One of the most important stages in life which everybody has to save for is retirement. We work hard to enjoy our current lifestyle but are we doing enough to ensure that we can continue to enjoy it in our retirement? Many of us live for today, but saving into a private pension plan can help us retire sooner rather than later.
Pension plans are as individual as the people who invest in them. There is no one-size-fits-all, tax-efficient solution for private pensions. Instead they should be tailored to match your particular needs and aspirations.
Enjoy the lifestyle you want in later years
Private pensions are a tax-efficient way of saving money during your working life so that you have an income when you want to retire. With proper planning, your private pension will allow you to enjoy the lifestyle you want in later years. A private pension plan, also known as a personal pension, is a good option if you’re self-employed, as you won’t have the option to be automatically enrolled in a workplace pension.
The term private pension covers both workplace pensions (also known as occupational or company schemes), arranged by your employer, and personal pensions, which you manage yourself. There is no restriction on how many pensions you can have, and some people will have both.
Cap on the amount you can save every year
A personal pension operates in a similar way to a workplace scheme, except that you make the contributions yourself into a plan of your choosing. You can make monthly payments, one-off payments or a combination of the two. But the government places a cap on the amount you can save every year, upon which you can earn tax relief. This cap is known as the annual allowance, which is currently £40,000 in the 2019/20 tax year.
In addition, the lifetime allowance is a limit on the value of payouts from your pension schemes – whether lump sums or retirement income. The lifetime allowance currently for most people is £1,055,000 and applies to the total of all the pensions you have, including the value of pensions promised through any defined benefit schemes you belong to, but excluding your State Pension. The standard lifetime allowance is indexed annually in line with the Consumer Prices Index (CPI).
Radical reform gives people greater pension flexibility
To take advantage of your available allowances, typically you should contribute as much as you can into your pension, as early as you can and for as long as you can. This will allow you to take advantage of any compounding effects and long-term rises in the market. You should also consider increasing your payments in line with your earnings to help make maximum use of your annual and lifetime allowances.
In March 2014 the then Chancellor of the Exchequer announced a radical reform of the pensions system to give people greater flexibility to access their pension savings. The new pensions freedoms took full effect from 6 April 2015. To access your pension pot you must have reached the normal minimum pension age – currently 55 (or earlier if you’re in ill health or if you have a protected retirement age). Up to 25% of your accumulated fund can be withdrawn as a tax-free cash lump sum with the balance used to provide an income.
There are different types of pension scheme.
Defined Contribution (DC) – also known as a money purchase scheme
This is the most common type of pension today and works like a tax-efficient, long-term savings scheme. The idea is to build up your savings over your working life. When you come to retire, as early as 55 years old, you can take up to 25% of the total pot out as a tax-free lump sum. The remaining amount can be left to build up further until you decide what to do depending on your scheme.
This is a simplified form of the defined contribution scheme, which allows you to pay low minimum contributions and is very flexible. Charges are capped and providers offer default investment strategies.
Self-invested Personal Pension (SIPP)
A SIPP is a specialist type of personal pension that allows you to invest in a wider range of assets than a standard personal pension, which is limited to a restricted list of funds. A SIPP can hold individual shares, commercial property and exchange traded funds, for example. As the name suggests, it is self-invested, meaning that you can have the flexibility for managing your own investment portfolio. This approach in particular requires professional financial advice, unless you are an experienced investor
Defined Benefit (DC) Scheme
Defined Benefit pensions (also known as Final Salary schemes) are a type of workplace pension that guarantees a generous, index-linked fixed pension income for life. Nearly all of these schemes are now closed to new members. The amount of pension received is calculated as a percentage of the members salary typically in the last year of employment, usually the highest earning year though some schemes use other calculations such as the average career earnings.
A PENSION IS A LONG-TERM INVESTMENT.
THE FUND VALUE MAY FLUCTUATE AND CAN GO DOWN, WHICH WOULD HAVE AN IMPACT ON THE LEVEL OF PENSION BENEFITS AVAILABLE.
PENSIONS ARE NOT NORMALLY ACCESSIBLE UNTIL AGE 55. YOUR PENSION INCOME COULD ALSO BE AFFECTED BY INTEREST RATES AT THE TIME YOU TAKE YOUR BENEFITS. THE TAX IMPLICATIONS OF PENSION WITHDRAWALS WILL BE BASED ON YOUR INDIVIDUAL CIRCUMSTANCES, TAX LEGISLATION AND REGULATION, WHICH ARE SUBJECT TO CHANGE IN THE FUTURE.
THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.
PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.
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