The Chancellor has recently called to action the Financial Services Industry, plus other interested parties to review the current savings regime for those who wish to improve their retirement income from the current state pension provision. The State Pension is £115.95 per week, (today) although this depends on your National Insurance Contributions, and I guess at some point, hopefully not too late, we all have to sit down and decide if that’s enough?
On average, a person will change jobs 5 to 7 times during their career so it’s not unusual to have multiple pension plans – especially if a workplace pension scheme was provided. Understandably, the copious paperwork received from each pension plan can make it extra hard to manage and keep track of the pension plans. So what are the options?
In this article I will focus on Self Invested Personal Pensions (SIPPs) and how they can help you save towards retirement, or indeed bring multiple different pensions under one roof, what are the benefits and equally the drawbacks. SIPPs were first introduced over 25 years ago and were focused on those individuals who had larger pots of money and who wished to manage their funds across multiple different investments. However in recent years they have become cheaper and easier to access, and you don’t have to hold esoteric investment strategies to have one, phew!
I often hear very negative things about pensions, and that pension planning is overly complicated. Well it’s true to say that if you hold many different types of pension plans, each with slightly different rules, yes it does become complicated and you could probably use the services of a Financial Adviser.
However let’s take Pension planning down to its simplest form. It is simply a vehicle that holds your savings in various different investments until retirement, along the way the nice people at the Inland Revenue will give you some Tax breaks (see the table below) – and whilst the money is there it will grow without the drag of taxation on the funds. Once you get to retirement, (after 55 in most cases) you can receive the money back, in various forms, (explained later) and hopefully you will have enough money on top of your state pension to do whatever it is that a “good” retirement looks like for you! (Clearly this depends on the performance of the funds you have chosen).
The annual allowance differs for investors who are already taking a flexible drawdown or taking cash lump sums from their pension – the annual allowance is then reduced from £40,000 to £10,000.
The concept of investing into a SIPP is similar to investing into a traditional pension plan – you can set up a monthly direct debit and add one off lump sum payments into your pension. These funds are then invested and become your retirement fund. However, the key difference between them is that the SIPP gives you the freedom and the flexibility to control what and how you invest your money. Investing in a traditional personal pension plan usually means you can only invest in a limited range of funds. For example, if you have a personal pension plan with Prudential, the plan can’t invest into individual shares. However, with a SIPP – like a Stocks and Shares ISA, you can invest in a variety of products such as shares, funds, investment trusts. Effectively, you are the “fund manager” of your own pension, so you can do your own research and decide what goes into your portfolio. You can switch and add funds to your SIPP at any time – it really is dependent on your decisions. With the right decisions, your funds may potentially perform better than a traditional pension plan!
There are some more rules that you need to be aware of when investing into a pension plan. The returns gained in a SIPP are tax free but there is a lifetime allowance applicable. For the tax year 2015/2016, the lifetime allowance is £1.25m – what this means is an additional charge is applicable if the benefits drawn from all your pension plans exceed £1.25m. The lifetime allowance will be reduced to £1m for the tax year 2016/2017. Once you are over the lifetime allowance, there is a 55% charge on lump sum withdrawals and a 25% charge on any uncrystallised funds (funds/ benefits that you have not drawn from the pension pot). Some people may have applied for fixed protection (these were designed to protect people’s pension pot from exceeding the decrease in the lifetime allowances). It is worthwhile mentioning that once a fixed protection is in place – no further benefits can be built or the protection will be lost.
