I’d rather put my money under the mattress than in a pension
Mr Murdoch has a lot to answer for. Plundering his employees’ pension funds has left many people wary of pensions. Bear with me while I try to justify them in around 500 words. This is my soap box that I clamber up onto on a regular basis!
If pensions were called ‘Probably the best, most tax efficient investment account in the world,’ then we’d all have one. In my opinion, that’s exactly what they are now that we have pension freedom and flexible access rules.
I challenge anyone to find another investment today that gives 20% extra boost, then grows virtually tax free until you want it. Never mind its other tax benefits. The only downside is you have to wait until you’re 10 years off the State Pension age to get the money.
Here’s my quick guide to the 3 main pensions.
1. The State Pension
When you work and pay National Insurance contributions, you build up an entitlement to a State Pension. How much depends on how long you’ve paid in, but you can buy qualifying years if you’ve a shortfall. You can check your own record at www.gov.uk/check-state-pension. The current full basic state pension is £168.60 per week, or £8,762.20 a year.
2. Final Salary or Defined Benefit Pensions
These are becoming increasingly rare and are often closed to new joiners.
A Final Salary Pension pretty much describes how it works in the name. How much you get as a pension is based on how long you worked somewhere and your salary when you left. Recently in many cases the Final word has been replaced by Career Average, but this depends on the individual scheme. It’s usually guaranteed and often linked to inflation.
Jo worked for Big Corporation for 25 years. Her salary when she left aged 60 was £75,000 a year. This means her pension could be 25/60 x £75,000 or £31,250 per year.
3. Money Purchase or Private pensions
This is a catch-all term that includes most Personal or Private Pensions, the Workplace Pension, Group Personal Pensions and Stakeholder Pensions.
In its simplest terms, you and/or your employer pay into a Money Purchase Pension, where it receives tax relief and is used to buy an investment within the pension account. The investments available range from very low risk Cash, through Property and Stocks & Shares up to Emerging Market investments. You choose the risk level. Generally, there is an ‘eggs in different baskets,’ default.
When you want to retire, you take the pot of money and decide how you’d like to draw it down (withdraw it) and use it.
Joe at Bigger Corporation earns £75,000. He pays 5% of his salary (£3,750 per year) into his pension, which receives 20% tax relief adding another £750. His employer pays in a matching 5%, or £3,750. This means, for his £3,750 payment, this year’s pension pot has increased by a whopping £8,250. And that’s before any investment returns!
Drawing down
The way you take money out of a Money Purchase Pension can be flexible and tax efficient. However, it’s wise to take advice at this point if you take it at no other time so you don’t miss out on some small but significant tax planning benefits.
It’s very difficult to explain the benefits of pensions in just a few words, but I hope I’ve helped.
Please call me on 01488 682890 if you’d like to better understand your own personal situation.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested. HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
