Don’t let your pension drive you potty
Exchange Accountants answers frequently asked questions about pensions
MOST people are aware that it makes sense to have a pension in place to provide them with an income when they decide to retire.
However, delve any deeper than this and you’ll find that there is still a lot of confusion out there in terms of what pensions are, how they work, and when you can start withdrawing money from your pension pot.
To stop people going potty over their pensions, the team at Lisburn-based digital accountancy specialist Exchange Accountants has provided a summary to help people understand some of the basic tax advantages to be gained from investing in your pension, and highlight some recent changes to pension allowances.
“A pension shouldn’t be seen as a luxury, but more of a necessity,” explains Exchange Accountants Tax Manager Melanie Peebles. “It is a tax efficient reward for your hard work and also provides a sense of security for your future.
“There is definitely a lot of confusion when it comes to pensions, but people shouldn’t let that stop them from planning ahead. We would advise that you seek professional advice, compare your options, and make informed decisions. Your future self will thank you for this!
“In the meantime, we’ve put together a few pointers that we hope will answer some of the most common questions that we are asked,” added Melanie.
Exchange Accountants – the plain truth about pensions
What is a pension?
A pension is a savings plan that is specifically designed to provide income during retirement. In short, it is a long-term investment that allows you to set aside funds during your ‘working years’ in order to support your financial needs when you stop working or reach retirement age.
How do pensions work?
A pension is funded by an individual (or their employer) making either regular or lump sum contributions into their pension fund during their working life. The pension fund itself then invests these contributions in various assets such as stocks, bonds, and real estate, with the aim of growing the fund over time. Upon retirement, individuals can access their pension savings as regular income, lump sum withdrawals, or a combination of both, depending on the particular pension options available to them for each fund.
When should I start planning for a pension?
It is advisable to start making pension contributions as early as possible. The sooner you begin contributing to your pension, the longer your savings have to grow – which will potentially result in a larger retirement fund. However, it’s never too late to start planning for a pension, and even small contributions can make a difference in the long-term.
What are the different types of pensions?
There are several different types of pension funds, including state pensions, occupational pensions (provided by past employers), personal pensions (private pensions individuals have set up themselves), and self-invested personal pensions (SIPPs) which offer you more control over the investment choices.
How much should I contribute to my pension?
There is no ‘set’ amount you should contribute to your pension fund. The amount will vary from person to person and will likely depend on various ‘affordability factors’ such as your current level of disposable income, as well as being driven by your retirement goals and future lifestyle expectations.
For those who are employed, recent ‘auto enrolment’ legislation requires eligible workers to contribute a minimum of 4% of your salary and employers must also contribute 3% – however some employers will now offer to match your contributions which can significantly boost your savings. For those who are self-employed, the same deciding factors will apply, but the optimum level of contributions may also be influenced by trying to keep your anticipated level of profits for the tax year within the basic rate tax band (see below for more on how tax relief on pensions works).
What is the government’s role in pensions?
The government is responsible for setting regulations and guidelines for pension schemes generally, in order to ensure they are well-managed and offer sufficient protections for pension holders. Most – but not all – people will receive a government ‘top up’ to their pension savings in the form of tax relief on their personal or workplace pension contributions (see below). The UK Government also operates a state pension, which is a regular income provided to eligible individuals upon reaching the state pension age.
Can I access my pension before retirement age?
The normal minimum pension age (NMPA) is set by the Government and is the lowest age at which you can start taking money from your pension pot. The NMPA isn’t necessarily the same as your retirement age (i.e., the age you’ve chosen to retire) which could be earlier or years later. The NMPA is currently set at 55 years old but is set to increase to 57 years old from April 2028. Earlier access to your pension pot may be possible in exceptional circumstances, such as the diagnosis of a terminal illness.
What happens to my pension if I change jobs?
If you change jobs, you usually have several options for your pension. You can leave your pension with your former employer’s scheme, transfer it to your new employer’s scheme, or transfer it to a personal pension scheme. It is always advisable to seek professional advice to understand the potential implications before making any decisions.
How can I track and manage my pension?
It’s important to regularly review and monitor your pension to ensure it aligns with your retirement goals. You can keep track of the current anticipated value of your pension through regular postal statements provided by your pension provider or accessed via their online platform. Seeking guidance from financial advisors or pension specialists can also help you to effectively manage and optimize your pension fund.
What is the Pensions Annual Allowance, and how is it changing?
The Pensions Annual Allowance is the maximum amount you can save into your pension pot each year without incurring a tax charge. In April this year, the annual allowance increased from £40,000pa to £60,000pa, allowing eligible individuals greater scope to save more tax-efficiently for their retirement.
What is the Money Purchase Annual Allowance, and how is it changing?
The MPAA replaces your annual allowance after you’ve started to draw your pension pot(s). Everyone has an annual allowance which restricts how much you can pay into your pension pot each year without triggering a tax charge (see above), but once you’ve started to draw your pension (with a few exceptions), this annual allowance is replaced by the MPAA. The MPAA increased from £4,000 to £10,000 from April 2023. It was essentially created to stop people from trying to avoid tax on their current earnings or gaining tax relief twice by withdrawing money from their pension pot and then paying it straight back in again.
How does the Tapered Annual Allowance affect higher earners?
The Tapered Annual Allowance (TAA) gradually reduces the amount high earners can save into their pension pot each tax year without triggering a tax charge. The TAA gradually reduces your Pensions Annual Allowance if your total income in a tax year exceeds both a ‘threshold income’ of £200,000 and an ‘adjusted income’ of £260,000 (increased from £240k pre-April). Until April 2023, the allowance could be reduced to a minimum of £4,000, but now that lower limit has been increased to £10,000 per annum.
What are the recent changes to the Lifetime Allowance?
The Lifetime Allowance is the maximum amount you can accumulate in your pension savings without facing additional tax charges when you access your pension. Currently, the Lifetime Allowance is £1,073,100. The government has announced that the Lifetime Allowance will be abolished from 6th April 2024. This means that individuals can save more into their pensions without worrying about breaching the Lifetime Allowance and incurring potentially hefty tax charges upon their retirement.
How does the pension tax charge for lump sums change?
Currently, the tax charge for taking certain lump sums from your pension when exceeding the Lifetime Allowance is a fixed rate of 55%. However, from April 2023, this tax charge was reduced to your ‘marginal rate’ of income tax, which is typically between 20% and 45%. This change provides individuals with a more tax-efficient approach if wishing to access larger lump sums from their pension savings.
What are the tax implications when taking an income from a pension?
You can take 25% of any pension pot as a tax-free lump sum. Other options for extracting income from your pension pot could be either to take regular monthly amounts or opt for an annual annuity payment. Generally, any pension drawdowns exceeding the 25% tax free allowance will be subject to income tax at your marginal rate of tax (currently 20%, 40% or 45%).
Exchange Accountants always recommends seeking professional advice from a financial advisor or pensions specialist before making any decisions in relation to your pension savings or withdrawals.
If you have any further questions on the points raised here, please don’t hesitate to contact the Exchange team at [email protected] or call 028 9263 4135.
Exchange Accountants was established in 2011 and provides premier accountancy services and tax advice to a wide variety of locally based SMEs and individuals. Exchange was the first accountancy practice in Northern Ireland to be recognised as a Xero Gold Partner – and in 2021, the company achieved Platinum Partner status with the market-leading cloud accountancy software provider.