Once you have built up your pot of money, we need to think about how this pot of money can support you through your retirement. Since 6 April 2015, the “pension freedom” rules set by the government meant that you can cash in the whole of your pension fund as and when you see fit. The methods for taking out your benefits are: 1) taking out an annuity, 2) taking out a flexi-access drawdown, 3) taking a series of lump sums, 4) taking your whole pension pot as a lump sum or 5) a combination of the options
These methods are very different by nature and your personal circumstances and attitude to risk will determine which method is most suitable. Taking an annuity can be good for those who prefer a guaranteed income; however annuity rates have not been as attractive as in the past and so the income may not sustain a desirable lifestyle. With the flexi-access drawdown, you can take 25% of the fund value as a tax free cash lump sum and leave the rest invested in the market. You can choose the frequency and how much income you receive. It is important to note that the income is supplied from the fund value which is dependent on market performance. For investors who are thinking of taking a series of lump sums, you can take this as and when you see fit but for each withdrawal, the first 25% is tax free with the rest being subject to income tax. You can also take the pension as a one-off lump sum with the first 25% being tax free and the rest subject to income tax at your marginal rate (the effective rate of tax you pay on income bands).
One of the frequently asked questions is “what happens to my pension after I die”? Although it is not a pleasant thought, knowing the recent changes can help with your inheritance planning. Since the “pension freedom” rules came into play in April 2015, it is now possible to pass on benefits within a pension to your beneficiary tax free if you pass away before 75 years old e.g. your beneficiary can draw a lump sum from the pension tax free. However, if you pass away after 75 years of age, the fund value becomes taxable. Any income that is drawn from the pension is subject to the marginal tax rate of the beneficiary and any lump sum drawn is subject to a 45% tax charge.
SIPPs are increasing in popularity because of the convenience of managing your pension under one roof. Imagine having all your pension plans and drawing benefits from one place – it will certainly help lessen the amount of paperwork! But is consolidating your pension plans into a SIPP suitable for you? In short, there is no right or wrong answer, but there are some points that I think will be useful to consider when deciding whether this is right for you.
You may have taken out a pension plan decades ago and these are likely to have early exit fees – if these plans are invested into with-profits fund, there is usually a market value reduction before a transfer is permitted. Transferring these types of plans over will mean you will lose some fund value and it may take you a while before you recoup this loss in a SIPP. Another thing to consider is whether you have any guarantee features that you will forgo if you transfer your plan away. If you are thinking of consolidating your pension plans into a SIPP to purchase an annuity, you need to consider whether there are any guaranteed annuity rates attached to the plans. Typically, guaranteed annuity rates provide a more competitive income than the current market rates and in these situations, it may not be worth transferring the plan. The other type of pension scheme that you may have is called the “final salary” scheme. These schemes include guaranteed benefits that are more generous than any benefits seen across personal pension plans. Because of the generosity of the benefits guaranteed, it is unlikely that when calculating the transfer value, it will fully represent the benefits lost. The FCA has said that financial advice must be given to transfer a final salary scheme that has a value of over £30,000 to a defined contribution scheme. The need to have compulsory financial advice highlights the safeguarding of these valuable benefits.
Overall, although the popularity of taking out a SIPP is increasing it isn’t suitable for every investor. For investors who are confident in managing their own investments or are looking to consolidate their plans, a SIPP can provide a cost effective and convenient solution.
The government has set up an organisation called Pension Wise
and it aims to provide guidance on what you could do with a defined contribution scheme. Please note that it does not provide guidance on final salary (defined benefit) schemes.
following the Summer Budget 2015, there are discussions involving scrapping the tax relief for higher and top rate taxpayers – though it has yet to be confirmed. In addition to this, it has been confirmed that for the tax year 2016/2017, there will be a tapered annual allowance for people with an income (including pension contributions) over £150,000
*You can also carry forward any unused annual allowance from the three previous tax years. The annual allowance for tax year 2012/2013 and 2013/2014 was £50,000 and for 2014/2015 was £40,000. This facility allows you to carry forward any unused allowances into the tax year of 2015/2016. This facility is beneficial for investors who have already contributed 100% of their earnings (up to £40,000) into this year’s annual allowance.
A SIPP is available on the Willis Owen platform
– please note that the Willis Owen SIPP does not have the three year carry forward facility.