How Pensions Work & How to Get The Most Out Of Your Pension
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- Опубліковано 16 чер 2024
- To maximise your pension you need to know how pensions work. For most people pensions are the best way to build wealth for the future. Pensions are a way for you, your employer and the government to provide money for your benefit in later life. Learning how to get the most out of your pension is very worthwhile.
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State Pension
State pension contributions are earned through working or looking after young children. When working you need to earn more than the lower earnings limit which is currently £6,240. State pension requires minimum 10 years contribution and 35 years to get the maximum payout which will be £221.20 per week or £11,502 per year from April 2024. Pensions grow in line with the triple lock of the higher of - wages growth, consumer price inflation or 2.5%. If you are missing contributing years you can purchase them for around £800. It is best to wait until you are near state pension age before buying additional years.
Workplace pension
Defined Benefit Pension
For workplace pensions there are two types, defined benefit where the benefit is a promise of a guaranteed future income one day when you retire it's a known or defined benefit now the amount of that income will be based on your earnings the length of time that you're with that employer and in the scheme. Some are calculated on a final salary basis others are calculated on a career average basis. Most private sector employers have shut their defined benefit pensions, but if you worked for a large company in the 1990s or earlier you might have one. You can use the government’s Pensions Tracing Service to track down all your old pensions.
Defined Contribution Pension
Defined contribution pensions are where you build up a pot of money by investing from your salary over the years until you retire. How much you get out of the end is unknown; it's the amount of contribution that is known or defined as you go along. How much the pension fund grows to is also a function of how the investments inside the pension perform over time. So you need to keep a close eye on how your money is invested. In the uk it's mandatory for employers to provide a pension of some kind, most likely a dc a defined contribution plan you will be automatically enrolled in the scheme but you can opt out.
You get free money with pensions in the form of tax relief. So if you don’t like paying tax, consider topping up your pension with an additional voluntary contribution. With pensions you are trading off only being able to access your money at a later date with tax concessions.
When you could contribute £100 to your pension via salary sacrifice the equivalent after-tax payment is:
£80 - Basic rate taxpayer
£60 - Higher rate taxpayer
£55 - Additional rate taxpayer
£40 - Higher rate taxpayer contributing income between £100,000 to £125,140 (the loss of the personal allowance)
If your income is £60,000 or higher, then £48,000 is the maximum amount you’re allowed to contribute into your pension each year - as you'll also be receiving a £12,000 tax top-up. If you are under 75, aren’t employed or earn under £3,600 annually then the most you can pay into a pension is £2,880 (or £3,600 with the tax relief applied).
You can backdate unused allowance for up to 3 years. Backdating pension contributions is relatively straightforward, as long as you have had a pension open for the entire period. But you still won't be able to go above the other annual limit - 100% of your earnings for the year. For example, if you earn £50,000 a year, that is the maximum you'll be able to add to your pension and still get tax relief - even if you haven't used up your allowance in the years prior. If you trigger the Money Purchase Annual Allowance the maximum amount that can be paid into your pension is £10,000 a year. The MPAA only applies to contributions to defined contribution pensions and not defined benefit pension schemes. The MPAA is triggered if you take income from a defined contribution pension. But it is not triggered if you only take a tax-free cash lump sum from your defined contribution pension. The MPAA is not triggered if you are under 75 and start to receive a state pension or a defined benefit pension.
Pensions are taxed as income when you take money from them. But there is no national insurance to pay and no capital gains tax. Pensions grow tax-free too so as you roll up wealth for the future there's no tax being taken off any dividend or interest payments received.
Chapters
00:00 Introduction
00:33 State Pension
01:35 Defined Benefit Pension
04:04 Defined Contribution Pension
05:51 Self Invested Personal Pension
08:41 UFPLS vs Flexi Access Drawdown
09:53 Retirement Calculator
Check out my retirement calculator ianshadrack.com/retirement-calculator
Very clear description. One thing not mentioned is that employees such as NHS workers contribute hugely to their DB benefits via superannuation. People often think these pensions are given away free !
