How to Make A pension Work for you

Don’t be scared off by the seeming complexity.. pensions are tax-efficient

IF YOU are planning to save for your retirement, a pension is likely to be at the top of your list of things to sort out.

Millions have been auto-enrolled over the last few years, which has encouraged more of us to use a pension as a way of saving for our later years.

They are one of the best ways of doing so because of the great tax breaks you get from the Government.

And if you are saving through your workplace, your employer will also be making contributions – helping to boost your pot and give you a better chance of building up a decent amount towards your retirement.

Andrew Tully, technical director at finance firm Canada Life, said: “Pensions continue to be the best way of saving for your retirement.

“Think of saving into a pension as a way of paying you a wage when you give up work.

“Take advantage of tax breaks, your employer matching contributions and think about how you want to invest the money for the long term.”

Unfortunately, many people have been put off due to the seeming complexity of pensions, and negative publicity around employers shutting final salary pension schemes.

But don’t be deterred, pensions are just a tax-efficient method of putting money away while working.

Tax breaks

This is the big advantage of using a pension to save for retirement over, say, choosing an ISA.

As a basic-rate taxpayer, for every £1 you save into a pension it actually costs you 80p – the taxman pays the 20p.

If you are fortunate enough to be a higher earner, pensions become even more generous because every £1 costs you 60p. That’s because pension contributions are deducted from your gross salary before tax is deducted.

Employer contributions

If you have been auto-enrolled into a workplace scheme, your employer will also be making contributions into your pension on your behalf.

From April, your employer will have been paying a minimum of three per cent into your pension alongside your five per cent of salary.

The Government pays part of this through tax relief so, combined with what your employer is paying, it costs basic-rate taxpayers four per cent to get eight per cent invested into their pot. Many employers will match any voluntary additional contributions you make, often up to a set percentage of your salary, so it’s well worth taking advantage of this if you can afford to.

Pension experts say the eight per cent contribution level won’t be enough for a comfortable retirement.

We should be aiming to save around 12 per cent to 15 per cent of our salary to build up sufficient funds.

There are limits

Because of the generous tax breaks, there are limits on how much you can save into a pension every year.

Annually, you can save as much of your income into a pension in that year, or £40,000, whichever is the lower amount. This is called the annual allowance. There are rules allowing you to carry forward unused amounts from previous yea which can be used, useful if you are self-employed and your earnings vary from year to year.

There is a limit, called the lifetime allowance, on the amount of pensio benefits you can take before you incur a tax charge. This increases each year in line with inflation.

Pension wills

As distinct from a normal will, a pension allows you to nominate who receives your pension after you die.

It’s really important to keep this up to date as your personal circumstances change, especially as your pension company has discretion over who receives the money. The form is officially called an “expression of wish” or “nominated beneficiary” form. And recent research from Canada Life suggests that three out of five of these forms are out of date, where people have got divorced, have re-married, or spouses have died.

Contact your employer’s HR department or pension company to ensure that your paperwork is up to date.

The good bit

So, you’ve diligently saved hard and have come to the stage where you want to start slowing down, give up the day job and start enjoying your retirement.

From age 55, you can do whatever you’d like with your pension. This doesn’t necessarily mean you should access it at that age, and you should always have a clear idea about what to do with the money.

The first 25 per cent of your pension can be taken tax-free.

After that, any withdrawals are subject to regular income tax. The taxman will combine all of your income to work out the rate of tax you pay.

This year, you can earn £12,500 before paying income tax and any state pension you receive is also included in the calculation.

It’s always worth checking online pension tax calculators to work out the tax due on any withdrawals you plan to make. Try canadalife. co.uk/tools/pension-tax-calculator

What happens if I don’t manage to spend it all?

Pensions can be passed down the generations tax efficiently. If you’ve started accessing a pension using income drawdown, any remaining funds can be passed on to your beneficiaries.

If you’ve turned your pot into an annuity to generate a lifetime income, then it can be more complicated as it depends on the choices you made at the start of the contract.

That’s why it’s important when you make your choice on how to access your pension pot that you understand the impact later down the line – you don’t want to leave a spouse or dependents unable to manage.

With annuities, you can choose for money to continue to be paid out to, say, your spouse, for a set period of time, or to ensure your family get the initial value of your annuity back less any payments you have received.

Final word

Tully said: “Save as much as you can reasonably afford from as young an age as you can and invest sensibly.”