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Pensions

This article is about pensions in general, not about Orbis Access in particular.

Pensions

Facing up to the passage of time?

Getting stuck in

It’s tempting to avoid planning for retirement. And many of us do just that. Overall, the level of UK pension savings means that “an average person retiring at 65 could receive under half the amount that they want.” Fewer than half are saving enough to meet their expectations. And one in five adults aren’t saving for retirement at all.*

This could be a big mistake. Relying on a state pension alone isn’t appetising. It is widely assumed that in future these will be modest, start later in life and thus won’t allow for much fun in your old age.

Distinct from the state pension, a private pension is just a tax-free wrapper that you or your employer pays into. The resulting pot of investments cover your living costs after you retire. Because pension contributions are currently made before tax, basic rate tax payers can save 20% and those on higher rates save 40% or more, and 25% of the pension pot can be withdrawn tax-free in retirement. In reality the rules are more complex, but it’s nevertheless a generous tax break, even if there is occasional speculation that it won’t last.

In any case, due to the effects of compounding, the earlier you can start saving for your retirement the better. If you only start thinking about it in middle age, it’ll be significantly harder to achieve the same goal.

The good news is that getting started needn’t be hard and it’s never too early or too late to get stuck in. If you’re unsure or need help, one good place to start is the government-sponsored Pensions Advisory Service.

Alternative routes

Personal pensions may be tax efficient, but they are subject to strict rules – not least being that you can’t access the money before the age of 55. This has led people to explore other ways of getting financially set in their old age. 

For example, more pensioners are funding their retirement income with money they stashed in ISAs, ploughed into a buy-to-let property or equity release from their home. In fact the Lifetime ISA, available from April 2017, is designed specifically as one way of funding retirement in the future. Some people also choose to work part-time (through choice or necessity) to boost their income later in life.

You can of course mix your options, but together they still need to deliver the income you’re aiming for in old age. Some routes are more flexible than a pension, but there are downsides too - so be aware of the pros and cons of pensions vs. ISAs.

In short, paying into a pension continues to make sense for most people, even if it’s only a part of the mix. In 2012 the government introduced auto-enrolment to encourage more people to save for old age. It means companies are obliged to sign up staff to a pension scheme automatically. However, individuals can opt-out if they wish.

How much should I save?

Unfortunately this isn’t a straightforward question to answer, as it needs to take account of a number of factors, such as:

  • your age
  • the amount of money you need in retirement
  • how long you expect to live
  • the size of your existing savings
  • investment performance
  • how much you can afford to stash away

Typical rule-of-thumb advice is that upwards of 10% of your income should be set aside for old age. A number of online pensions calculators, like this one by the Money Advice Service – or this basic one from This Is Money – can help work out if you are on track to save enough for your retirement.

Types of pension

State pensions are arranged by the government and are what you get after paying compulsory National Insurance (NI) contributions. Not everyone gets a full state pension, but most qualify for something, with the amount depending on how long contributions were paid. When it comes to private pension arrangements, the two most common types are:

  • Defined contribution – otherwise known as ‘money purchase’ – where the cash you contribute over the years is invested. When you retire, your pension pot is used to purchase an annuity or provide income. This is the most common form of pension nowadays. If the investments perform badly, the risk lies with the individual.
  • Defined benefit – most commonly these are ‘final salary’ or ‘career average’ company schemes. These provide employees a pension related to the size of their salary, either at the point of retirement or the average during their employment. This type is becoming less and less common. If the investments perform poorly, the company scheme (not the individual) bears the risk of making up any shortfalls.

