From April the unpopular tax rules that meant most people had to buy an annuity will change. Pensions are having a makeover which will give you better choices and more freedom.
But to take advantage of this makeover, you need to know what you want and what choice is best for you, this means a little preparation. So what should you be doing to get ready for “pension freedom day” on 6 April?
Here’s a 10-point action plan, aimed not just at individuals on the point of retirement, but at all savers from their 40s upwards who are putting money aside to finance a pension.
If you are in a final salary-style scheme some of this won’t apply to you. This guide is about the workplace pension schemes which simply give you back what you saved over the years plus whatever investment returns the money earned.
1 Work out your total pension savings.
Did you work for a number of employers before working where you do? The chances are that you have money in schemes that your former employers paid into. You may have lost touch with the scheme administrators.
Your first step to finding a lost pension is to contact the Pension Tracing Service online, and the good news is that it’s a free, government-financed service.
You’ll be asked to fill in a form, and it will locate the address of your scheme provider if it can find a record.
Or call 0845 6002 537.
It helps if you can identify when you worked at the previous employer, their address, and any change of address you have had since. Be warned that even if you have a certificate from a pension scheme, it doesn’t always mean you have a pension entitlement. You might well have had a refund of your contributions when you left that employer, for example. Many pre-1975 pension schemes required five years’ membership before giving any benefits.
Generally, if you left the employer after 1988, you will be entitled to a pension, as long as you completed two years’ service.
If you left the scheme with fewer than two years’ service, you probably received a refund of your contributions at the time you left.
2 Bring your pensions under one roof
Long-forgotten pension plans can end up wasting away in expensive, poorly performing funds.
So should you transfer them and keep them under one roof?
There are advantages to switching your pensions, but also pitfalls – (charges called exit penalties which can reduce the amount you thought you’d saved by up to 15%)
But don’t let that put you off, as most schemes have few penalties and it’s relatively simple to transfer the cash either to your existing workplace pension (if it is a defined contribution scheme) or into a private pension.
If you don’t currently have a workplace pension, ask your employer when you are going to be auto-enrolled into one. All employers are bound to offer and pay into a plan for you by the end of 2017.
3 Find out how much state pension you will get
The days of picking up a state pension at 60 (for women) and 65 (for men) are now seriously numbered. Women’s state pension age will increase gradually to 65 between April 2016 and November 2018. From December 2018 the state pension age for both men and women will start to increase to reach 66 by October 2020.
The basic state pension rises from £113.10 to £115.95 a week this spring, but you only qualify for the full amount if you have a full record of national insurance contributions. You can find out your state pension age and how much you’ll get. The government’s Future Pension Centre also gives estimates about your future entitlement. Call 0845 3000 168.
You may also be entitled to an additional state pension (previously known as the state second pension or Serps). Just to add to the brain-withering complexity of Britain’s system, you may not get much in the way of an additional state pension if you were contracted out by your employer.
Matters become a little simpler in 2016 when the government introduces what’s called the single tier flat rate, worth around £150 a week if you have a full (35-year) contribution record.
4 Boost your state pension
Millions of pensioners and people set to retire will be able to buy up to £25 a week of extra state pension under a scheme which is particularly beneficial to many women who went part-time and/or took a career break to raise a family when they were younger, and also to the self-employed.
For example, to obtain an extra £1 of pension a week (£52 a year) for life, will cost a 65-year-old around £890, while to get the maximum extra £25 a week (£1,300 a year) of state pension, someone aged 65 would need to pay more than £21,000. As you get older, the cost comes down. There is a full calculator at gov.uk/state-pension-top up.
If you are still working in your late 60s, you can choose to defer taking your state pension and, in return, the government pays your more in later years. But it’s a finely balanced calculation. If you reach state pension age before April 2016, it’s very good value; defer it by one year and you’ll get an extra £611 a year on top of the current £5,881.20 a year (£113.10 a week). But it’s bad news if you’re retiring after that, as the government has halved the value of deferrals for people retiring beyond April 2016.
5 Work out how long you are going to live
Obviously we can’t be too precise about these things. When Bismarck introduced the first state pension in 1889, it was from age 70 at a time when average life expectancy at birth in Germany was just 45. Current UK government data suggests a 65-year-old male can expect to live a further 18.2 years, but also has a 26% chance of living to 90. Sadly, 17-stone Bert, who smoked 40 Player’s Navy Cut from age 15, won’t be among them.
