How to get the best possible pension in 2016
The year 2015 has been monumental for pensions. It has seen the implementation of some of the most dramatic pension reforms in a generation.
In April new freedoms were introduced allowing savers to spend their retirement funds how they liked – or at least in theory. In practice, many have found it hard to access their pension pot or have discovered they have to pay charges to do so.
In another change, pensions have become available to millions of people for the first time through auto-enrolment in the workplace.
In yet another move, savings limits for the well-off have been scaled back even further.
If that seems tumultuous, next year promises even more – with the new state pension being introduced in April, and a potentially seismic overhaul of tax relief being announced in March.
With all this change those nearing retirement may feel bewildered.
What follows are some guiding principles to help you get a grip on your pension, and set it on track to deliver maximum growth.
If you’re retiring next year
The first thing you need to do is work out exactly what pension assets you have.
This means locating all your pensions and calculating how much they are worth in total. The process can take months as most people have several pensions with different companies, some of which may not have been paid into for decades. Along with projections from all your pension schemes, get a free state pension forecast from the Government to see how much retirement income you’re likely to have.
Next, review your pension beneficiaries.
These are the people who will benefit if you die. You need to nominate a beneficiary for all of your “defined contribution” (non-final-salary) pensions.
That’s because after April 6 any funds you have in a defined contribution pension can be passed on to your loved ones in a tax-efficient way. Your beneficiaries will be able to access your funds flexibly, at any age, and they will be liable for tax at their “marginal” or top rate of income tax only if you live beyond the age of 75.
Then, explore how you might turn your retirement fund into an income stream.
You’ve got more options open to you than ever now – so take your time. If you’re hoping to take advantage of the new pension freedoms, you need to check that all the options are available with all of your pension providers.
Not all providers have adopted the new flexibilities in full, and some charge more than others for the privilege of having flexible access.
So you might have to transfer to a new plan that will allow you to do what you want, which could entail having to pay for advice.
Be warned: Alan Higham, a pension expert and founder of Pensions Champ, said you should allow 10 weeks for transferring from one provider to another.
The next step is to draw up a retirement plan.
You’ll need to consider how many years your money might have to last, what kind of lifestyle you want, the annual income you’ll need to fund that lifestyle, and whether you might need more money in the early years (to travel, for example) and less later on.
All this will affect how you plan your retirement.
Top tip: If you’re over 50, why not take advantage of the Government’s free guidance service, Pension Wise, to discuss your retirement options? If your finances are at all complicated you may then want to consult an independent financial adviser to get a full financial health-check and personal recommendations.
If you’re several years or even decades away from retiring, you could still make 2015 the year in which you get your retirement fund on track.
If you’ve got less than five years to go before retirement
If you’re within a few years of retirement, getting your pensions and other savings (ISAs, other savings and property) in order should be your top priority.
Once you’ve worked out what you’ve got, decide when you want to retire and the income you’ll need to live to the standard you’re expecting.
Draw up a budget of everything you spend now, and then do the same for your retired self. Think about expenses you won’t incur when you stop work, such as commuting costs. Equally, you might want to spend more on leisure travel and other pursuits.
Next, calculate all your potential sources of income in retirement (remember to include the state pension, ISA investments and company and personal pensions). If there’s a shortfall when you compare income with expenses, you have two options: accept a lower standard of living, or take action.
There are several changes you can make to get the retirement you want. If you retire later your retirement pot won’t have to last as long, and you can also defer your state pension, which means you get higher payments.
Another option is saving more now. Make full use of your company pension, if you have one, as your employer will contribute, too. Or you could consider setting up a self-invested personal pension (Sipp), where you can attract tax relief at your marginal rate on your savings and investments. If you want to give your pension pot a boost, you can top it up with a lump sum.
You can get tax relief (20pc for a basic-rate taxpayer and 40pc for a higher-rate taxpayer) on up to £40,000 of pension contributions a year. And your allowance can be topped up for the current tax year with any allowance you didn’t use from the previous three tax years. However, you only get tax relief on up to 100pc of your earnings so it is less tax-efficient to save more than this amount into a pension.
The other option is to try to make your money grow faster by choosing riskier investments with bigger growth prospects. However, the higher the potential gain, the greater the volatility and the potential to lose capital. Savers thinking about buying an annuity should be especially careful about investing in riskier assets such as shares. If your investments plummet in value just before you’re due to retire, you’ll have to buy your annuity with a smaller lump sum.
