Pensions

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What is Pension?

Your pension generally and simply speaking is a pot of tax free* cash, in which your employer and yourself save money for your retirement. At the age of 55 you can start accessing your saved money and take as much as you like.

*you pay tax on any income above your tax-free Personal Allowance. If you take a lump of cash from your pot – 25% of it, is tax free. Tax is taken off the remaining 75% before you get it, this applies to each time you take the money out.

There are several types of pensions:

State Pension. When you reach 62-65 you will receive an income from the state. To claim the state pension you have to have made National Insurance (NI) contributions throughout your working life. Workplace Pension. To top up your state pension, these are the contributions from you, your employer and the government, taken as a percentage from your salary. Personal Pension. These work by you paying money into a pension scheme from a provider (selected by you, rather than your employer, unlike a workplace pension) and getting a sum at the end with which to buy an annuity or arrange income draw-down. Personal pensions are particularly suitable for the self-employed or people who aren’t in work.

Annuity. How does it work?

You can purchase an annuity from an insurance company. This allows you to receive regular income for the rest of your lifetime. You will be quoted for an annuity with the rate as a percentage. You’ll need to multiply by your pension savings to calculate how much income you’ll get every year.

Example. Your are offered an annuity rate of 5%. That means if you invest £50,000 you will get £2500 of regular income annually.

The rates depend on many factors including: Life expectancy (the longer you are expected to live the lower your rate), Your healthInterest Rates(this is due to pensions being partly funded by the interest earned when your money is invested), Gilt Yields (Government bonds – fixed amount of interest insurers buy from the government). Note that it is illegal to rate annuities based on gender.

From 2015 April onwards, people will be allowed to access their defined contribution (DC) pensions as they wish from the point of retirement and not have to arrange an annuity.

For more Changes in Pension Flexibility from 2015 please click here.

Types of Annuity

  • Single life annuities – all the income is paid to you
  • Joint life annuities – some or all of your income is paid to your partner after you die
  • Escalating annuities – your income rises every year, often by the rate of inflation
  • Enhanced annuities – these pay you more income if you have a medical condition
  • Investment annuities – your money remains invested with the potential for higher income
  • Flexible annuities – these are complex products that pay you a guaranteed income but leave the potential for your money to grow by keeping part invested
  • Fixed-term annuities – these pay out for a fixed period, after which you get paid a lump sum.

Unfortunately the biggest disadvantage of annuities is that you can not change your mind. Once you purchased it you can’t ‘switch’ for a better deal. So you have to get it “right” from the beginning.

Drawdown

Another way of taking out the pension when you retire. You can chose how much of your pension you want to move into drawdown. You can usually take up to 25% of each amount you move as a tax-free lump sum, as mentioned above and keep the remainder invested, drawing taxable income directly from the pension. You can also choose to convert your entire pension to drawdown all at once, or you can convert smaller segments as and when you need them.

With the benefits of 2015 changes in pension rules the more attractive option is to use income drawdown to fund your retirement instead of buying an annuity, although the “old fashioned way” may still be an option for people who want to feel completely sure about regular income each year, there’s no chance of running out of money altogether if you spend or invest unwisely, which there is with drawdown.

Please contact MNK Accountants for referral to financial adviser or if you are not sure who to approach.

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