Totally agree with your comment about many people treating DC pensions like passive DB schemes. Before I moved my workplace pension into a SIPP with interactive investor, I had a DC pension with Scottish Widows and although this had far few options than the ii SIPP it still allowed me to choose where my money was invested. A few years ago I started actively managing my SW pension and moved from the default funds (with large exposure to bonds) into passive global equity funds. As a result, when the bond market crashed in '22 my portfolio stayed intact, while for many others their hard-earned went down the pan! From comments on social media, it's clear that many people had no idea where there pension was invested, only that it had crashed. 😵
Good work. I think I was down 3% in 2022 which wasn't bad. I used a Ray Dalio all weather type strategy to protect against losses
@@matt49125 Nice! Yes, I feel sorry for the many thousands who lost out big time, thanks to their pension provider's "safe" lifestyle funds as they neared retirement. I understand some are planning to take legal action against their providers for failing to safeguard their money...not sure how that will work out, given all the disclaimers!
It is incredible that in workplace DC schemes that the majority of people either do not understand or care where their money is invested. I retired early at age 55, but when I was in a company DC pension scheme with a relatively large employer, the pension consultant in his annual visit advised me that I was one of only a few employees who had self selected the investment funds (100% equities) and deselected the lifestyle option. If I hadn't self selected, then early retirement would not have been an option.
The situation with bond prices decreasing when interest rates increased and adverse effect on pension pot value is a painful experience for many. Fortunately many years ago I had a "fall out" with my then financial advisor after years of lack lustre investment returns and I decided to educate myself and become DIY investor. My experience is that you alone perhaps with a bit of coaching as and when required are probably the best person to manage your own money.
@@jocar-1735 👍Sounds similar to my experience. Shocking really.
Fantastic content Ian …
Hopefully 80085 is a lucky number for you
I have both a DC (SIPP) and DB (Employer) pension scheme over the last 22 years. When I became a HR tax payer I wrote to the HMRC and they adjusted my tax code in order to claim the extra tax relief on the SIPP contributions. In the actual SIPP account it takes about 6 weeks until you are credited the first 20% from the HMRC.
The main downside to DCs is picking the right funds, but if you start educating yourself you can do quite well if you have the time. Over the years I've roughly 4 x what i put in, but to a certain degree it was down to monetary policy causing everything to go up.
I also have DC (SIPP) and DB pensions and just retired early at 55, but I've not yet taken any ££ from either. I'm curious, have you started to take from either or both? I'm thinking of taking my DB to supplement my SIPP, and just take 16,760 tax free / year from this via UFPLS.
@@stevegeekIf you take your DB pension then you will not be able to take £16760 tax free each year from your SIPP due to the DB pension being taxable.
I am in a very similar situation, taking the tax free maximum from SIPP each year, but then supplementing income to the required level from GIA and ISA accounts.
My DB pensions are being left until when they start to pay out at which time my SIPP annual drawdown can reduce accordingly.
@@jocar-1735 OK, interesting. I’ve heard conflicting advice about taking DB and DC together and tax implications. My DB is not huge anyway, so I’m not relying on it and may well leave it as-is until I reach normal retirement age. I can supplement my DC with ISA and income from a BTL property. I may take on some P/T work also at some point. It’s good to have options! 😉
@@stevegeek It is good indeed to have options. The only reason I can think of for taking (crystallising) a DB pension earlier than the DB scheme normal pension payment date is if you are likely to be in a fortunate enough situation in future where the pension lifetime allowance from all pensions crystallisation is going to be breached assuming that a future government will reintroduce the LTA. In this instance I would look to crystallise everything in the next 1 or 2 years as it will take a few years for the LTA to be brought back into legislation if ever it is.