Top tip: Consider making Class 3A National Insurance contributions. If you reach state pension age before 6 April 2016, consider making Class 3A National Insurance contributions, which can buy you up to £25 a week of extra state pension. There’s no upper age limit, so even if you’ve been retired for many years.
If you’ve got more than five years to go before retirement
Even if you’re in your 30s, 40s or 50s and don’t plan to retire until your 60s or 70s, it is not too early to work out how much money you will need to support yourself in future. The simplest way is to draw up a spreadsheet of your likely income and all your likely outgoings in retirement.
If you’re going to be investing your pension pot yourself and drawing income from it, you’ll also need to consider how long you might live.
A man aged 65 living in Britain will live to 83 on average, while the average 65-year-old woman will live to 85, according to 2011‑13 figures from the Office for National Statistics. This means a man retiring at 65 will need an average of 18 years’ worth of income, while a woman will require 20 years’ worth. A “comfortable” retirement for the average man requires an income of £518 a week (£27,000 a year), or £342 (£18,000 a year) for women, according to MGM Advantage, the insurer.
If you find there’s a big shortfall between what you’ll get and what you think you’ll need in retirement, take action now. The longer you leave it, the more it will cost you to make up the difference.
To buy an annuity that will pay the “living” wage (currently £13,364 a year) a 20-year-old would need to build a pension pot of £200,000 by 68. If they were earning £20,000, this would mean a salary contribution of 12pc a year. A 30-year-old on the same wage would have to contribute 17pc of their salary to build the same pot, according to RedSTART, the financial educator.
If your employer offers you a workplace pension, you should take full advantage.
Under new “auto-enrolment” rules, companies are obliged to contribute to your pension, although many do this already. Often, the more you put in, the more your employer puts in – up to a cap, usually 10pc to 15pc of salary. So before you think about making other savings, make sure you’re getting the most pension money you can from your employer.
If you’ve been automatically enrolled (everyone earning £10,000 or more will have been by 2018), you should probably stay in the scheme unless there’s a very good reason not to.
It might be worth looking at the investment choices available in case the default one isn’t the best for you. If you’re young you can afford to take greater investment risk and you could reasonably invest in areas promising higher long-term growth, such as emerging markets or smaller companies.
But if you do choose specialist funds be aware of extra costs.
To get a sense of whether you’re “on track”, ask your employer for a pension projection, which will tell you how much income you’re estimated to get in retirement, based on your pot. Ask for a projection “in today’s money”, to allow for inflation. This will give you a much better idea of what you’ll be able to buy with your pension fund.
Top tip: If you get a pay rise that’s greater than price inflation, why not use the additional monthly amount to increase your pension savings?
…And for high earners
Grab 40pc tax relief now while you can
Higher rate taxpayers beware: Tax changes to pensions are expected in the Chancellor’s next Budget in March and experts predict it will spell an end to higher rate tax relief on pensions. In other words, top up your pension now if you can.
Although annual pension contributions are capped at £40,000, carry forward rules allow investors to potentially add up to a further £140,000 to their pension pot in the current tax year 2015/16.
If you have contributed less than the annual allowance in any of the previous three years (£50,000 for 2012/13 and 2013/14, £40,000 for 2014/15), you can carry forward the unused portions and add them to your contribution for the current year.
Apply for protection against the lifetime limit
If your pension pot is likely to be close to or over £1 million by the time you retire, consider whether you should apply for protection against the lifetime allowance, which reduces to £1,000,000 in April. This could mean you pay a substantial amount in this tax year and nothing after that to get the strongest protection.
Very high earners should top up now
If you earn over £150,000 a year, including anything your employer pays into your pension, buy-to-let profits and other income, you may be caught by a reduction in the annual allowance of what you can pay into a pension with tax benefits.
Depending on how much you earn your limit could reduce from £40,000 a year to just £10,000 a year. For this reason you should consider making a large contribution this tax year, if possible making us of unused allowances from the last three years that can be carried forward.
Robert Cochran, retirement expert at Scottish Widows, said: “A complex set of rules coming into play mean anyone earning over £110,000 may have a tax relief cap on pension contributions, with those earning more than £210,000 capped at a maximum contribution of £10,000.
“Those earning less can still get tax relief on contributions up to £40,000. So for higher earners there is a last opportunity to maximise their contributions to pension and still get higher rate relief before it’s too late.”
Read the original story on the Telegraph website.