With a vast range of options available, the pension arena can be bewildering. The decisions and choices you make will affect the income you receive when you do reach retirement. It is essential, therefore, to take into account your needs and objectives and to receive expert advice in this complex area.
Pension Simplification
On the 6th April 2006 major changes were introduced to the structure of UK Pension schemes. These changes heralded probably the most radical overhaul of the UKs' Pension tax regime. The new simplified regime was largely a replacement of the past pension framework as opposed to the addition of another layer of legislation. Many changes were introduced, some of the main ones are as follows:-
Introduction of a Lifetime allowance
Each member of a pension scheme previously had a maximum permitted tax-advantaged fund at retirement, known as the Lifetime Allowance. The Lifetime Allowance was abolished from 6 April 2024 and no longer applies. Prior to its abolition, the allowance had been set at £1,073,100.
Contributions & The Annual Allowance
There is an annual pension input allowance (known as the Annual Allowance) set at £60,000 for the 2026/2027 tax year for all pension schemes. An individual can contribute up to 100% of their relevant UK earnings each tax year and receive tax relief, subject to the Annual Allowance. Individuals with no earnings can still contribute up to £3,600 gross each tax year.
Pension Commencement Lump Sum (Tax free Cash)
The maximum pension commencement lump sum (Tax Free Cash) from any pension arrangement is generally 25% of the value of the pension rights, subject to a maximum Lump Sum Allowance of £268,275 unless the individual holds valid protections entitling them to a higher amount.
However, in some cases prior to pensions simplification, members may have built up the rights to a lump sum greater than 25%. If this is the case, these members can apply to protect these benefits. This is a complex area of pensions advice and consultation with an advisor would be highly recommended.
Retirement Age
The concept of a normal retirement age is less definite than it was in the past. Members of pension schemes can choose (within certain age ranges) when to take their benefits, making the process of retiring more flexible. The minimum normal pension age for drawing benefits is currently 55, rising to 57 from 6th April 2028. The different options at retirement are featured below and covered in more detail on the Annuities, Pension Fund Withdrawal and Phased Retirement pages.
Death Benefits
The maximum lump sum death benefit is no longer linked to the Lifetime Allowance, as the Lifetime Allowance was abolished from 6 April 2024. Tax treatment of lump sum death benefits now depends on factors such as the member’s age at death, the type of pension arrangement, and the available Lump Sum and Death Benefit Allowance.
(There are transitional provisions in place in respect of some of these key areas of planning, and certain tax charges may still apply depending on the benefits taken and the allowances available.)
Drawing your pension
Retirement income is now commonly classified under the following main headings: -
- Scheme Pensions - typically, drawing your income directly from your employer’s occupational pension scheme.
- Lifetime Annuities - taking your income as an annuity. Commonly associated with drawing income from Personal Pension / Stakeholder Pension type schemes.
- Flexi-Access Drawdown - taking an income directly from your pension fund while leaving the remaining funds invested. This replaced Capped Drawdown for new arrangements from April 2015, although some existing plans may still retain capped drawdown status. Phased retirement may also be used alongside drawdown planning.
Above is an overview of some of the headline changes to pension legislation over recent years. Pension freedoms introduced from 6 April 2015 significantly increased the flexibility available when accessing pension benefits. The requirement to purchase an annuity by age 75 has been removed, and individuals can now remain in drawdown for their lifetime. This means it is possible to defer purchasing a pension annuity until the member is older or in poor health, when annuity rates could potentially be higher.
The rules are detailed and may affect different individuals in different ways, so to obtain further information or see how these changes may affect you, please contact us.
A PENSION IS A LONG TERM INVESTMENT THE FUND VALUE MAY FLUCTUATE AND CAN GO DOWN. YOUR EVENTUAL INCOME MAY DEPEND ON THE SIZE OF THE FUND AT RETIREMENT, FUTURE INTEREST RATES, AND TAX LEGISLATION
Personal Pensions
Personal Pension Plans (PPPs) were originally designed for the millions of employed & self-employed individuals who did not have access to a company pension scheme.
Introduced in July 1988, they were part of a government push to extend pension choice & encourage those people not in company schemes to build up a retirement fund; one that could cater for their retirement needs more realistically than the state. Many financial institutions offer PPPs, though most are run by the large insurance companies and banks.
