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A pension is a way of making sure you get a regular amount of money coming in, in retirement. Current & previous governments have encouraged regular saving towards a pension by giving tax relief on the amounts you pay, the idea being to encourage people to provide for their own retirement rather than rely on the state.
This short guide is intended to give you some basic information on how the current system works.
Whilst we cannot advise you as to which type of scheme might be best for you we can give you the ground rules about how pensions work in general and how much you can pay in to your scheme to stay within the available tax reliefs. We will be looking at the four main kinds of pension scheme - occupational pensions, stakeholder pensions, personal pensions and retirement annuity pensions - in this section.
We also explain what the State Second Pension is and how this works.
What are the types of pension I might have and how are they all different?
What is the State Second Pension?
What is a rebate only personal pension or appropriate personal pension?
What are the rules for paying into pensions?
What are the types of pension I might have and how are they all different?
Stakeholder & personal pensions
- A personal pension plan is a way of saving regularly for your retirement. Bear in mind you that you invest personally in a personal pension plan - as opposed to an occupational pension which is generally set up through your workplace.
- A stakeholder pension is a special type of personal pension plan which is available to both earners and non-earners.
- £3,600 is the total amount a non-earner can contribute to a stakeholder scheme from any source during a tax year. This total includes £720 of tax calculated at 20% which means you only pay £2,880 (£3,600 less 20% basic rate tax).
- All personal pension payments are paid net of basic rate tax so in fact you only pay the net premium of 80% after tax (100-20% basic rate tax) but you are treated as having paid 100%.
- So for example if you actually paid £4,000 (which is £5,000 less 20%) into your pension scheme you would be treated as having in fact actually paid £5,000.
- You can get a personal pension or stakeholder pension from financial services companies such as insurance companies, bank and building societies (known as providers).
- The funds in the scheme are invested to pay your pension when you retire. Depending on the type of investment there may also be some charges you will have to pay to the pension provider out of the amount you pay - your contribution.
Retirement annuity schemes
- If you took out a pension policy before 1 July 1988 - this would have been called a retirement annuity policy. Quite often these were linked to insurance policies and any payments to the insurance policies were also treated as being pension payments.
- Retirement annuity policies are able to pay out larger lump sums than personal pensions but they only pay out at age 65 or later.
- At present payments to retirement annuity policies are made without any tax taken off and so you will need to get tax relief through your coding notice or your self-assessment tax return.
- If you are getting relief through your coding notice - the full amount of the payments you are making will be shown in the allowances column of the coding so you will effectively be setting that amount against your income and paying tax only on the balance.
- If you pay your tax through your self assessment because you are self employed - you will be claiming the full amount of the payment in boxes 14.1-14.5. You will then get tax relief via your tax calculation for the year in question or you can carry back the payment to be relieved in the previous tax year.
- Retirement annuities are paid under PAYE in the same way as wages & personal pensions.
Occupational pensions
- An occupational pension scheme is one provided by your employer.
- Generally it is worth joining one of these schemes if they are available to you as most employers who run the schemes also contribute themselves on your behalf. These extra payments an employer makes are tax and NIC free.
- You can also make extra payments of your own to the employer's scheme. These are called Additional Voluntary Contributions (AVCs) or Freestanding Additional Voluntary Payments (FSAVCs) and you can pay in up to £235,000 for 2008/09 (£245,000 for 2009/10 and £255,000 for 2010/11) if you have not made payments to any other scheme.
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What is the State Second Pension?
- When you are working you can choose to build up an extra state pension as well as the basic pension.
- This was previously called the State Earnings Related Pension or SERPs but from 6 April 2002 it became the State Second Pension (sometimes also known as Additional State Pension).
- SERPs was based on your National Insurance contributions record and the level of your earnings.
- You could choose to opt out (called contracting out ) of SERPs; if you did so, the Revenue paid part of your National Insurance contributions directly to the pension provider of your choice to fund a separate pension scheme with them instead of increasing the amount in the Government SERPs scheme.
- A similar option is available with the State Second Pension.
- Neither SERPs nor the State Second Pension apply to you if you are self employed. So you will need to make separate pension arrangements. Normally you will take out an individual personal pension but you need to consider that you will only get the basic State Pension and so you might want to check you are paying enough into your pension scheme to cover the missing Additional State Pension.
- Any SERPs entitlement to date is protected.
- The idea with the State Second Pension is that this gives employees earning to around £31,100 (for 2008/09) , and those with a long-term illness or disability, a better pension than SERPs would have done with those on lowest incomes benefiting the most.
- If you are earning less than about £13,500 a year (for 2008/09) or are close to retirement, it may be worth staying in the State Second Pension scheme and putting any spare money in a savings account such as an ISA. This may be better than investing in a personal pension scheme and incurring charges payable to the provider and assuming all the risk yourself.
- However the best choice for you will depend on your own circumstances and how long you have left to retirement and also if you are close to retirement already, how annuity rates are performing etc.
