is why it’s advisable to review your nomination as you approach 75 to avoid this tax charge. However, it’s important to note that there might be valid reasons for not changing your nomination.

The role of pensions in planning your estate

Because a pension fund is held outside of your estate, the value does not typically suffer IHT when you die, which opens up a number of opportunities to plan your estate in a tax efficient manner.

Robin Melley TEP, Founder and Director, Matrix Capital, Chartered Financial Planners

How can I leave my pension to the person I choose?

Posted on By Joanna Pegum
father and son

It’s easy to think that everything you own will be distributed according to your will when you die. Your pension, though, is a different matter. Pensions are not considered part of your estate, and generally not subject to inheritance tax. Most importantly, you will need to specify who will benefit, via a particular form, known as a nomination form or Expression of Wish form.

What is a nomination form?

Most pensions, aside from the state pension, will require you to complete a nomination form. This will allow you to give details of the loved ones that you would like to benefit from your pension when you die, who are known as your beneficiaries. While nomination forms usually only apply to lump sum benefits from a pension on death, and not to the transfer of a drawdown pension (i.e pension income),  providers do vary. You will need to ask your provider(s) what they require.

Who can I nominate?

You can nominate anyone you like, including family, friends, charities, clubs or associations.

If I am married, will my spouse automatically get my pension?

Your pension provider may automatically nominate your spouse or civil partner to receive the lump sum in the absence of a nomination form, but you should check the details of your policy and make sure it complies with your wishes.

How many people can I nominate?

Each individual pension provider should specify their requirements on the form. Some providers state that you can nominate up to 25 beneficiaries.

What happens if I nominate my personal representatives?

If you nominate the ‘personal representatives’ or ‘executors’ of your will, or more simply your ‘estate,’ there is a good chance that your pension lump sum will form part of your estate and will become subject to inheritance tax.

Is it legally binding?

Most pension providers will state that your nominations will not be legally binding, and the distributions will be made at their discretion. In the majority of cases, they will comply with your instructions if they are clear and up to date. They may be more inclined to disregard your wishes if the information appears to be out of date or inappropriate, for example if someone has died or got divorced.

What happens if I don’t fill in the form?

Distributions are usually made at the provider’s discretion if you don’t submit a nomination form. Some pension providers have a policy that they will automatically pass the lump sum to your spouse or civil partner, but this is not guaranteed, and you should check your policy.

What information should I provide?

Each pension plan is different, but generally you will be asked to provide your pension account number or reference number, the full name of each beneficiary, their date of birth and address and their relationship to you. You will then be asked what percentage share of the lump sum you would like to leave them. You must ensure that the shares add up to 100%, otherwise your provider may be obliged to use their discretion. You can of course leave 100% to one person or organisation.

How can I update it?

The nomination form can be updated as frequently as necessary, and often online, so make sure you keep your beneficiary’s personal details current and correct. The forms can usually be revoked or amended at any time.

How do I prepare for retirement?

Posted on By admin

Retirement can be fulfilling for many people, with more time available for family, friends, and leisure. Make the most of it by ensuring you are financially secure for your later years; there is much you can do to plan ahead.

We’ve put together a few tips to get you started.

Calculate your pension income

The first step is to get a State Pension Statement, which should tell you how much State Pension you’ll get when you retire, based on your National Insurance record.

Then you’ll need to add the pensions you have built up during your working life. Almost everyone has had a number of jobs these days, so that may mean more than one pension pot.

If some of your paperwork has gone astray, and you think you are entitled to more pensions, the UK Government has a service you can use to track it down. The Pensions Advisory Service may also be able to help.

Work out your savings

You’ll also need to work out how much savings you have. Check your bank statements, and any building society accounts. If you have ISAs (Individual Savings Accounts), shares or other financial assets, get a snapshot of their valuation and if any are due to mature or expire by a particular date, keep a note of this.

If you have a mortgage, find out when it is due to be paid off, as that will free up some money. It may make sense to pay it off early, if you can afford to, or if there are no heavy penalties.

For both pensions and savings, jot down the total value, and how much income they will produce.

Prepare a budget

Once you have collected the figures for your likely retirement income, it’s time to work out how far your money will go. As a retired person, you’ll have no more commuting costs, but there will be plenty of expenses left to deal with, so estimate how much money you will need from month to month.

Make a note of your regular outgoings, starting with essentials like rent or mortgage payments, utility bills, insurance, food, and your car, if you have one. Work out what you spend on holidays, hobbies, grandchildren and pets. Add some extra for a rainy day, in case of unexpected household repairs or illness.

Clear any debts

If you have debts, your pension will stretch that much further if you are able to clear them. Some debt, including credit cards and payday loans, can be very expensive. Even if you can’t clear it, you may be able to consolidate it into one loan so it’s more manageable. Make sure you get good professional advice before committing to anything.

When to retire

Once you’ve done your sums, you can start thinking of when to retire. Do you want to retire early – and can you afford to? Or would you prefer to work a bit longer, and have a larger pension when the time comes? If you are delaying your retirement, it’s usually worth contributing more into your pension fund, and this may be matched by your employer. Talk this through with your pensions advisor.

You should also discuss your potential investment options with a financial planner, especially if you are withdrawing a lump sum or buying an annuity, which is a way of putting all your pension pots into one, to get an income for life.

Keep your paperwork up to date

Have you reviewed your pension paperwork recently? It is extremely important that you review your pension policies regularly to ensure that, in the event of your death, the lump sum will be inherited, tax free, by the loved one that you have decided to nominate.

It would also make sense to check your life insurance policies, and your will at the same time, so everything is in order and to give you peace of mind.