We can research the market on your behalf to find a suitable Pension plan; it may be that a PPP meets your needs for retirement provision. These contracts are very flexible and can allow tax relievable contributions to be made of up to 100% of your earnings or £3,600 (whichever is the greater) subject to a maximum of £60,000 per annum which is the current annual allowance. Furthermore, these plans can be set up for non-working spouses and even children and grandchildren.
How they work
Unlike some company schemes, all personal pensions work on a 'money purchase' basis. This means that the money you save each month or each year into your Personal pension plan is invested (typically in investment funds) and is then used at retirement to provide you with pension benefits. So in theory the more you save the better your pension should be at retirement.
At Retirement
On reaching retirement, you use the money that has built up in your personal pension to purchase pension benefits, these benefits can be taken in the form of either income only or income with a tax free lump sum (The Pension Commencement lump sum). Alternatively, the benefits can be transferred to another type of plan which provides a drawdown facility (see the section on Flexi-Access Drawdown). These types of plan allow additional flexibility in that pension benefits can be drawn whilst your pension fund remains invested.
The value of your pension at retirement is mainly dependent upon:
* How much money you've paid in over the life of the plan
* How well the fund has performed
* The annuity rate that the provider applies to your pension fund (if you choose to take an annuity)
* level of Pension Commencement lump sum taken. (Up to a maximum of 25% of your pension fund)
So a Personal Pension Plan is really just a long-term savings plan (albeit a very tax efficient one) that is designed to produce a fund at retirement.
At retirement, provision can be made to protect your pension from the effects of inflation, protect your income in the event of your death, and make provision for your spouse or dependants. (see the Annuities page). Benefits can currently be drawn from age 57 from 6th April 2028.
A PENSION IS A LONG-TERM INVESTMENT. THE FUND VALUE MAY FLUCTUATE AND CAN GO DOWN. YOUR EVENTUAL INCOME MAY DEPEND ON THE SIZE OF THE FUND AT RETIREMENT, FUTURE INTEREST RATES, AND TAX LEGISLATION
Stakeholder Pensions
A Stakeholder pension is a form of low cost Personal pension aimed at encouraging those people who do not currently have pension provision to save for their retirement. They became available on 6th April 2001. They are not a form of state pension.
In order to reach as wide an audience as possible, Stakeholder pension schemes are intended to be flexible and easy to understand. Employers with 5 or more employees have had an obligation to provide their employees with access to a stakeholder pension scheme since 8th October 2001, although it is not compulsory to save for retirement with a Stakeholder Pension plan or any other savings related product.
Stakeholder pension plans are privately managed and funded but must operate within a standard framework laid down by the Government.
Stakeholder Pension plans are very similar to Personal Pension plans; they are individual pension arrangements, meaning that they are personal and portable - you can take them with you if you change jobs.
We can research the market on your behalf to find a suitable Stakeholder Pension plan, it may be that a Stakeholder Pension plan meets your needs for retirement provision. Following the recent sweeping changes made on the 6th April 2006 to pension legislation (see section on Pension simplification) these contracts are very flexible and can allow contributions to be made of up to 100% of your earnings. Furthermore these plans can be set up for non-working spouses and even children and grandchildren where up to £3600 can be invested annually.
An important aspect of many modern pension plans is that they can usually be transferred to another provider if your circumstances change or if you are dissatisfied with investment performance. However, charges, market value reductions, exit fees, or loss of valuable guarantees or benefits may apply in some cases, so advice should be taken before transferring.
Stakeholder pensions were designed to offer flexibility, including low minimum contribution levels and the ability to stop and restart contributions without penalty. Many providers allowed minimum contributions from as little as £20 per month, although minimum contribution levels and features can vary between providers and pension arrangements.
Company Pensions
Employers’ pension schemes, occupational pension schemes, defined benefit schemes, defined contribution schemes and company pensions all refer to employer-related pension arrangements.
A good proportion of the UK’s working population are members of a workplace pension scheme. Occupational pension schemes are those run by your current or former employer(s). These come in two basic types: defined benefit, where the benefits paid in retirement may be based on a combination of your age, length of service and pensionable salary; and defined contribution, also known as money purchase, where the benefits available at retirement depend on the size of the pension fund built up through contributions and investment growth.
