Retirement is becoming an increasingly nuanced concept. At one end, there are people who are perfectly happy to work until the end of their days (if they can). At the other, there are people who would like to retire as soon as possible. Regardless of where you currently sit on this spectrum, there is a lot to be said for contributing as much as you can to your pension.
Understanding the modern pensions landscape
Before pensions freedoms of 2015, most of your pension pot had to be used to buy an annuity. This is a guaranteed income for life for the named beneficiary or beneficiaries. When they died, the annuity ended regardless of how much or how little had been paid.
Now, however, individuals can choose whether or not they wish to buy an annuity. If they do choose to buy an annuity, they can choose how much of their pension pot to spend on it. Any funds left in their pension pot after their death can be left to their chosen heirs. What’s more, under current rules, they are excluded from inheritance tax.
How pensions are funded
Pensions come in two main forms. These are state and private. Private pensions can be further divided into two main forms. These are workplace and non-workplace. Workplace schemes can be further divided into defined contributions and defined benefits (although there are very few of the latter).
The state pension
The state pension is funded through national insurance contributions. This means you have relatively little control over its funding levels. With that said, if you have gaps in your national insurance history, you may be able to fill them. If you can, then it’s a matter of individual judgement whether or not this is worthwhile.
As their name suggests, workplace pensions are provided through a person’s employer. Some workers have to be enrolled in a workplace pension scheme unless they opt out. Others can choose to be enrolled if they wish.
Most workplace pension schemes are defined-contributions schemes. This means that the eventual benefit depends on the performance of the investments they contain. These are funded by contributions made by the employee and the employer.
The employer’s contributions are one of the biggest reasons why it’s so important to participate in a workplace pension scheme if you possibly can. If you don’t, you will effectively lose out on money that should rightfully be yours.
What’s more, making the necessary contributions costs less than the headline figures might suggest. At a minimum, the employee’s contribution will be made before taxes. In some cases, employees may be able to opt to sacrifice some of their salary in return for their employer paying their share of the pension contributions. This can be even more tax-efficient.
Even so, any reduction might be more than an employee can manage at a given point in time. Legally, if an employee does not contribute to their workplace pension, the employer does not have to contribute either. With that said, there is no harm in asking if an employer will voluntarily make a contribution to either a private pension or a Lifetime ISA.
Some workplaces still run defined-benefits pensions. These are also known as final-salary pensions as the end benefit is a percentage of your final salary. Defined-benefits pensions work on a very different set of rules. In general, if you are offered membership of a defined-benefits pension scheme, your best option by far is to take it and follow the rules.
Other private pensions
You do not have to be in the workplace to have a pension. You can set one up independently. If you’re not in the workforce, you’ll miss out on employer’s contributions. You will, however, get the benefit of making your pension contributions before your income tax is calculated.
If you’re married or in a civil partnership, you can have the higher-earning partner fund a pension for the lower-earning partner. This can help to save even more tax.
For advice on your pension, please get in touch.
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.
Approved by The Openwork Partnership on 8/9/2023