Your pension questions answered

In the latest instalment of our Q&A article series, we shine a light on the world of pensions.

Despite being an essential part of the financial planning toolkit, some people find pensions confusing and don’t invest early enough. A delayed start risks creating a shortfall when the time comes to leave the workplace, so it’s good to clear up any confusion as quickly as possible.

To help you better understand how pensions typically work, we’ve collated some commonly asked questions of our Smart Investor team.

This time, our pensions expert Lee Platt offers his insights on the challenges and opportunities when saving for retirement.

Q. What makes pension an attractive place for retirement savings?

Quite simply – the tax perks. If you’re a basic rate taxpayer, for every £80 you pay into a private pension, HM Revenue & Customs will currently top it up to £100. And if you're a higher or additional rate taxpayer, you can currently claim back up to an additional 20% or 25% through your annual UK self-assessment tax return.

However, if you make contributions via salary sacrifice or net pay arrangements through your employer, you may not need to claim additional tax relief.

Any income or gains from the funds invested within a pension are also free of income tax and capital gains tax (CGT). In relation to CGT this could be a valuable perk because the annual CGT exemption is now just £3,000 per person, per tax year. If you invest outside a pension (or ISA) any profits made above the annual CGT exemption are generally subject to tax at 18% or 24% depending on your tax band and the asset disposed.

Contributing to a pension can also reduce your tax bill – as long as you complete an annual UK self-assessment tax return. For those employed and self-employed sole traders, money paid into a private pension (or employer pension which is under Relief at Source) will extend the basic rate band, by the gross amount paid into your pension scheme.

This is particularly helpful if you cross into a higher tax band, and for those earning more than £100,000 salaried or other income, and whose personal allowance is tapered.

However, pensions rules can change, so it’s worth maximising these tax breaks while you can, if it’s something you can afford.

Q. How much can I save in a pension?

There’s an annual limit to how much you can place into your pension (this limit covers both personal/employee and employer pension contributions). For most people in the UK, that is £60,000 or 100% of your relevant UK earnings – whichever is lower, provided that you haven’t withdrawn a taxable income from any pensions.

The annual allowance is tapered for higher earners. Where earnings exceed £200,000 and your combined income and pension contributions exceeds £260,000, the allowance is gradually tapered down to a minimum of £10,000 which begins to kick in when these adjusted earnings go above £260,000.

No matter what you earn, pensions offer a unique benefit that allows you to 'carry forward' unused annual allowances from the previous three tax years. So, if you haven’t used your maximum allowance in the previous three tax years (provided you were a member of a registered UK pension scheme during those years) and have some spare cash, you might want to consider additional pension contributions. Getting professional advice to best understand your individual position would be a sensible move.

Q. Can I retire on £30,000 a year?

When it comes to working out what you will need in retirement, you might consider how long you will be retired for and what kind of lifestyle you would like.

In terms of how long you’ll be retired for, that clearly depends on when you stop working and how long you’ll live. The average 65-year-old male can expect to live for another 20 years, and the average 65-year-old female can expect to live for another 22 years, according to the latest government data.¹ However, many people live much longer.

The Pensions and Lifetime Savings Association (PLSA) has suggested three Retirement Living Standards – minimum, moderate and comfortable.

Its latest study² says an individual would need an annual income of £14,400 for a minimum, £31,300 for a moderate retirement, and £43,100 for a comfortable retirement. The PLSA suggests that a minimum retirement income will cover your essential needs, with some funds left over for fun. At the other end of the scale, a comfortable retirement provides more financial freedom and some luxuries.

The amount of £30,000 mentioned in the question above, therefore falls into the category of a moderate retirement.

According to estimates,³ a £425,000 pension pot could pay out around £30,000 each year for 20 years.

However, this is not guaranteed and depends on the performance of your investments. But having a goal means you have something to aim for and can check your progress as time goes on.

Don’t forget to factor in your state pension which will boost your own private provisions. You can find out how much State Pension you could get, and when, on the Government’s website.

Q. Is a pension the only place for retirement savings?

You can set money aside in several places to spend in retirement. But it’s worth considering those investment vehicles which come with tax benefits.

That means, as well as investing via a pension, there is potentially a valid role for an ISA when it comes to retirement planning.

The drawback of investing in a pension is that you cannot access the money until the age of 55 – age 57 from 2028. If you’d rather keep some of your retirement money where you can access it earlier, then an Investment ISA, also known as a Stocks and Shares ISA, offers a tax-efficient route to investing, with an annual limit of £20,000 each tax year, regardless of earnings.

As well as a standard Investment ISA, a Lifetime ISA (LISA) is also worth considering as these were designed with retirement in mind. You can put up to £4,000 a year into a LISA, with a government bonus of 25% on top of the money you put in. However, if accessibility is important to you, then it’s worth noting the restrictions on this type of ISA.

Money in a Lifetime ISA can be used for retirement after the age of 60 (or buying a first home), but withdrawals for any other reason are subject to a 25% penalty (aside from if you are terminally ill). The maximum bonus that you can get is £1,000 each year. To be eligible to apply for a Lifetime ISA, you must be aged over 18, but under 40 and generally a UK tax resident.

Q. How can I make my pensions easier to manage?

It’s not uncommon to hold multiple pension policies by the time you’ve worked for a few different employers. In some cases, older schemes can be expensive and offer limited investment choice – which could limit performance and reduce the amount you get in retirement. So, you might think about moving your money to a better value pension with improved investment options.

Having lots of pension schemes with multiple providers to keep up with can also become time-consuming with different systems and options to navigate (and different fees to pay). It might make things easier to have some or all of them under one roof.

On the flip side, holding a single pension allows all your pension assets to be invested according to one strategy and with the same goals in mind, and you’ll be able to easily assess more easily whether you’re on track for the retirement you want.

Having just one pension also means that in retirement when you start drawing on your money, you would need to trigger just one scheme and then receive just one single payment rather than multiple sources of income. This will make doing your annual tax return easier too.

But remember, transferring to another scheme is not always the right decision as it might not make sense to give up any valuable guarantees or benefits included in an existing pension scheme. It’s crucial you check what you would be giving up and the associated tax consequences if you’re considering moving your money.

If you are in a final salary pension scheme, also known as a defined benefit pension, or hold any pensions with ‘Safeguarded Benefits’, it’s worth thinking very carefully before transferring out. This is because these schemes usually come with a guaranteed income for life and inflation protection, as pay outs will generally rise with the cost of living, as well as other valuable benefits which may be lost on transfer. Final salary schemes might also pay out to a surviving spouse. We recommend that a tax advice is sought prior to the transfer.