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Solving the Pension Puzzle
By Drew Mitchell
With auto enrolment on the immediate horizon for every company across the UK, pensions again seem to be at the forefront of the agenda. But are you in the same boat as many of the general UK population in not having a clue about your pension?
Arguably the most significant investment that you should be concerned about is often the one that is neglected the most, usually down to the fact that the vast majority of people simply don’t understand them.
This may be largely down to the seemingly unnecessarily complicated annual statements that are issued, amongst other things stating your “Projected with-profits and unit-linked” valuations along with “Number of Units”, “Bid Price”, “Lower, Medium and Higher” rates and your “Drawdown” and “Cash free lump sums” all estimated at varying ages and under several different circumstances. This is after you have worked out what sort of pension it is in the first place and all before the further layer of confusion added by the funds that you are invested in and their cumulative performance. No wonder people are completely put off by the idea of discussing their pension arrangements and taking an interest in actively planning for their retirement. The whole system appears to be a giant puzzle that nobody is quite sure about how to approach.
This article sets out to distinguish between the different types of pensions that you may hold and explain a little about what can be done to simplify the way you visualise your pension provisions and retirement goals.
Types of Pensions
Company Pension/ Workplace Pension Scheme
A Company Pension Scheme (otherwise known as a Workplace or Occupational Pension) is a pension that is set up by your employer to provide retirement benefits to you while you are employed by them. It allows you to accumulate a pension fund during your working life. You will usually be required to make regular pension contributions based on a percentage of your salary into the workplace pension scheme. It is customary for your company or employer to match the level of contribution you make. Over the next few years, most employees will be auto enrolled into a pension scheme.
Money Purchase Pension Plan
A Money Purchase Pension Plan or Defined Contribution Plan is a pension scheme where the final benefits are not linked directly to your salary. You (and maybe your employer) pay regular contributions into your pension pot. Upon retirement, the total pool of capital in your pot can be used to take an income in retirement. The amount in each money purchase plan member's account will differ from one member to the next, depending on the level of contributions and investment return earned on such contributions.
Final Salary Pension Scheme
A Final Salary (or Defined Benefit) scheme is a type of occupational pension where the amount of retirement income is based on your final salary. These are becoming less common.
Additional Voluntary Contributions (AVC)
As a member of an Occupational Pensions Scheme, payments in the form of Additional Voluntary Contributions can be made above the normal level of contribution to gain additional pension benefits.
Small Self-Administered Schemes (SSAS)
Small Self-Administered Schemes (SSASs) are generally very bespoke pension schemes designed for the directors of a business. They are generally not available to other employees as they are more complex and limited to no more than 11 members.
Personal Pensions/ Private Pensions
A personal pension is usually arranged by yourself, not your employer, and is a type of money purchase plan.
A personal or private pension is a tax-efficient savings plan that enables you to save for retirement. Your pension contributions attract tax relief (up to annual limits) and can be made in various ways - regularly, by lump sum, or a combination of both.
On retirement, up to 25% of your pension fund value can be taken as a tax-free cash lump sum. The remainder of the funds left in your pension pot can then be used to buy an annuity (a guaranteed income for life in return for a lump sum investment) or left invested to produce an income directly from the fund. Alternatively, you could withdraw the whole fund as a taxable lump sum.
Self Invested Personal Pension (SIPP)
A Self Invested Personal Pension (SIPP) is a type of personal pension. A SIPP is a pension plan that gives you the freedom and control to totally manage your own investment decisions by buying stocks and shares and a range of other types of assets. Any contributions that you make to a SIPP will receive tax relief, up to certain limits.
A stakeholder pension works in a similar way to other personal pensions, in that you pay money into your pension to build your pension fund. However, they have to adhere to Government rules and minimum standards on annual management charges, access and terms to ensure they offer value for money, flexibility and security.
- You can switch to a different pension provider without the provider you leave charging you.
- You can start contributions from as little as £20, and pay weekly, monthly or at less regular intervals.
- You can stop, re-start or change your contributions whenever you want – there are no penalty fees.
- The scheme must be run by trustees or by an authorised stakeholder manager, whose responsibility will be to make sure that the scheme meets the various legal requirements.
A State Pension is also known as a Government Pension or Old Age Pension. Your entitlement to the pension accumulates during your lifetime and is paid by the Government when you reach state pension age, which depends on your date of birth.
A state pension value is based on the number of years of National Insurance (NI) contributions made throughout the person's working life. You have to have at least 35 qualifying years' worth of NI contributions to qualify for a full State Pension.
What pension do I have and what are my options?
It is extremely common for us to speak to clients who do not know any information about their current or previous pensions that they may or may not have contributed towards in the past. In the first instance we suggest that clients work backwards and list any previous employers where they may have made pension contributions, we can then contact the employers and pension providers to ascertain what type of pension they have. It may be the case that a client has a completely mixed bag of different types of pensions, for example they may have an occupational pension from one previous employer, a final salary scheme from another and a stakeholder pension with their current employer, in addition to this they might have set up a personal pension plan as well.
You can see how easy it is to lose track of the running total as clients are unaware of previous contribution amounts, whether or not companies were, or still are, matching their contribution, the value of each plan and more importantly when they can access the money and what the value of the pension means in real terms of spending power in retirement. Is it going to be enough? How long will you be able to survive for? And what age can you plan to retire?
Of course, the answers to these questions are very unique to each individual and that is why we encourage clients to take an active approach to discussing their own circumstances with an advisor. We are then able to unravel any issues that you think you might be facing and try to help simplify the retirement puzzle for you. In many cases it is beneficial to consolidate any previous pensions that you have historically contributed towards into a private self-invested pension, this can then run alongside your existing workplace pension. The situation is different for each individual though and it really depends on your circumstances along with your plans for the future, not least of all when you are looking to retire.
Cadence Wealth offers a free, no obligations, initial pension review service which will provide you clarity on your existing pension arrangements. With autoenrollment currently being mooted to all employers across the country, which requires 2% of your salary being paid into a pension, it might be the perfect time to start taking a closer interest and book a meeting to discuss your situation with an advisor. Although 2% may not sound like a significant amount, the rate is rising to 5% as of April next year and then to 8% in 2019, this might have too big an impact on some household’s surplus income. Recent studies carried out by Aviva, have shown that one in eight workers are thinking about leaving their workplace pension schemes when contributions rise next April. The insurance giant said that while only 4% of people have definitely decided to opt out of their pension schemes next April, with half of people still planning to save into one, everyone else is on the fence.
This is certainly one of the most important investment that you are going to make, and you only get one shot at it, so don’t just go along with the crowd and take your employers word as gospel, speak to an advisor and get some assistance to see the whole picture.