Group Personal Pensions remain popular with employers. These are personal pension plans arranged by employers for groups of employees, often benefiting from lower administration costs. In addition, many employers now use Master Trust pension schemes as part of their workplace pension arrangements. (See section on Personal Pensions.)
Your employer may make contributions to your workplace pension scheme in addition to deducting a percentage of your salary and paying it into the scheme. You may also make additional contributions to boost your pension provision, subject to the Annual Allowance. Tax relief is generally available on personal pension contributions up to 100% of your relevant UK earnings each tax year. (You may contribute more than your relevant earnings, but tax relief will not normally be available on contributions above that amount.)
Eligibility
Eligibility to join a company pension scheme varies from employer to employer. Under automatic enrolment legislation, eligible employees are enrolled into a workplace pension scheme automatically, although waiting periods and eligibility criteria may still apply in some circumstances. Some employers allow employees to join immediately or shortly after starting employment, whilst others may apply conditions such as a minimum period of service or minimum age requirements.
The two main types
There are two main types of company pension scheme: defined benefit and defined contribution. They differ greatly in what they offer and how they work. Defined benefit schemes, often referred to as final salary or career average schemes, provide retirement benefits based on factors such as salary and length of service. Defined contribution schemes, also known as money purchase schemes, build up a pension fund through contributions and investment growth.
Most new workplace pension arrangements are now defined contribution schemes, as many employers have moved away from defined benefit schemes due to the higher cost and long-term funding commitments involved.
Annuities
Annuities are used to provide a pension income; in the case of pensions, this income is guaranteed for life. The pension fund is exchanged for a pension income. Once the annuity has been bought, the income is fixed; the contract cannot be reversed - the pension fund becomes the permanent property of the annuity provider.
The level of income that you will receive from an annuity depends upon several main factors:
- The level of Investment
- Age of 'annuitant'
- Health
- The prevailing annuity rates at the point of annuity purchase
In general, the older an annuitant, the higher the income which can be secured. Furthermore, males usually receive a higher income than females due to generally have a shorter life expectancy.
How they work...
Annuities, in the main, are supplied by Life Assurance Companies. The underlying 'annuity fund' is usually invested in fixed interest investments, such as long term government gilts in order to maintain the guaranteed income and ensure regular income payments are made to annuitants.
Annuities can be set up to provide different benefits / options:-
- Spouses pension (to protect a spouse, by providing an income, following the death of the annuitant)
- Guaranteed payment periods; 5 years is typical but 10 year guarantees are possible
- Escalation of benefits; income can be protected from inflation - RPI linked escalation, alternatively a fixed % annual increase in income can be secured at outset e.g. 5%.
Annuity income can be linked to investment performance for example by a 'With Profit Annuity' or 'Unit Linked Annuity'
Annuities: The options available
It's important to understand the options available to you when you buy an annuity. Like all things, there are pros and cons to each. Which option suits you depends upon your circumstances and attitude to risk.
Level Annuity
Income will not increase in payment. It provides the annuitant with the highest attainable income from outset compared to other options. However, as time goes by and inflation sets in, the value of the pension, in real terms, decreases. In the case of someone who retires early and then lives a long time, this reduction in 'buying power' could be considerable.
Joint-Life Basis
With this option, either a full or reduced income will continue to be paid to the partner if the annuitant dies. Because women tend to live longer than men, a wife several years younger than her husband could reduce the income payment offered at outset significantly. Joint life annuities are usually taken out by married couples, especially when the spouse has no other independent pension income.
Guaranteed Annuity
It is possible to ensure that the income to be paid is guaranteed at a set level for a period of time after the death of the annuitant. Typical guarantee periods may be 5 or 10 years. This option will almost certainly reduce the starting income.
If the annuity is on a joint-life basis and both parties die within the guarantee period, the payments will continue to be paid to the deceased annuitant's estate.
Escalating Annuity
These provide an income that will increase annually at a predetermined rate, or sometimes in line with the retail price index. The advantage of this is the income provides some protection against inflation. However, the initial starting income will be reduced in comparison to a level annuity.
With or without overlap
Applicable when a joint life guaranteed pension has been chosen. With overlap, the spouse/dependent's pension will commence immediately upon the annuitant's death. Without overlap, the pension will commence at the end of the guaranteed period or immediately upon the annuitant's death, whichever occurs latest.
