It depends on what your employer is providing. If you are in a Defined Benefit scheme, you might not need to pay anything at all beyond the scheme’s standard contribution rate. If your employer operates a Defined Contribution scheme (or a Workplace Pension), the contributions may or may not be sufficient to meet your needs. It also depends on how much you want to receive and when you want to retire.
If you have a full National Insurance record, under current rules you should receive £9,100 a year from age 68. If you want to increase that by £10,000 a year, and you’re not in a Defined Benefit scheme, current annuity rates suggest that you might need a fund of around £400,000.
If you want to build up a £400,000 pension pot, you would need to invest (at 2.5% net annual growth after inflation until age 68):
|Starting at age 25||About £425 per month|
|Starting at age 35||About £625 per month|
|Starting at age 45||About £1,040 per month|
|Starting at age 55||About £2,000 per month|
Remember that you and your employer may already be contributing part or all of that already. If not, you should consider topping up the current contributions.
You might prefer to retire before you reach 68, in which case the figures will be significantly higher.
Finally, bear in mind that those figures are based on current annuity rates, which are very low by historical standards, due largely to low interest rates. If rates increase, the fund required will probably be lower. So don’t be daunted if those numbers seem high; every little helps, and you might find that you don’t need as much at 68 as the figures currently suggest. If you decide, when the time comes, not to buy an annuity you might find that the fund required to achieve your £10,000 a year is a lot lower, but then the income is not guaranteed.
Money purchase / Defined Contribution pension
This is a pension provided by an employer or a pension set up by an individual which does not have any guaranteed benefits. If you set up this type of pension, it remains yours until it has run out of money or you have passed away. You have to take control of this type of pension ensuring that it is invested suitably for your needs in retirement. You receive 20% tax relief at source and if you are a 40/45% tax payer, you will have to submit a tax return to receive the additional tax relief. You may be in a net pay or salary sacrifice arrangement in which the contributions are deducted from salary before tax.
Final salary / defined benefit pension
This is a pension provided by an employer that guarantees a portion of salary to be paid on retirement. If you are in the NHS or public sector, you are likely enrolled in a defined benefit scheme. You take no personal investment risk and it provides you with a guaranteed income for life. Ask your employer for details of this scheme and become familiar with the pension projections.
There are other specialised pensions which may be suitable for company or property owners.
If you are working for an employer, they have to provide an auto-enrolment workplace scheme unless there is a suitable scheme already in place. This pension will receive employer contributions of a minimum of 3% of your qualifying salary, and 5% minimum from your qualifying salary each month.
Your qualifying earnings are between £6,240 and £50,000. If employer chooses to use basic pay then minimum employer contribution is 4%, giving you a total of 9% contribution.
If you are self-employed, it is up to you to set up a pension and arrange for a payment to go in either each month or regularly using your available annual allowance.
If you are a director of a limited company, your company can set up a pension for you.
Employer pension contributions are an allowable expense and will reduce corporation tax for a limited company.
The maximum annual allowance is set at £40,000 per tax year. To calculate if you can use all of this allowance, you need to determine your “earned income”. In addition, you may have three years of carry-forward annual allowance.
An employee where the only income is their salary and if lucky, a bonus, earning more than £40,000 per year would have the full £40,000 annual allowance. This may reduce if your earnings are over £200,000.
Income from property or investments is not considered earned income.
This can be sometimes tricky to calculate, so do seek out an advisor to support you with this if you are struggling.
It is estimated that 95% of people in auto-enrolment have their pension invested in the default investment fund that was provided to your employer.
The default fund can offer some benefits, such as provides steady return through income fixed interest, and is often invested in less equity. There is little administration for you, no charges for advice, and low or discounted charges from the pension provider.
The default fund may not match your attitude to risk and provide limited growth potential. Ask your provider for the full list of funds, charges and performance available to you.
If you have been working and paying National Insurance and are on target to have 35 years of contributions, then you will be entitled to the full flat rate State Pension. This is currently £9110 per annum and rises by the higher of CPI, wage growth or 2.5% per annum. You might hear this called the “triple-lock” and it may change in future. A couple may have £18,220 per year.
However, this amount is unlikely to provide you with a sufficient income, and it will be important to set out an income plan. I would suggest speaking to a financial adviser and creating a personal financial plan. While a pension may provide tax relief if you are working, an ISA may provide tax-free income. You also may have plans to sell a property to fund retirement, and it is best to plan for this approach carefully. A financial adviser can also support you by setting up a low cost pension with investment advice if this is advised.
Your pension can normally be passed on to your beneficiaries free of tax. It’s important that you complete an expression of wish form with your pension provider so that they know where the funds should be distributed on death, and this form provides them with your wishes.
Pensions and ISAs (individual Savings Accounts) are both “tax wrappers” but they have different rules. A pension will grow free in the fund free of tax, and then provide 25% tax free cash and the remainder of the fund is taxable income.
An ISA allows investments to grow free of tax, and will provide tax-free income. Withdrawals from Cash ISAs may have interest penalties and Stock and Shares ISAs will have to sell investments in order to provide the income.
An ISA can be accessed before age 55 while a pension cannot usually be accessed until 55. Taking income from your pension may affect your ability to make future contributions.
They are both useful to have for retirement as it is important in retirement to manage your income for tax efficiency.
There is no doubt that Covid-19 is impact the financial markets with a significant drop in March 2020. It is likely your pension is invested in various stock market funds around the world and the volatility and reduced dividends paid from companies will inhibit growth of your investment.
However, pound cost averaging by continuing with your regular monthly pension or investments where you can afford it will allow your funds to be bought at the lower prices in a market downturn, improving your return as it rises.
Compounding over the long term will also continue to support your fund growth. Keep earning, keep saving and investing over the long term.
This last question is for you to think about and work through with or without a financial planner. With a goal in sight, it will be much easier to put an effective strategy in place.
Taisha Betz is an independent financial planner at Continuum Wealth in Buckinghamshire and one of our Brand Ambassadors passionate about pensions and investing!
Opinions and views expressed are personal and subject to change. The value of an investment and the income from it can go down as well as up and investors may not get back the amount invested.. You should be aware that past performance is not a reliable indicator of future results. Tax benefits may vary as a result of statutory changes and their value will depend on individual circumstances.