I have seen a few retirement vlogs & this is probably one of the best, easy to understand & presented. This must have taken some time to do.
Yes it does take a while to produce everything
@@IanShadrackInvesting thank for for a well presented Vlog & the effort you put into them.
Hi Ian, one area of savings/wealth management that is really grey is the success of defined benefit workplace pension plans. It would be great to see more analysis on benefits of moving money out of workplace schemes and into SIPPs.
It is very difficult to do such a move these days
Thanks, very informative. Can you do a video of how someone can start a SIPP, while also keeping the workplace pension and the employer's contribution? Confused how this is managed and how the money can be transferred between the two.
Read reset by David Sawyer it is covered in that book
I think it would be great to do a more thorough analysis of pension schemes performances. To give people indications of underperformance versus some funds
I think the underperformance comes from holding bonds. Also you can make a partial transfer out of your current pension scheme.
Hi Ian, great information- thank you. If I use fad and have the max tax free lump sum available, can I take say 40k tax free, but have the remainder c 228k still invested in stock market funds within the pension? Much appreciated and hope that makes sense. I don’t want to convert it all to cash at the one time and lose any market growth.
Yes you can take the tax free cash over several years with fad hence the name flexible access drawdown
As I understand FAD, if you want to take 40k tax free you would need to crystallize 160k...40k is 25% of this. The remaining 120k would be taxable, depending how much you take per year, and can remain invested in the stock market.
@@stevegeek much appreciated mate - thank you. 👍🏻
Another informative video. Thank you!
Quick question regarding the £2,880. Are you not allowed to do this if you are over 75?
Not allowed if over 75
Thank you Ian.
I'm currently planning to spend the next three years piling all savings into a cash ISA (currently 5.5% for two years) to pay off the mortgage. Then 11 years paying all savings and mortgage payments into a pension via salary sacrifice. Question: if I put some into a pension now, would the extra three years make much difference or should I focus on mortgage? trying to understand how I estimate the differences in how I sequence these things
I had a similar decision to take many years ago. I don't think that there is a one size fits all answer as it depends on personal circumstances.
Putting excess income into a pension via salary sacrifice will secure NI relief as well as income tax relief (so at least 30% in total) and this will compound over the years so probably the best option.
However, it is also a good idea to have an ISA cash buffer built up for immediate access requirements say for instance self insurance against redundancy etc. Some of the ISA could be flipped into a pension in the last few years before planned retirement to boost the pension and gain the tax relief.
It's probably only worth paying the mortgage off if the debt interest is particularly high.
It’s 2.5% so not tax efficient but is peace of mind efficient. We’re planning to save up enough to clear it, then use the saved amount to cover the monthly payments until the end of the 10 year fix to avoid penalty charges. Should leave a bit extra at the end but with knowledge we can pay it off anytime with the balance.
It depends on things like attitude to risk so it isn't appropriate to answer in a short comment
Interesting to see the history of Triple Lock and component values. Looks the real problem has only occurred recently with the inflation spike as the prior years are pretty much in line with the component values. The lock has been too political without media ever showing the historical comparisons thus not understanding when it is an issue and when not (majority of years)
SIPP Non-earner contribute £2880 - does a person receiving only pension income fall into this category?
Yes provided they are under 75
Regarding the £2880 that can be put into a pension by a non-employed (retired person) which would then secure tax relief:
1. Is this permitted given recycling rules if an income is already being taken from the pension such as annual FAD ?
2. Is it worth it anyway since income tax at marginal rate will need to be paid, if pension withdrawal is more than £1047 per month ie. tax relief is offset by income tax to be paid ?
1 yes 2 withdrawal would be to top up the gap between personal allowance and state pension or don't withdraw and leave as inheritable estate
@@IanShadrackInvesting Thanks Ian.
I need to now why I'm been scammed out of my private pension please let me know if you can help I'm a contracted out pensioner
I would contact the financial ombudsman