- You may need to contact an independent financial adviser but check first what charges might be involved particularly if you end up not buying a product from the adviser.
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What is a rebate only personal pension or appropriate personal pension?
- As mentioned in What is the State Second Pension, if you work for an employer you can take out a personal pension to replace the additional State Pension.
- This type of personal pension is called an Appropriate Personal Pension (APP) .
- The amount of the rebate from the Revenue to your APP scheme depends on your age and your earnings.
- The Revenue payment is called the minimum contribution and will be paid once your earnings are known at the end of the tax year.
- If you contract out of the Second State pension and you earn less than around £13,500 a year (for 2008/09) you will also get a top-up to the minimum contribution paid into your APP.
- You can also make additional payments of your own to an APP.
- Some personal pensions are rebate only which means that the only money being paid into the scheme is the National Insurance rebate. This type of personal pension is just intended to replace the additional state pension.
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What are the rules for paying into pensions?
Overview
- Providing your pension scheme provider agrees, there is no limit on the amount you can put into your pension although the tax relief you can get may be limited.
- You can also save in more than one pension scheme at the same time, for example in both a personal pension and an occupational pension.
Tax relief on payments
- You can get tax relief on contributions of up to 100% of your UK earnings if you are a UK taxpayer. For most people tax relief is given automatically either through their wages or by their pension scheme.
- If you are a non-taxpayer, every £100 of contributions will receive a contribution of £25 from HMRC up to a maximum of £3600 per tax year.
- For every £100 you want to put into your pension you only physically need to pay £80 out of your income after tax - the government pays the remaining £20. This is in fact a downside the reduction in basic rate tax from 22% to 20% as previously whilst the tax rate was higher the government paid £22 instead of £20 for every £100 you paid.
Annual and lifetime allowances
- Your employer's contributions are not taken into account against the tax relief you could receive. There is an annual allowance of up to £235,000 for 2008/09 (£245,000 for 2009/10 and £255,000 for 2010/11). If the increase in the value of your pension rights or your contributions (plus any contributions from your employer) exceeds the annual allowance, there is a tax charge at 40% on the excess.
- There is also a lifetime allowance (LTA), which has been set at £1.65 million for the year 2008/09 rising to £1.75 million for 2009/10 and £1.8 million for 2010/11. If your total pension savings exceed this, you may be taxed on any amount over £1.65 million. This Lifetime Allowance charge is set at 25% if you take the additional savings as a pension and 55% if you take them as a lump sum.
When can you take your pension?
- The rules about when you can take your pension have changed. This is currently 50, although many pension schemes may have a higher limit. By 6 April 2010 every pension scheme must have an age limit of at least 55. You must start taking your pension by age 75 and there are a number of ways of doing this which your pension provider can advise you on.
- Different rules apply if you retire due to serious ill health or if you already have the right to retire before age 55.
Lump sums
- Any pension that you receive will still be taxable. However most schemes, in addition to a pension offer a tax-free lump sum. The amount of lump sum you can take will depend on the rules of your particular scheme, but the new rules mean that all schemes can, if they choose, offer a tax-free lump sum of up to 25% to members when they first take their pension.
Trivial commutation
- From 6th April 2006, if the total value of all your pension savings (in all schemes if you are a member of more than one scheme) is £16,500 or less (for 2008/09 - this amount will increase in later years) and your scheme rules permit, you may be able to take your entire fund as a lump sum. This is known as trivial commutation .
- 25% of the lump sum would be tax-free and the rest would be taxed as part of your income. Trivial commutation of pensions already in payment would be fully taxable as income. You can find more about how trivial commutation works and some example in our information article here.
- You can find information about deferring state pension and taking a lump sum payment instead by having a look at What are my choices at State Pension age? on the Pension Service website.
- You can also find information on this topic on this website in our articles State pension: to defer or not to defer? & State pension: to defer or not to defer? (Part 2).
- The new rules mean that everything you have built up in your pension pot up to 6 April 2006 (A-Day) has been automatically transferred into the new system and you will continue to get, at the very least, the same benefits that you were entitled to before.
Large pension funds
- Only those few individuals with pension savings (or potential pension savings) of over £1.65 million, or a potential lump sum of greater than £412,500 will have to apply to HMRC to ensure they are exempt from the lifetime allowance charge. Those with expected lump sums greater than 25% but that are worth less than £412,500 automatically receive protection so long as they stay in their pension scheme.
- You can claim protection of rights applying before 6 April 2006 (A-Day) from the lifetime allowance charge by registering a claim with HMRC. You can also protect existing lump sum rights where these would be greater than is permissible under the tax rules after A-Day.
- Claims must be registered by 5 April 2009 on the Protection of Existing Rights form. If you think you may be affected by this, you should seek financial advice.
Helplines
- HMRC have a pensions simplification helpline on 0115 974 1600 or 0115 974 1777 (Monday to Friday 9.00am to 5.00pm) which you can phone for further advice.
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