Accumulating provisions for your retirement
“Am I saving enough towards my retirement?”
“I want to know what my pensions are worth, but I don’t want to be sold another one.”
“I’m putting plenty of money into my pensions, but I have no idea whether I will be able to afford to retire.”
“I get eight pension statements a year, I understand none of them.”
As financial planners these are all things we often hear before we develop a plan to ensure clients meet their retirement income goals.
It is important to note that retirement is not just about pensions. You should also take the following into account when planning ahead:
- When you hope to retire and whether you see retirement as an event or a gradual process
- Your aspirations for retirement; in particular where you intend to live and what you would like to do
- The level of income you will need – the amount needed to cover your essentials and the amount of income you would like
- Your view of investment risk
- Other related issues, like estate and inheritance tax planning and your views about nursing care in your old age
- How your other investments and assets can be used
Pensions do however offer tax breaks and can be one of the most efficient ways to save for your retirement:
- Your employer may make contributions into your policy too
- You receive income tax relief on your own personal contributions
- The funds held within a pension are not subject to capital gains tax
- 25% of the value of the fund can be drawn as a tax-free lump sum or income after age 55 (increasing to age 57 in 2028)
- Pension funds are not subject to inheritance tax
- If you die before age 75, the whole value can be paid to your beneficiaries free from tax
However, there is a catch! HMRC stipulate upper limits which can be saved into pensions before a tax charge is made.
- Annual Allowance: this is the maximum annual payment which can be made into a pension to receive tax relief.
- Lifetime Allowance: this is the maximum you can save into all your pensions (except the state pension) before a lifetime allowance tax charge is made
This allowance was introduced in April 2006 and was originally £215,000. Since then, the allowance has been reduced to £40,000 for the current tax year. In April 2016 this allowance became linked to your total taxable income so the more you earn the less you can add into pensions from all sources i.e. personally and your employer. It is advisable to liaise with a financial planner before paying into your pension if you believe you may be caught by the annual allowance tax trap.
In addition, if you are over age 55 and you have accessed some of your pension benefits you may find that this £40,000 allowance is reduced to only £4,000. This is known as the Money Purchase Annual Allowance (MPAA).
This is the maximum amount that you can save into all of your pensions over the course of your life. You usually pay tax if the value of your pension funds exceeds £1,073,100 (2020/21 tax year). Under current rules, this allowance increases with CPI each tax year.
A lifetime allowance tax charge of up to 55% is calculated against the excess amount. In addition, any tax free cash is limited to your lifetime allowance. So, the maximum amount of tax free cash you can access would be £268,275 in this current tax year.
Each time you access your pension benefits, the amount withdrawn will be tested against the lifetime allowance. There is a common misconception that investors draw their pension funds in an attempt to keep the value below the lifetime allowance limit, but this is not the case.
Your pension funds are also tested against the lifetime allowance at age 75 or death, so this is a tax charge which is unavoidable. HMRC offer protection against the lifetime allowance and you may be able to apply for this if you meet the eligibility criteria.
With many different and sometimes complex considerations, it is important that you seek professional advice in ensuring you can accumulate as much as you can for providing you with the lifestyle you want in retirement.
The content of this article is for information only and does not constitute formal financial advice.
This material is for general information only and does not constitute investment, tax, legal or other forms of advice.
You should not rely on this information to make, or refrain from making any decisions.
Always obtain independent, professional advice for your own particular situation.
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