Things can get bewildering here, especially as an individual can have multiple pensions which may be of different types. But broadly they fall into three categories:

  • Personal pensions – are arranged by you, the individual, with contributions made directly from your bank account to your personal pension account.  This type of pension is available from a wide range of financial service providers.  That said, there’s nothing stopping an employer contributing to your personal pension.
  • Workplace pensions – are arranged by your employer and sometimes known as ‘company’ or ‘occupational’ schemes. Usually employers top-up contributions made by the employee, with deductions made through PAYE before your salary is paid. A few Workplace pensions are Defined Benefit and the rest are Defined Contribution schemes.
  • NEST and stakeholder pensions – specifically target those on low-to-middling incomes. Introduced in 2001, stakeholder pensions weren’t adopted as widely as hoped. The National Employment Savings Trust (NEST) is effectively taking their place. Although technically a workplace pension, NEST pension accounts are transferrable between employers and also open to the self-employed.

What’s a SIPP?

A Self-Invested Personal Pension (SIPP) is a form of do-it-yourself personal pension. Other pensions appoint a professional pension fund manager to look after your pension savings, but with a SIPP you’re in charge of making your own investment decisions.

That may be good thing if you’re totally comfortable managing your own financial destiny. But they’re not suitable for everyone. Less expert investors may prefer somebody else to make investment decisions on their behalf.

As with ISAs, a SIPP is a tax-efficient account into which you can put a range of investments. Like regular pensions, you can put money into your pension pot before it gets taxed. And like regular pensions, the biggest and most obvious downside is that you can’t access the cash until you reach retirement age (currently set at 55+). As with other pensions, there are also limits on how much you can put into SIPPs and how you use the money once you retire.

What’s an annuity?

An annuity works like this: in return for a lump sum of cash when you retire, a financial services company promises to pay you a regular income until, ahem, you no longer need it. It’s a little bit like a mortgage in reverse. Instead of monthly payments from you to acquire a big asset (your property), a big asset (your pension pot) pays out monthly to you.

The headline annuity rate – often expressed as a percentage – describes what portion of the up-front cost comes back at you as annual income. For example, purchasing a £100,000 annuity with a 5% rate will generate £5,000 income each year for the rest of your life.

But not all annuities are the same. They depend on how old you are when you start. Some promise to pay the same nominal amount until death, while others grow to help combat the corrosive effects of inflation. Some continue paying out to your partner after your death, others don’t.  These are important factors to take into account when comparing annuity rates being offered by competing providers.

In the past, most people converted their pension savings into an annuity when they retired. However, in recent years annuity rates have been low by historical standards (see chart). Meanwhile, pension reforms announced by the government in 2014 relaxed rules forcing people to buy annuities when they retired. This is encouraging more people to hold on to all, or part, of their pension pot without converting it into an annuity. Instead, pension savings are retained as investments and either used to produce income or cashed in over time.

Annuity Rate

Choosing an annuity – or not – is a major financial decision and seeking professional advice is recommended. If you do want an annuity, be sure to shop around before choosing one, rather than automatically signing up with the one suggested by your existing pension provider (which may not be the best deal).

* Source: Pensions Advisory Service

Related links

  • Pension need-to-knows

    The 15 key things you need to know about pensions, including the new rules which mean, over time, every employee will be auto-enrolled into a workplace scheme.

    Money Saving Expert

  • Seven top tips

    Following these simple tips can make a big difference to the benefits you could enjoy in later life.

    Pensions Advisory Service

  • How much do I need to save for a decent retirement?

    Saving for retirement is easy to put at the bottom of the to-do list but for every decade that you wait, you will have to double the amount you save.

    CityWire

  • The new State Pension

    The new State Pension will be a regular payment from the government that you can claim if you reach State Pension age on or after 6 April 2016.

    UK Government

  • Workplace pensions

    By 2018, every employer in the UK will have to automatically enrol their eligible employees into a workplace pension.

    Citizens Advice Bureau

  • SIPP basics

    A self-invested personal pension is a pension ‘wrapper’ that holds investments until you retire and start to draw a retirement income.

    Money Advice Service

  • Compare annuities

    It’s your right to shop around and you’ll usually get a higher retirement income.

    Money Advice Service