The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.
Pensions do a simple job: they should encourage you to not spend now so you’ll have money to spend in the future. Simple ideas are not easily put into practice, however. There are rules to govern how we all save for the future.
We’ve classified those rules into two groups: money in, and money out.
The ‘money in’ element is what goes into your long-term savings and how. It may be contributions you make yourself, or that come from your employer.
The ‘money out’ is all about your retirement income, the way in which you access your money.
Traditional personal or company pensions have benefits on the way in, effectively removing all or some of the income tax you’ve paid on your earnings that go into your pension fund.
Tax treatment will depend on individual circumstances and may change in the future.
Pay in £800 and automatic tax relief makes it up to a round £1,000. And the more you earn, the bigger that benefit can be – up to 45% (tax year 2016/17)1 for top earners, although they have to claim back the extra via their tax form.
So what’s the catch? For starters, you can’t touch the fund until age 55 or later. And there are limits on how much you (and your employer) can contribute each year and over your whole lifetime. For the tax year April 2016-April 2017, the usual allowance is £40,000 per year, or £1 million over your lifetime.
The limits are subject to change and can vary depending on your circumstances. The taxman provides annual allowance calculators to check whether you have exceeded your allowance and if so, the charges you are likely to face. Find out more here: [http://www.hmrc.gov.uk/tools/annualallowancelimit/index.htm]
Individual Savings Accounts (ISAs) also offer tax benefits. These are usually on the way out, as there’s no income or capital gains tax on withdrawals. But there is a new exception, the Lifetime ISA that starts in April 2017.
The Lifetime ISA is designed to encourage saving for a first home or for retirement. In retirement mode, the new ISA will pay a 25% “bonus” on contributions made every year.
There are restrictions, of course. The Lifetime ISA will only be available to those aged 18 to 40. And contributions are capped at £4,000 per year and must stop at age 50. Your employer cannot contribute for you (like in a pension), so all the money in must be your own from taxed income1.
This is the big one for anyone with a traditional personal or work pension that does not promise a guaranteed regular payment based on your old salary.
The schemes affected are called ‘Defined Contribution’. If you are nearly 55, or are older and not made your retirement income choices, read on.
As of April 2015, new pension freedoms mean what they say.
- From age 55, you can take your pension pot and use it as you wish, depending on your needs.
- Previously, retirement choices were restricted. Retirees could take up to one quarter of their pension pot as a lump sum without having to pay tax on it. The rest had to eventually be converted into an annuity – insurance that pays out a set amount each month for as long as you live.
- The annuity rules have been swept away. Now you can take your pension pot and organise your income your own way.
- Small pension pots under £10,000 can be taken in cash entirely tax-free.
- Bigger pots still get that old one quarter (25%) lump amount, but the rest can be spent, reinvested or converted to an annuity – or a mixture of all three.
- Even better, anyone who opts to retire in stages, moving from full- to part-time for example, has more flexibility too. You can take a bit of your pension to top up your income, but keep adding to your pension pot later if you’ve money to spare.
Again, what sounds simple in theory can often be complex in practice. It is worth getting independent advice about which retirement income options suit you best.
The www.unbiased.co.uk website lists the authorised, regulated independent financial advisers in your area.
- 1 Source: HM Treasury, September 2016, https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/508117/Lifetime_ISA_explained.pdf