pensions

we all know that pensions do exist, but what exactly is a pension?

here we will break down the various types of pensions available to people these days and what they mean for retirement.

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defined benefit pension

defined contribution pension

defined contribution pension

what exactly is a defined benefit pension and can i still have one?

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defined contribution pension

defined contribution pension

defined contribution pension

what is a defined contribution pension and is it right for me?

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state pension

defined contribution pension

state pension

what is the state pension and should i be paying into it?

defined benefit pension

what is a defined benefit pension?

a defined benefit pension is a pension that promises to pay out an income for life. that income increases each year, usually by the increase of the CPI (consumer prices index).

 

the pension is usually an employer-sponsored scheme whereby the company contributes to the scheme and is responsible for ensuring there’s enough money at the time you retire to pay your pension income.


the income that you receive in retirement depends mainly on the following factors: 


  • how many years you were a member of the scheme (pensionable service)
  • final salary or average salary (pensionable earnings)
  • accrual rate (a portion of salary you get for each year you were part of the scheme)


an example of a pension income calculation is below: 


  • james worked for Tesco for 20 years (pensionable service)
  • his final salary was £45,000 (pensionable earnings)
  • the accrual rate for this scheme is 1/60th. 
  • pension income = £45,000/ 60 x 20 = £15,000


james has a current pension income of £15,000. 


tax-free lump sum: 


with most defined benefit schemes, you have the option to take a 25% tax-free lump sum at retirement. this is known as a ‘pension commencement lump sum’ (PCLS). 


how this lump-sum works is that you give up 25% of the income in exchange for a lump-sum. how much you get as a lump-sum depends on the commutation factor. 


a commutation factor is how much annual pension is being given up for every £ of lump sum taken. 


if we use james’ example, if he would like to take 25% PCLS and the commutation factor is 15:1, he will give up £3,750 of income (25%) for a lump sum of £56,250 (x15).

 

are defined benefit pensions guaranteed? 


far from it. the pension income is referred to as a ‘promise’ of income rather than a ‘guarantee’ because the company will only ever continue paying out pension income for as long as they can afford to. 


we have seen many cases recently of companies going into liquidation and the defined benefit pensions falling into the pension protection fund (PPF). 


companies that have gone into the PPF recently include:


  • Thomas Cook 
  • Carillion 
  • Arcadia Group
  • MG Rover
  • Lehman Brothers 
  • UK Coal 
  • Scottish Electric
  • Toys ‘R’ Us


reviewing your pension


it is vitally important to keep reviewing and understanding your defined benefit pension. 


the areas that you need to check include:


  • changes in retirement calculations 
  • scheme deficit (how much debt the pension scheme is in)
  • tax on retirement
  • portability of scheme 
  • cash-equivalent transfer value


transferring your pension


if you are not drawing income from your defined benefit scheme, it is possible to transfer into a defined contribution pension scheme.  


you can request a cash-equivalent transfer value every year, to see how much money your scheme will give you, if you were to transfer your benefits to a defined contribution pension. 


there are several reasons people consider transferring, including the following: 


portability: defined benefit pensions are not portable, meaning that they will always stay in the UK and the income that you draw from them will be in GBP. defined contribution pensions can be moved overseas and can be based in a different currency. 


retirement age: most defined benefit schemes have a retirement age of 65 years old. with a defined contribution pension, the retirement age is 55 years old. this means that you could have flexible access 10 years earlier, without penalty. 


drawdown: defined benefit schemes have a steady stream of inflation linked income every month. with a DC scheme, you can draw down from your pension as flexibly as you like, so you can take more money when you need it and less when you don't. 


investments: with defined benefit schemes, you have no control over where your pension is invested. by moving into a DC scheme, you have full control over your pension therefore you can choose a range of investments that suit your needs. 


pension scheme security: many defined benefit pension schemes in the UK are running large deficits. what this means is that the money that is funding the pension from current employees is not enough to cover what is being paid out. this offers a lot of uncertainty for future retirees and leaves questions marks over the companies’ ability to fulfil their promise.


tax: with a DC pension scheme, you are entitled to a 25% tax-free lump sum from the age of 55. this is compared to taking a tax-free amount at 65 that then reduces your income. 


death benefits: most defined benefit pensions allow for 50% of your income to be passed to a spouse. if there is no spouse then in most cases, the pension ends. with a DC pension scheme, if you were to pass away, 100% of your pension can be passed to whoever you like. whether it be the spouse, kids, grandkids etc. in most cases, passing on a SIPP to a beneficiary is tax-free. 


growth: currently income from defined benefit schemes is linked to inflation (average of around 2%). in a DC pension, the value of your fund can grow by an unlimited amount each year because it is investment linked. of course, this is dependent on your risk profile. average growth figures for most defined contribution schemes are between 5-8% per annum.

