Everything you need to know about pensions – MoneyWeek

Thenameconjuresupimagesofmis-sellingscandals,budgetdeficits,dodgysmallprint,anddesperatelyscrimpingtogetenoughmoneyforacupofteainyourtwilightyears。

IknowI’mnottheonlyonetofeelthisway。

Thefactthatwe’veallbecomesoaversetowhatisultimatelyafairlyinoffensiveword,showsjusthowbadlythefinancialindustryandthegovernmentbetweenthemhaveshreddedourfaithinpensions。

Butrelax。

Putasideyourprejudices。

Likean?

individualsavingsaccount(Isa),apensionisjustanothercontainerthatyoucanputyoursavingsinifyouwanttoprotectthemfromtax(whichwedo)。

Nothingmore,nothingless。

Sure,theyaren’tquiteasstraightforwardasIsas,butthey’renowherenearascomplicatedasthefinancialindustrymakesthemsound。

Anddespitethefrequentbadpresstheyget,theywillalmostcertainlyformatleastpartofyourlong-termsavingsplan。

Sohere’syourpain-freeguidetounderstandinghowtheywork。

Let’slookatthebasicsfirst。

Pensionscomeinvariousforms。

There’syourstatepension。

That’sthemoneythegovernmentwillgiveyouwhenyoureachacertainage。

Youcan’tknowhowmuchitwillbe,butyoucanbesurethatonitsown,itwon’tfundanythingmorethanaverybasiclifestylewhenyouretire。

Youremployermayofferapension。

Ifyouworkforthepublicsector,youwillprobablyhavesomesortofdefinedbenefitpension。

Thismeansyouknowwhatyouwillgetwhenyouretire。

Theendsumwillbebasedonsomecombinationofyourfinaloraveragesalary,andyourlengthofservice。

Thisisagreatbenefit。

Itputsalltheinvestmentriskontheemployer。

Youknowwhatyou’llget–it’suptothemtomakesuretheycanprovideit。

Perhapsunsurprisingly,thisispreciselywhyveryfewprivatesectoremployersofferthesepensionsanymore。

Andwiththegovernmentheavilyindebt,thebenefitsarebeingerodedinthepublicsectortoo。

Soevenifyouhaveoneofthesepensions,youshouldstillbemakingotherprovisionsforyourretirement。

Mostprivatesectorworkerswithacompanypensionwillhaveadefinedcontributionpension。

Thismeansyoupayinacertainamount,butwhatyougetintheenddependsonhowyourinvestmentsperformbetweennowandwhenyouretire。

Ifyourcompanyoffersoneofthesepensions,andwillmatchyourcontributionsifyoupayintoit,youshouldtakethemupontheoffer。

It’sfreemoneyeffectively。

Yes,youmightnotliketheinvestmentoptionsonoffer。

Butifyou’reputtingin5%,say,andthecompanyismatchingthat,thenyou’vemadea100%returnrightaway。

Sotheinvestmentperformancewillhavetobereallybadbeforeyou’veactuallylostmoneyonthedeal。

Wanttotakechargeofyourownpensionfund?

Thisiswheretheself-investedpersonalpension(Sipp)comesin。

Yougettochooseexactlywhattobuy,andyoucanmakechangesasfrequentlyorinfrequentlyasyoulike。

Thetaxbenefits

Whenitcomestotax,thebigdifferencebetweenanIsaandapensionliesinthetiming。

MoneygoesintoanIsaalreadytaxed,soanyincomegeneratedorcapitalgainsmadewhenyousellarenottaxed。

Withapension,ontheotherhand,thegovernmentgivesyouyourtaxbreakupfront。

WhatdoImean?

Sayyou’reabasic-ratetaxpayer。

Whenyoupay£80intoapension,thetaxmangrossesitbackupto£100。

(Inotherwords,yougetbackthe20%taxyoupaidonthat£100whenyouearnedit)。

Ifyou’rea40%-ratetaxpayer,youonlyhavetopay£60tomakea£100?

pensioncontribution?

Yougetthe£20basicratetaxbackfromthetaxmanimmediately,andthen?

youcanclaimbackafurther£20onyourself-assessmentform。

Therearelimitsonthistaxrelief。

Currently,theannuallimitis£50,000ayear,withalifetimelimitof£1。

5m,soyoucanputplentyofmoneyaway。

Theflipsideisthatincomegeneratedbyapensionistaxable。

Whenyouaccessyourpension,youcantakea25%lumpsumtax-free。

Therestmustbeusedtoprovidearetirementincome。

Formostpeople,thiswillbeintheformofanannuity(anincomestreamthatyoupurchasewithyourpensionpot),althoughthereareotheroptions。

We’lllookattheseinmoredetaillateron。

Butthekeypointisthatincomefromanannuityoranythingelseyoudowithapension,isliableforincometax。

Whatdoesthisallmeaninpracticalterms?

Youcanseehowtheycompareinthispiece?

mycolleaguePhilOakleywroteforMoneyWeekmagazine:Howtogetthebestincomefromyourpensionpot。

Buttosumup,intermsofthenumbers,forbasicratetaxpayers,thereisn’tahugegapbetweenpensionsandIsas。

Thetax-freelumpsumisthemainadvantageenjoyedbythepension。

Forhigher-ratetaxpayers,pensionswinout。

Thisisbecausethetaxreliefisparticularlygenerous。

It’sevenbetterifyouendupinalower-ratetaxbandonceyou’reretired(whichisquitelikely):yougethigher-ratetaxreliefgoingin,thenonlypaylower-ratetaxgoingout。

There’sjustonecatch。

Thetroublewithpensions

Thebigriskwithpensionsistheirlackofflexibilityyoucan’tgetatthemuntilyou’reatleast55,andthatagelimitwillonlyrisefromhere。

Thatmightnotbesuchaproblemifyoucouldtrustthepottojustsitthere–butyoucan’t。

Thebigproblemwithpensionsisthatthegovernmentcanfiddlewiththematanytime。

Andtheydo。

ThepensionsruleschangewitheveryBudget。

Ofcourse,thegovernmentcanchangetheIsarulesanytimeitwantstoo。

Thedifferenceisthatyou’dbeabletowithdrawyourIsamoneyifyoufeltyouhadto。

Apensionisstuckthere。

Whichonetodonow

Considerhowyouwanttosplityourlong-termsavingsbetweeneachofthese‘safes’。

There’snorightorwronganswertothisitalldependsonyourcircumstance,andyourattitude。

Theidealwouldbetogetasmuchhigher-ratetaxreliefasyoucaneachyearoutofyourpension,thenshiftfocustoyourIsa。

Inotherwords,ifyouearnover£42,385ayear,savewhatyoucanoverandabovethatamountinapensiontobenefitfromthehigher-ratetaxrelief。

Butyoumaynotbeabletosavethatmuch。

YoumayalsoprefertheflexibilityoftheIsaoverprioritisingthepensiontaxrelief。

Alternatively,youmightliketheideaofyourmoneybeinglockedawayuntilyou’reolder,sothatyoucan’tgetatitearly。

(Althoughyoushouldalsorealisethatthisimpliesthatyoutrustyourselflessthanyoutrustthegovernment!

)

Myownviewisthatifyouremployerwillcontributetoapensionalongwithyou,takemaximumadvantageofthat。

Onceyou’vesortedthatout,focusonfillingupyourIsa。

Afterthat,topupyourpension。

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