Do you NEED a pension?
November 16, 2021 - 5 minutes read
Posted by James Spencer
Financial freedom is all about having the means to spend your time as you wish.
Most of us don’t want to wait until we reach old age before we’re able to give up work – which means figuring out at an early stage how you’ll pay for your lifestyle when you’re no longer working.
The question of whether a pension is a good investment is largely academic, says Jonny Lord, a member of our Chartered Financial Planning team. Pensions are a highly tax-efficient way to save for your later life and are an essential part of the wealth planning toolkit.
Did you know:
- You get the income tax back on anything you invest right up to additional rate
- Your employer is legally obliged to put at least 3% of your income into a pension for you
- Your pension pot will grow free of income tax and CGT throughout your lifetime and beyond
- You can get 25% of your money back tax free after age 55
- You can take flexible income from age 55
- If you’re a business owner, your company can contribute up to £40k per year to your personal pension, and that contribution is corporation tax-deductible. If you have had a personal pension but haven’t used your £40k allowance in the previous three years (perhaps because you’ve been reinvesting in your business), you can make up those contributions tax-free which is particularly good to know if your business has grown and you have managed to build up a reserve of cash. You can also use carry forward with personal contributions.
- You could buy commercial property with your pension fund and receive tax-free rent and pay no CGT if you sold it – even your own business premises
- You could use your pension to make loans to your own business
- That your pension is partly protected from creditors and care fees assessment
- That your pension sits entirely outside your estate for IHT purposes so £500k invested could save the beneficiaries of your estate £200k in IHT
- And that your pension can be passed on to later generations indefinitely and in many cases tax free.
It’s never too late
As with every type of savings or investment plan, the earlier you start the better so that you can benefit from compound interest and withstand the foibles of the markets.
That said, it’s never too late – a pension that you pay into for just five years can, if you pay enough in, can make a worthwhile contribution to your post-work finances.
Despite this, it’s thought that around 35% of people in the UK have no pension provision. It’s understandable – a pension means you have to put off something pleasurable today (ie a fun purchase) for benefit many years hence. No one really wants to do it, no matter how affordable!
But it pays to remember that good decisions now could save you a few years of work at the end of your career. Not days, weeks or months – years.
How much does a pension need to be worth?
Questions about how much you need to pay into your pension can only be answered when you start to build a picture of what income you need in later life.
Whilst it can be difficult to pinpoint this, most of us have some idea of how we’d spend our time if we weren’t working. Knowing that you would travel the world; buy a boat; enjoy the luxury of a second home, whatever’s important to you, will tell you what your ideal future lifestyle looks like. Overlay that with an understanding of what your everyday life costs ie. bills, food etc and you can see a picture emerge of the money you need in later life.
When we go through this exercise with our clients, we plumb in the data to our advanced cashflow modelling software, this helps you to see the long-term reality of your situation. Will you have enough money; too much money or not enough money?
That insight helps you make better decisions about your finances and lifestyle, now and in the future. Enough money and you can continue to enjoy life without anxiety. Too much money means you can perhaps look at improving your lifestyle or doing more for others without jeopardising your future.
And if you realise you don’t have enough money you can either look at ways to increase your retirement savings or make the necessary adjustments to your lifestyle (though this, of course, is never the preferred option – life is too short for significant compromise, we want to help you live your dreams.)
A pension as part of your retirement plan
You can clearly see that a pension cannot be considered in isolation, it needs to be considered as part of an overall financial plan.
The right pension arrangement is very much dependent upon your individual circumstances, particularly whether you have other assets and sources of income. Ideally, you won’t rely solely on your pension and will have other investments which give you a healthy income too – ISAs, cash savings, investments, property. That way, your situation will be more robust and you will have more choice about how you take your pension and when.
When you reach 55 years of age, you’ll have the option to take your pension. You’ll be able to take a 25% lump sum tax free and take the remainder as an annuity or as drawdown.
An annuity gives you a fixed income for the rest of your life. This can give you a good level of security, but your pension stops when you die and this might not be the best outcome for your loved ones. Drawdown means you take an income from your pension but over time the fund may become depleted. For many this is acceptable (depending on how large the pension post in relation to expenditure) because expenses generally get lower as we reach old age, though it underpins the need for alternative sources of income to give you peace of mind and a clearly costed cash flow model
When you’re planning your pension, you should also be aware of what would happen to it when you die. You can nominate who you want to benefit from your pension when you die. If you die before you’re 75, your beneficiaries inherit your pension pot tax-free. If you die aged 75+ your pension will be subject to income tax at the beneficiaries marginal rate of tax.
How we can help
As you can see, it’s not always easy to navigate your options. Much depends on your specific circumstances, there certainly is no one-size-fits-all.
Our financial planners are here to provide tailored support and advice to help you make the most of your money for an enjoyable and worry-free retirement.