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defined contribution pension

what is a defined contribution pension?

a defined contribution pension is a pot of money. that pot of money is made up of your own contributions, your employers’ contributions and the growth of the underlying investments. 


ultimately, how much you drawdown in retirement from a defined contribution pension, depends on how much has been put into the pot and how well the investments have performed. 


there are usually two types of defined contribution pensions available: 


  • workplace pension
  • private pension 


a workplace defined contribution pension is a scheme that your employer will set up for you. they will usually use a large insurer or institution to manage the funds and will offer their members a limited selection of investment and risk profiles. 


a private defined contribution pension is something that has been set up by an individual and has much more flexibility compared with a workplace pension. employers can still contribute to a private pension if the individual has informed the employer and they have agreed to contribute. 


private pensions offer a much greater choice of investments compared with a pension that has been set up by an employer. they are usually run by someone with a good understanding of investments, or someone that is working with a financial advisor. this in turn can greatly improve their situation in retirement but can also have potential downfalls. 


upon retirement


defined contribution pensions have much greater flexibility compared with defined benefit pensions. the main features on retirement are as follows: 


  • access from the age of 55
  • flexible income drawdown 
  • 25% tax-free lump sum from the age of 55 
  • 100% of pension pot can be passed to any chosen beneficiaries 


when drawing income down from a defined contribution, you can purchase an annuity to provide you with a guaranteed income for life or you can drawdown flexibly. 


since pension freedoms in 2015, it is no longer a requirement to purchase an annuity. this is just as well because due to record low levels of interest rates, purchasing an annuity can be very expensive and you are often a lot better off drawing from your investments flexibly. 


as defined-benefit pensions are very rare these days, most of the working population will be invested into some sort of defined contribution pension. this means that how much income you get in retirement is dependant on the decisions you make with your pension pot throughout your working life. 


if you’re uncertain about what to do, get advice from a regulated financial adviser (see below).

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state pensions

what is the new state pension?

the new state pension is a regular payment from the government that most people can claim in later life.


you can claim the new state pension at state pension age if you have at least 10 years National Insurance contributions and are:


  • a man born on or after 6 April 1951
  • a woman born on or after 6 April 1953


if you were born before these dates you will get the basic state pension instead.


how much state pension will I get?


the full rate of the new SP will be £168.60 per week (in 2019/20) but what you will get could be more or less, depending on your national insurance (NI) record.


you can check your how much SP you could get on the government website or, you can request a paper statement if you prefer.


if you have:


  • 35 years or more of NI contributions, you will get the full amount
  • between 10 and 34 years of contributions, you will receive a proportion of the pension
  • less than 10 years of NI contributions, you aren’t usually eligible for the new State Pension.


can i use my partner’s contributions?


the SP is based on your own contributions and in general, you will not be able to claim on your spouse or civil partner’s contributions at retirement or if you are widowed or divorced.  however, if you're widowed you may be able to inherit part of your partner’s additional SP already built up.


if you are a woman who paid the reduced rate ‘married woman’s contributions’, you may be able to use these contributions towards the SP.


can i increase my SP?


if you’re not on course to get a full SP, there may be some things you can do to help boost your pension.


do i have to take my SP straight away?


you don’t have to claim your SP when you reach SP age. this is known as deferring, and could mean that you get extra SP when you do claim.


how much extra you get will depend on how long you defer claiming it. the SP increases by 1% for every 9 weeks you put off claiming it, or around 5.8% for each full year. this may not apply to you if you get certain benefits.


if you live abroad or used to


if you live abroad or used to, you may have a gap in your NI record which could affect the amount of SP you’ll get.


you may be able to get a pension from the country you live/ lived in. contact the department responsible for SP in that country. if the country is in the EEA then the DWP may be able to help you contact them.


if you reach SP age after 6 April 2016, you might be able to use the time you worked abroad to make up some of the qualifying years that you need to get the new SP. this depends on the country you lived in though.


if you have gaps in your NI record


if you have gaps in your record and want to boost your SP you could make voluntary NI contributions. how much these are and if you are eligible will depend on your individual circumstances.


you can find out more about state pensions on the government's website: 


 https://www.gov.uk/check-state-pension 

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advice on pensions

would you like advice on any pensions that you have in the UK? feel out the contact form below to speak to us today.