A pension is a way of making sure you get a regular amount of money coming in, in retirement. Current and 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 stakeholder pensions, personal pensions and retirement annuity pensions - in this section.
We also explain what the State second pension is.
What are the types of pension I might have and how are they all different?
What is the State second pension?
What are the rules for paying into 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.
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%.
£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).
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.
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.
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 self-assessment tax return. 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.
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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 called the State second Pension (S2P) and sometimes as Additional state pension. SERPs was based on your National Insurance contributions record and the level of your earnings.
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.
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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.
You can get tax relief on contributions of up to 100% of your UK earnings if you are a UK taxpayer.
If you are a non-taxpayer, every £100 of contributions will receive a contribution of £25 from HMRC up to a maximum of £3,600 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.
If you pay tax at the 40% higher rate you will also be able to claim an extra 20% tax relief. You can claim the difference through your self assessment tax return or by making a claim to HMRC by telephone or letter. However from 6 April 2011 this additional tax relief has been removed for those on incomes of £150,000 or more.
There is an annual allowance of up to £50,000 (£255,000 for 2010/11). If the increase in the value of your pension rights or your contributions 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 £1.8 million for 2011/12 reducing to £1.5 million for 2012/13. If your total pension savings exceed this, you may be taxed on any amount over the limit. 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.
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 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.
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.
You can find our comprehensive guidance using the link.
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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