Planning your pension is one of the constant conundrums of adult life, trying to guarantee that once you retire into your senior years you’ll be safe, comfortable and ready to live the life you’ve always dreamed of.
We spoke to one of our financial partners, Elliott Winner of KWM Wealth Ltd., about the planned rise in pension age, the rise in interest surrounding pensions, and when is the best time to get your affairs in order…
In your view, what is the current state of the UK pension scheme?
The State Pension is not enough to sustain people’s lifestyles in retirement, and there is already a crisis with people not saving enough for their retirement, therefore creating a dependency culture.
Overall, the current pension scheme is good, as it allows for people to be taxed efficiently, whilst saving towards their future. The government will give both individuals and companies tax relief for making contributions, making it a really attractive strategy for accruing a nice amount of money which can be used for an investment later down the line.
Pensions are one the areas though which has seen so many changes over the past few years. From the level of contributions you can make in a given tax year, to Lifetime Allowance reduction, and pension freedom in 2015. These changes to regulations can be confusing and very frustrating.
With the Institute For Fiscal Studies recently announcing record highs in employment among 65-year-olds, do you think the planned 2026 rise in pension age to 67 is a good idea?
There are two main considerations here – firstly, we are living longer because of health and technology advancements, and secondly, many are not necessarily aware of the importance of planning for retirement in their early years of work. The latter means some are working longer than they may have planned to. This has ultimately led to research highlighting that the average age of people in work is rising, which isn’t necessarily a good thing for the economy or livelihood in general.
The other factor here, is that some people are simply working past the retirement age because they want to, not because they need to. This rise to 67 on the State Pension (for those people) is likely to be more of a bonus income rather than a thing that they rely on to survive.
Have you found over the course of the past two years of the pandemic that there has been a rise in interest surrounding pensions?
I would say for most people life became simplified and scaled back over the pandemic. We enjoyed the sun, taking walks, and thinking about loved ones with more intent. People had time to think further than their workload, their commute and all the other daily stresses, so this likely encouraged thoughts about the future and what they want from it. I think another trend was that people were thinking more about their own mortality, as a result of people they knew or loved ones passing away from COVID.
With the increased time that people had, there was also a rise in interest around stocks and shares. One of the ways to hold stocks and shares is within a pension wrapper, so this would consequently had a knock-on effect on pension interest.
There were also many people whose lives changed within weeks, unfortunately finding themselves in financial difficulty and distress through the pandemic due to the economic repercussions. This would have inevitably made them feel insecure financially, and in a situation that they wouldn’t want to find themselves in again later in life. This focus on pensions and planning for the future has increased.
What major developments and updates in pensions can we expect for the year ahead?
Because pensions have so many attractive tax benefits, they will likely always be under scrutiny for change especially now with the Government in so much debt due to borrowing. Three areas that are likely to see change are:
Lifetime Allowance (LTA)
This is the amount you can build up in pension benefits over your lifetime with full tax benefits. If you go over the allowance, you must pay a tax charge on the excess at certain times (25% or 55% depending on how the withdrawal is made).
The standard lifetime allowance for tax year 2021/22 is £1.0731 million, which has been higher in previous tax years. This was set to increase in line with CPI (Consumer Price Index) year on year, however it is now frozen until April 2026, which will likely remain unchanged for time being.
Contributions receiving tax relief
Currently individuals receive income tax relief on contributions up to their marginal rate of income tax i.e. 20%/40%/45%. For several years now, there has been talk of bringing tax relief into a flat rate system i.e. 20% or 30% for everybody. This could be something the government look to change, which would make it less attractive for higher earners who currently receive income tax relief at 40% or 45% respectively.
Withdrawals from pensions
Individuals can take money out of their pensions with 25% of the pot tax free, and the remainder at their marginal rate of income tax (20%/40%/45%). The Government could decide to reduce the amount of the tax-free element from pensions, therefore taxing a higher proportion of the pot on withdrawal to try and claw back the national deficit due to huge spending during the pandemic.
What are the main ways to plan your pension strategically and pay less tax within legal boundaries?
We would always suggest taking advice with pensions, particularly because so much has changed in the past few years, especially around contribution level vs amount of income earned. Pension tapering rules came into force in April 2016, which essentially meant for every £2 of adjusted income over £150,000, an individual’s annual allowance is reduced by £1. This has since changed to £240,000, which can become quite confusing for high earning individuals and directors taking large levels of income out of their limited companies.
If over contributions are made into pensions, this must be declared to HMRC and then a tax charge will be levied. By taking advice from a qualified professional, this should ensure that this does not happen.
It is also important that people have a strategic plan around what the pensions will mean for them contextually in the future i.e. if I contribute X amount, what would this provide me with as an income at age 60?
Consistently going over your figures and scrutinising them will leave you in a great position to plan appropriately and with great effect.
What is your message to younger people out there who don’t think it’s worth signing up to a pension scheme (whether through employment or as a sole trader)?
The earlier you start contributing to your pension, the more it will be worth when you come to retire, and therefore allowing you to live a better life in retirement. This is because of the ‘8th wonder of the world’ – compound interest. The longer you leave something to grow, the growth will begin to compound giving you better returns in monetary terms. A way to visualise this better is by looking at the below scenarios.
Assumption for all 3 scenarios are that contributions increase by 2.5% each year and a growth of 2.4% net of charges. Selected retirement age is 67 and £200 contributions being made per month:
- Scenario 1:
- Start saving at age 20 – pension pot at retirement = £349,000
- Scenario 2:
- Start saving at age 30 – pension pot at retirement = £215,000
- Scenario 3:
- Start saving at age 40 – pension pot at retirement = £123,000
Disclaimer: These figures are examples only and are not guaranteed/adjusted for inflation. What you get back depends on investment growth and tax treatment, therefore you could get back more or less than this. Please note that the value of a pension can fall as well as rise and you could get back less than the amount invested.
We hope this has outlined to you the laws, thresholds and updates around pensions, and why planning sooner rather than later is highly recommended. If you require any further information on pensions, or anything accounting related for that matter, please don’t hesitate to get in contact with us at Nordens where one of our trusted advisors would be happy talking you through your query.