Pensions for employees

A pension is a way of making sure you get a regular amount of money coming in, in retirement. Saving for a pension is a way of deferring current income until a later point in time.

Saving is encouraged by giving tax relief on contributions paid in to a pension scheme, the income arising on those savings is generally free of tax and although when pensions are paid they are taxable, there is the opportunity to take some part of the pension as a tax-free sum.

This short guide is intended to give you some basic information on how the current system works. We do not cover the rules for a basic State pension here; you need to look at our Pensioners section for that information.

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.

Pensions savings are complicated and if you need detailed advice then the Pensions Advisory Service have an excellent website and a free helpline.

In the following section we will briefly consider the main types of pension plans which exist, namely stakeholder and personal pensions, retirement annuity schemes, occupational pensions, the State second pension and the new personal account which will come into existence in 2012.

What are the types of pension I might have and how are they all different?

• Stakeholder and personal pensions
• Retirement annuity schemes
• Occupational pensions

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?

• Overview
• When can you take your pension?
• Lump sums
• Trivial commutation

The new Personal Account from 2012

• 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%.

• 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 (or wish to have it paid within the rules). 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.
• Personal pensions, when coming into payment, will be paid by the providers as income subject to tax under the PAYE system.

• If you took out a personal pension before 1 July 1988 - this would have been called a retirement annuity policy.
• Retirement annuity policies are able to pay out larger tax free lump sums than personal pensions.
• 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 and personal pensions.

An occupational (or works) pension is one organised by your employer. Normally it is worth joining because your employer is likely to contribute so giving you extra income, albeit deferred until you retire.

Generally you can make extra payments of your own into the employer’s scheme which are often called additional voluntary contributions (AVCs) or freestanding additional voluntary payments (FSAVCs). There are ceilings on the level of payments that can be made with tax relief, but these do not impact upon people on low incomes.

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• 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 is now known as 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 or you do not work at all or if you earn less than £5,304 for 2011/12. 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.
• If you are on a low income 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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• 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 HMRC to your APP scheme depends on your age and your earnings.
• The HMRC 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 State second pension and you earn less than a set limit, 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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• 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.

• The rules about when you can take your pension have changed. This is currently 50, although many pension schemes may have a higher limit. Since 6 April 2010 every pension scheme has to 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.

• 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 £18,000 for the tax years 2011/12 to 2015/16 and your scheme rules permit, you may be able to take your entire fund as a lump sum. This is known as trivial commutation.

A detailed analysis of the trivial commutation rules with advice about your choices and traps to avoid is contained in our Pensioners section.

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• From 2012 there will be another radical change in pensions as we know them with the introduction of the new Personal account. This has arisen because according to government statistics, around 7 million people in the UK are not saving enough to give them the pension income they are likely or want, or expect in retirement.
• A Personal account will be a UK-wide pension plan backed by the government, which is intended to act as a top-up for the current state system.
• It will affect all employees and employers.
• The changes will effectively force many workers to save for a pension for the first time with their employers additionally required to contribute.

• Once Personal Accounts regulations come into force in 2012, if you are aged between 22 and state pension age (currently 60 for women and 65 for men), your employer will either have to enrol you in a Personal Account, or put you into the company's existing pension plan, provided that the plan is as good as a Personal Account.
• If you do not want to be a member of a plan you will have to opt out of the scheme.
• As part of the process, members of pension plans who do not choose an investment fund for their Personal Account will have their pension monies invested in a Default Fund.

• The result of these changes is that you may find yourself with a pension plan for the first time and but it also means you could see a reduction in your take-home wages of 4%.
• So, for example if you take home £300 per week after all deductions this might fall by £15 per week.
• Minimum contributions for personal accounts (to be phased in over a number of years):
  • 4% of your earnings between around £5,000 and £35,000
  • 3% from your employer
  • 1% from the Government through tax relief
• There will be contribution limit of £3,600 per year (based on 2005 earning levels) and a general ban on transfers in and out the scheme.
• At the same time as personal accounts are introduced – employers will no longer have to provide access to a stakeholder pension but contributions will still have to be deducted through the payroll for those employees who have schemes in place when the rules are changed.
• The upside of this is that, possibly for the first time, you will be building up a pot of money for your retirement in a pension plan, which is also receiving contributions from your employer and the government. The downside is that if your budget is very tight a 4% drop in earnings may be more than you can afford.
• However you will need to make sure you are aware how you will be affected.
• Even though the contributions will be phased in over time you will need to build the reduction in your take home earnings into your day-to-day budgeting.

• Pension saving can also have the effect of reducing your means-tested benefits.
• For example, the guarantee credit element of pension credit is currently £130 per week for a single person over the age of 60.
• All state and private pensions together with any earnings and the value of any savings are assessed and income is topped up to the minimum if necessary. So, saving in a Personal Account may reduce the amount of this means-tested benefit that is payable.
• What this will mean in effect is that you may not get the best return on your savings, even taking into account the contributions made by your employer and government.
• Trying to decide how this is likely to affect you is a very complicated equation, because it means trying to work out what your situation might be when you retire.
• You will need to take into account whether you will be in your own home or rented accommodation, what other savings you and your spouse or civil partner may have and what other state and private pensions you and your spouse or civil partner might have earned.

• The Government is hoping to provide some form of general basic advice, which will include information on Personal Accounts – do take advantage of any advice that is available to you.
• The key issue is about how much money you have to spend, whether saving in a pension makes sense and whether you can afford a financially secure retirement.
• But of course you need not wait until the changes take place - many employers already provide access to company pension plans. You may in fact get a better deal by joining now than by waiting for the introduction of Personal Accounts.
• You should ask your employer what if anything is available to you. But in any event between now and 2012 your employer should discuss the options with you to help you understand the implications of Personal Accounts.
• If you do not understand, do ask for help either from the government's service (when available), your employer or your union.

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