There are now plenty of online calculators which will estimate your death date, with the more sophisticated ones including health factors. Try riskprediction.org or Confused.com, which both make for scary reading if you’re a smoker.
6 Now decide how to spread the money over retirement
This is the big change from 6 April next year. Before, you were herded into buying an annuity with your pension pot.
Now you’re free to use the money as a bank account, drawing it down as and when you want. The choices are vast, and so are the risks and the tax consequences.
Have a play with Legal and General’s retirement income calculator at http://www.legalandgeneral.com/worksavepension , where you can enter the sum of money you have saved, your retirement age and what that could be worth as regular income.
But it all depends how you invest the money. The big thing from 6 April will be “drawdown” products that let you choose the amount you take out over the years, maybe with a small annuity thrown in to make sure you have a base income to cover essentials.
It’s possible to model lots of scenarios, too detailed to repeat here, about your options depending on the amount of cash you have saved.
7 Consider the tax consequences
Amid all the hype about the new pension freedoms, hidden away in government documents was an estimate that they will raise nearly £3bn extra in tax from the reforms. Why? Because all those people who cash in their pension pot immediately will have the money treated as income for that tax year.
Someone with £300,000 is eligible for 25% tax-free, but the remaining £225,000 is taxable – potentially landing them with a £121,127 tax bill. In general, it’s best to manage the drawdown of your pension money while keeping below the threshold for 40% tax.
8 If you’re under 55, pile money into your workplace scheme
Many employers offer auto-enrolment. Doing nothing and not-opting out can be among the best financial decisions you can make, especially now you are free to do what you like with the money after the age of 55. Under auto-enrolment rules, your employer promises to match your contribution at £1 for each £1 put in.
Employers only have to match you on a band of earnings that starts at £111 and ends at £850 each week and then only 1%. But some employers offer you a great deal more, simply for joining the plan.
Let’s say your employer just chooses to match your at the minimum 1% match.
For a 40%-band taxpayer, that means you effectively pay in 60p (£1 minus the tax relief) and get £2.00 out. It’s a no-brainer.
You can pay in additional amounts into your workplace pension up to £40,000 a year and get tax relief at your highest rate. So a 40% taxpayer only pays £600 for each £1000 that goes in.
Be careful though, if you pay in too so much that you wipe out all your higher rate tax relief, you may find yourself only getting relief at 20% on the bottom slice. Even this is a good deal as your money grows tax free (like an ISA) and your money comes back to you with a quarter tax-free (the rest is taxed at you tax-rate when you are drawing your savings).
9 If you’re 55 or over, you can grab the cash now
You can choose to pay down the mortgage or clear credit card debts after 55 with your pension money, but obviously you’ll be wrecking your retirement income. You can do a buy-to-let if you wish – but remember, all pension withdrawals are taxable, so that makes investing in property very expensive.
One controversial trick is to “wash” your salary through your pension scheme. Let’s say you are 55, earning £50,000 a year. Your company offers a workplace pension and pays in 1%. You pay in £500, but that only costs you £300after tax relief and, with the company contribution, £1,000 goes into your scheme. The next tax year, you take the money straight back out. You get 25% tax free – that’s £250 – then pay 20% in tax on the rest – £150 – but you are still left with £850– a great return on your £500. HMRC is wise to this, though, and will restrict tax relief on personal pension contributions above £10,000 a year (the standard cap is £40,000) if you start playing this game.
10 Get advice – and look out for the rascals
From 6 April everyone will have the opportunity for free face-to-face guidance (crucially, they are not calling it “advice”) on their pensions, paid for by the government.
Citizens Advice will do the face-to-face guidance. The Pensions Advisory Service will offer guidance over the phone at 0300 123 1047. The usual suspects, though, will be keen to steal some, or all, of your cash now you can access it easily. Standard Life recently warned that “the ability of pension providers to prevent transfers of funds into fraudulent, too-good-to-be true investments will diminish once the new freedoms come into force”.
Credit; much of this guide was inspired and some taken from Patrick Collinson’s 10 point action plan published in the Guardian. You can read Patrick’s article here