Mon 11 Sep 2023

Pensions - more exciting than you might think?

I'm not sure if the above title counts as "clickbait"?  It isn't unusual for me to hear people say that they find pensions boring, though I'm always quick then to remind them that that's my working life they are disparaging.

So, on Pension Awareness Day it seems timely to recap on how pensions work, as well as how they fit into both retirement but also wider financial planning.

Let's leave the slightly dry "how they work" bullet point list until later.

Pensions are not just about retirement: but equally, retirement is not just about pensions.  It is when you put these two perspectives together that things can get a bit more interesting.

Currently, a pension fund can be accessed from age 55, though this is proposed to increase to age 57 from 2028.  Regardless of any increase, this access for most of us will come well ahead of any actual retirement.  However, this accessibility can be very helpful in terms of wider financial planning.  Two classic examples might be: using a pension and its associated tax benefits in order to accumulate funds to repay mortgage capital by utilising the tax free lump sum available from the pension; and using the flexibility of withdrawals from the pension to provide income and/or capital that might help facilitate a move to part-time working as part of a phased transition from full-time employment into retirement.  Or maybe it's just to access funds for that big 60th birthday party.

It is of course important to acknowledge that the earlier a pension is accessed, and the more money that is withdrawn, then the less will be available in later life.  But there is flexibility within pensions that can be valuable, if used prudently and cautiously.

As well as building up a pension fund, there are a variety of other tax efficient wrappers available for accumulating for retirement.  Most notable are ISAs.  Whilst these don't have the attractive upfront tax relief aspect of pensions, once funds are in an ISA they thereafter grow tax free and are available without restriction, including pre-55.  These therefore have a strong attraction as a long term vehicle for retirement funding, but without the restrictions (most notably around age) that come with a pension.

Then in retirement, the careful structuring of a phased tax free pension lump sum, taxable pension income, and ISA withdrawals, can provide significant income with minimal income tax.

To briefly recap the main features of a pension:

  • Money contributed by you gains full income tax relief i.e. you effectively don't pay any income tax on the money you divert into your pension
  • Thereafter funds grow tax free
  • Funds can be accessed from age 55 (or age 57 from 2028)
  • Typically 25% of the fund is available tax free, either as a "lump sum" or taken gradually
  • There are now no restrictions on the other withdrawals from the pension.  Ultimately, the whole fund can be withdrawn if so desired (albeit this is very rarely a sensible strategy and can have adverse tax consequences: seek advice!).  But these flexible withdrawals can be designed to precisely match your needs
  • These withdrawals are subject to income tax, though often this is at a lower rate than the rate of income tax relief that was received on contributions in.

The fundamental aspect of pensions is undeniable: that they involve putting money aside for tomorrow rather than spending it today.  But the lesson is clear from every survey that asks those in or approaching retirement what their biggest regret is: that they wished they'd started saving earlier.  There is a reason why "let time and compound interest do the heavy lifting" is one of my favourite financial phrases.

And if any further evidence was needed as to just quite how exciting pensions really are, then note that Pension Awareness Day actually runs from the 11 to 15 September: one day just isn't enough to fit it all in.

If a free 30 minute video call chat with one of our Pension Planners would be helpful, then please get in touch.


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