In its most basic form, a pension is a savings pot into which you save money during your employment years, to draw upon in your retirement. There are several different types of pension, each with their own characteristics. Here we will cover the benefits of investing in a pension, and the main features of the different types of pension available.
Benefits of investing in a pension:
• Unlike most other forms of saving, pension contributions qualify for tax relief. This means the government top up the amount paid into your pension. The amount of tax relief and the way you receive it depends on your earnings, and the type of pension scheme you have. Usually, contributions are limited to a maximum of £40,000 per year per person.
• Any income you earn or capital gains you make within a pension are not currently subject to UK tax. This means you don’t have to declare it on your tax return, if you do one.
• Pensions are normally exempt from UK inheritance tax.
• If your pension still has money in it when you die, you can pass it to your spouse or future generations.
• Pensions are a good way of protecting your money from impulse spending, as the money in your pension cannot currently be accessed until you are at least 55 years old. This is rising to age 57 from 2028.
So, what are the different types of pension, and why might one be more suitable for you than another?
A workplace pension scheme is a way of saving for your retirement through contributions deducted directly from your salary. The pension is arranged by your employer, and if you are eligible for automatic enrolment*, your employer has to make contributions into your workplace pension alongside your own. You will also receive a bonus from the government in the form of tax relief on your own contributions. If your workplace pension is invested in the default fund, the ongoing charges are capped at a maximum of 0.75% per year. Default funds are designed to offer an appropriate investment strategy for people who can’t or don’t want to make their own pension investment decisions. The maximum charges cap doesn’t apply if you make an active choice to select a different fund within your workplace pension. The charges in this case will vary, depending on the fund or funds you choose to invest in. If you are a member of a workplace pension, you have the make the minimum monthly contributions set out by the scheme. There is limited flexibility to stop and restart your contributions.
*Auto-enrolment was introduced in 2012 and differs from how workplace pensions traditionally worked. Previously, the onus was on you to join your employer's pension scheme if you wanted to. Under auto-enrolment, you are automatically put into your employer’s workplace pension scheme – though you can still choose to opt out if you wish.
If you don’t have a workplace pension, a Stakeholder pension might be a good place to start if you want to start saving for your retirement. Stakeholders have been around since the early 2000’s. They were introduced by the government to encourage long-term retirement saving among those with low or moderate earnings. Stakeholders offer low minimum contributions with more flexibility on stopping and starting your payments. You are also able to make one-off lump sum contributions. Stakeholders offer capped ongoing charges, meaning the annual cost of the pension can’t exceed 1.5% for the first 10 years, and 1.0% thereafter. Stakeholders were designed as a cheap and easy way to set up a pension. However, being cheap, they can often offer limited investment and retirement benefit options. This generally isn’t a problem for people starting out on their pension journey, but it is something to consider when your pension starts to grow in value, or as your near retirement. As with a workplace pension, you receive tax relief on your contributions, boosting the amount that gets invested.
A personal pension is similar to a stakeholder. They tend to offer a wider range of investment and retirement benefit options. You benefit from the same flexibility with stopping and starting your contributions, and the ability to make lump sum payments. Personal pensions tend to have slightly higher limits on the minimum amount you can pay in each month, with generally, £30 - £50 per month being the minimum. As with workplace and stakeholder pensions, you can receive tax relief on your contributions. However, unlike a stakeholder or workplace pension, there is no cap on charges so the ongoing cost of a personal pension can be higher.
Self-Invested Personal Pension (SIPP)
A SIPP is an alternative type of personal pension. They generally offer a far broader range of investment options than other types of pension, including the ability to invest in direct equities and commercial property. It’s also possible to invest in fixed rate deposit accounts within a SIPP. These can be a useful tool in mitigating capital value erosion. Rules for SIPP contributions and benefit withdrawals are the same as for personal pensions. SIPPs commonly offer the most flexible options for withdrawing your money in retirement. They do generally have set up fees, and many apply charges for additional administration at retirement. The higher costs are offset by the potential for the pension fund to grow at a greater rate because of the broadened investment options.
Small Self-Administered Scheme (SSAS)
A SSAS is a type of trust-based occupational pension. They are usually set up by directors of limited companies for the benefit of specific employees within the company. These types of pension are suited to groups of individuals who run a common business and wish to have complete control over their pension fund. Depending on the number of members, the cost per member can be lower than using individual SIPPs. The trustees of a SSAS (usually the company directors) can invest the funds as they consider appropriate to the needs of the SSAS. The investment options within a SSAS are very similar to those within a SIPP. As with all other pensions, the growth of the investments within a SSAS are tax free. Your contributions will benefit from tax relief, and your employer can make additional contributions to the pension.
If you are considering opening a pension or would like a review of the pensions you already have, contact us.
The above information is for educational purposes and is not a personal recommendation or investment advice. Content is accurate at time of writing. Tax limits and pension regulations may change. The value of investments can go down as well as up. Wise Investment is authorised and regulated by the Financial Conduct Authority (FCA 230553). Wise Investment is not authorised to provide advice on defined benefit pension transfers.