An introduction to Pensions.

Written by AJN Accountants
11 September 2023

This is a guest blog by Roy Dravid, an Independent Financial Adviser part of AJN’s network. He specialises in managing investments and pension portfolios. He enjoys working with clients and can discuss all aspects of Financial Planning. You can book an initial consultation with him here: Calendly – Roy Dravid

Pensions, often perceived as intricate and perplexing, tend to elude the grasp of many individuals. Consequently, people frequently procrastinate on initiating a pension plan or, in some cases, disregard the matter entirely. However, the fundamental concepts are relatively straightforward, and dedicating time to grasp them now can profoundly impact the quality of your retirement. In this comprehensive discussion, we aim to address common queries our clients pose and guide you through the intricate landscape of pensions.

What is a Pension?

At its core, a pension is a long-term savings strategy devised to help you accumulate funds for your later years. It enables you to regularly set aside a portion of your earnings during your working life to secure an income stream when you choose to retire or reduce your working hours. The funds contributed to your pension are typically invested, alongside contributions from other pension savers, in various investment products. Pensions also enjoy favourable tax treatment, making them attractive investments.

Types of Pensions

There exist three major pension avenues, with most individuals relying on a combination of one, two, or all three of these options:

  1. Workplace Pensions: These are organised by your employer and may be called ‘company pensions’ or ‘occupational pension schemes.’ You automatically contribute a percentage of your salary into the scheme, with your employer often matching your contributions. Additionally, you benefit from tax relief from the government. The implementation of automatic enrollment since 2012 has led most companies to enrol their staff in workplace pensions.
  2. Personal Pensions: You arrange personal pensions yourself, sometimes known as ‘defined contribution’ or ‘money purchase’ pensions. You contribute a portion of your earnings into your pension pot, which, along with tax relief, is then invested by your pension provider in various assets, such as stocks or bonds. Your retirement income depends on your contributions, investment fund performance, administrative fees, and your chosen withdrawal method.
  3. State Pension: This is a government-provided weekly payment for individuals who reach the State Pension age. Eligibility is established by paying or being credited with National Insurance contributions (NICs) during your working years. To qualify for the new full State Pension, a 35-year NIC record is required.

Tax Relief on Pension Contributions

Regardless of the type of pension plan, you receive tax relief at the highest rate of Income Tax you pay on all contributions you make, subject to annual and lifetime allowances. This essentially means that a portion of your earnings that would have been taxed is redirected into your pension pot.

Tax relief is received ‘at source’ when you contribute to your personal pension or when workplace pension contributions are deducted directly from your pay. In both scenarios, you automatically receive 20% tax back from the government, effectively increasing your contribution.

Even if you do not earn enough to pay Income Tax, you still qualify for tax relief up to a certain amount, with the maximum annual contribution currently set at £2,880, which, with tax relief, totals £3,600 per year into your pension scheme.

Contribution Limits

While there is no upper limit to your pension contributions, there are limits to the amount of tax relief you can receive annually. The Annual Allowance is currently £60,000 or 100% of your earnings, whichever is lower. However, you can carry forward any unused allowances from the past three years, provided you were a pension scheme member during those years.

For the 2023-24 tax year, the Threshold Adjusted Income Limit is £200,000, and the Adjusted Income Limit is £260,000. Contributions exceeding these limits reduce your Annual Allowance.

Additionally, a Lifetime Allowance imposes a cap on the total value of all your pension funds without incurring extra tax upon withdrawal. The limit was £1,073,100 but has been removed as of April 2023.

Accessing Your Pension

The pension freedoms introduced in 2015 grant access to your pension from age 55 (57 from 2028). You can choose to withdraw any amount from your pension pot as you see fit. While this newfound flexibility is advantageous, it necessitates careful consideration. Seeking professional financial advice before accessing your pension is crucial to minimise potential tax implications and maximise your retirement benefits.

Top Tips for Retirement Planning

  1. Start Early: Commence saving for retirement as early as possible, allowing your savings to grow over time.
  2. Better Late Than Never: Don’t assume it’s too late to save for retirement. Pensions offer tax benefits and potential investment growth, making late contributions still impactful.
  3. Self-Employed Planning: Self-employed individuals should proactively manage their pension planning.
  4. Regular Monitoring: Review your pension arrangements periodically to ensure they align with your retirement goals.
  5. Inheritance Planning: Plan for transferring your pension benefits in case of your passing.
  6. Take Control: When you reach retirement age, consider your pension options carefully, seeking professional advice to optimise your choices.
  7. Professional Advice: Tailor your retirement planning with financial advice that suits your unique circumstances.

In conclusion, while pensions may initially seem complex, understanding the basics can significantly enhance your financial security in retirement. These long-term savings vehicles, bolstered by tax advantages, offer a path to a comfortable and prosperous post-working life. Whether you’re just beginning to save or nearing retirement, thoughtful planning and professional guidance can help you navigate the pension landscape and secure a brighter financial future.

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