With Profits & Unitised Annuities
Traditional annuities provide a guaranteed income; however, there are other types available, namely With Profits and Unit Linked Annuities. They differ from traditional annuities in that the guaranteed element is either reduced or removed altogether in exchange for the possibility of increased income over the longer term.
In respect of a With Profits Annuity, a lower guaranteed income level is initially secured, and then annual bonuses may be added from the linked with-profits fund. The level of income can therefore fluctuate from year to year and is dependent upon the performance of the with-profits fund.
Under a Unit Linked Annuity, little or no guaranteed income may be provided. The income received is dependent upon the underlying performance of the linked investment fund(s), which are likely to fluctuate over time. In favourable market conditions, a unit linked annuity may, over the long term, produce income that exceeds that of a traditional level or escalating annuity. However, adverse investment conditions may significantly reduce the level of pension income received.
Since the introduction of pension freedoms in April 2015, investors have had greater flexibility in choosing when and how they take their pension benefits, and there is no longer a requirement to purchase an annuity by age 75.
Phased Retirement
Phased retirement allows you to gradually access your pension rather than taking all benefits at once. You can typically take a combination of tax-free cash and taxable income over time, either through drawdown or by purchasing annuities in stages. The remaining pension fund stays invested and may continue to grow.
Today, phased retirement is generally achieved through Flexi-Access Drawdown rather than older “segmented” phased retirement arrangements.
It is a flexible way of easing into retirement, but the suitability depends on individual circumstances and pension value, so professional advice is usually recommended.
Phased retirement is still used, although it is less prominent since the pension freedoms introduced in 2015 made drawdown much more flexible.
Pensions Fund Withdrawal
Pension fund withdrawal (also known as Income Drawdown) is an important retirement option, particularly for individuals who wish to keep their pension invested while taking income.
Income drawdown allows income to be taken directly from the pension fund while the remainder stays invested. This provides flexibility and can allow the fund to continue to grow depending on investment performance.
Most pensions now operate under Flexi-Access Drawdown, which allows flexible income withdrawals from age 55 (rising to 57 from 2028). Up to 25% of the pension fund may typically be taken as a tax-free lump sum, subject to available allowances.
Under Flexi-Access Drawdown, there is no maximum income limit, meaning individuals can take as much or as little income as they choose, although withdrawals are subject to income tax.
On death, any remaining drawdown funds can usually be passed to beneficiaries. If the member dies before age 75, benefits are generally paid tax-free; if death occurs after age 75, benefits are usually taxable at the recipient’s marginal rate.
A pension is a long-term investment. The eventual income will depend on factors such as fund value, investment performance, and future tax rules. Professional advice is strongly recommended when considering this option.
Capped Drawdown
With capped Drawdown you can elect to take a tax free lump sum and rather than buy an annuity leave the fund invested to continue growing tax free.
An annual income can be taken from the fund if required. However a maximum level is set by the Governments Actuary Department (GAD) based on the size of the fund, age, sex and current gilt yields. These GAD tables are broadly equivalent to a single life annuity that you could have purchased. The maximum income can be no more 100% of the GAD rate. This GAD rate will be reviewed every 3 years.
There is no minimum income limit so an annuity does not need to be purchased so funds can remain invested until death. Upon death the residual fund can be taken as a lump sum with a 55% tax charge or the fund can be used to buy an annuity for the nominated beneficiary or they can continue to undertake drawdown until their death.
Flexible Drawdown
Flexible drawdown was introduced from April 2011, allowing individuals to take as much income as required from the pension fund from age 55, whilst keeping any remaining fund invested. However it is possible that the whole fund could be utilised as income, subject to a personal tax liability, and on the basis that flexible drawdown is only available to individuals who have other secure pension income from other sources amounting to £20,000 a year (this can include state pensions).
This minimum income requirement (MIR) will be reviewed every five years although there will no further test of the MIR once flexible drawdown has been opted for.
Upon death any remaining fund in flexible drawdown would be subject to a tax charge of 55% if paid to a named beneficiary otherwise the fund would pass to a nominated charity.
Flexible drawdown could be suitable for individuals who have no need to guarantee any further income because they already have pensions of at least £20,000 a year. Given the nature of the facility that this type of drawdown offers the inherent risks would mean that any individual considering this type of drawdown needs to be relatively sophisticated in understanding the implications.
A pension is a long term investment. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation. We strongly recommend advice from us be sought if you are considering this option.
