Pension – What is it?



What is a pension?

It might appear to be an obvious question, but pensions aren’t necessarily as simple as they may seem.

  • A pension is a savings product designed to give you income in retirement
  • Once you have paid into it, money can’t be taken out again until you are age 55
  • You receive tax relief on contributions. This is as good as Strawberries with double cream. You put money in it; the taxman puts some in, too (there’s always a “but”)
  • But… when you draw your pension you may have to pay tax on the income you receive. However, the first 25 per cent of your fund is paid to you tax-free

Should I bother with a pension?

Until recently, some pensions offered poor value – high charges, inflexible rules and low income. However, new rules make them more flexible:

  • You can choose when to take income (after the age of 55)
  • You don’t have to buy an annuity (which provides an income for life but is often seen as bad value)
  • You can pass the money on to your heirs
  • You can plan when to take the money so you minimise your tax bill

What’s next?

There may be more change. Chancellor George Osborne is consulting on the idea of scrapping tax relief on pension contributions, making them more like Individual Savings Accounts (Isas) where money grows tax-free.

Other changes might include:

  • Removing the extra tax relief higher earners receive on pension contributions
  • Introducing a flat rate of tax relief
  • Removing the 25% tax free cash on future contributions

In pensions, nothing stands still, take some advice and use the most flexible option to enable yourself to take advantage of future changes.

Can you blow your pension on a luxury car?

Pension freedoms introduced in April 2015, mean over-55s have additional options for how they use their pensions. So yes, you could blow your pension on a car. But hold your horsepower…

Previously, most people had little option but to buy an annuity. However, under the pension freedoms introduced in April 2015, over-55s have additional options for how they use their pension savings:

  • They can withdraw the entire sum
  • Put it into income drawdown
  • Mix and match the above (among other options)

So it’s entirely true you could blow your pension on a luxury car.

Or, as the then pensions minister Steve Webb put it in 2014, people are free to spend their savings on a Lamborghini1.

But do the math… or you could face a hefty tax bill.

  • If you have a defined contribution pension (where you have built up pension savings over your working life), you can take a 25 per cent lump sum tax-free
  • You can take more, but dependent on your tax situation you could end up with a tax bill.
  • If you leave your pot invested and take out smaller amounts, ad hoc, you’ll get 25 per cent of each withdrawal tax-free

So let’s say you decide to throw caution – and a comfortable retirement – to the wind and cash it all in for a shiny Lamborghini (£288,840). You’d actually need a pension pot of £415,000 to start with.

That’s because you would be taxed on 75 per cent of the money. As figures from consumer group which show2, the tax you would pay the Treasury would be £126,206 – enough to buy George Osborne a Porsche 911 (£120,598).

Now that’s just wrong.

  2. Methodology: to buy the Lamborghini Aventador LP 700-4 Roadster (£288,840) you’d need a defined contribution pot of £415,000. The tax would be £126,206 – enough to buy a Porsche 911 Turbo (£120,598) – and you’d have £288,795 left after tax (including your 25 per cent tax-free lump sum) to buy the Lamborghini. This assumes the person has no other source of income and withdraws their whole pension pot of £415,000 in one go. 25 per cent of this is tax free – £103,750 – which leaves £311,250 that is taxable. This is taxed at various rates. The first £31,785 is taxed at 20 per cent, the next £118,215 is taxed at 40 per cent and the remaining £161,250 is taxed at 45 per cent. The car prices are based on prices found on the Porsche website and the website for the car dealer HR Owen at the time of writing. Courtesy of Which
How an adviser helps… plan for retirement

A financial adviser can help you with all aspects of retirement planning – whether you’re starting to save for a pension or approaching the stage in life when you need to use it.

So will consulting an adviser make the difference between sipping 1982 Bordeaux – in Bordeaux and glugging flat lemonade on the prom? Maybe.

Understand what an adviser can offer

An adviser can work alongside you as you move toward your retirement goals. They will:

  • assess your attitude to risk and security of income
  • recommend specific solutions and product providers
  • help you implement their recommendations
  • look at changes to pension and tax rules
  • monitor whether your investments are performing better or worse than expected
  • suggest changes along the way based on your situation to ensure your financial planning remains on track
  • Navigate the complexities of accessing your money in the most tax-efficient way, and making sure your income lasts as long as you do!

But how much will it cost?

Some people are put off seeking financial advice because of the perceived cost. The key thing to remember is that good financial advice should cost less over the long term than no advice at all.

Initial consultations are often free, but do check. This meeting should enable you to judge whether paying for financial advice will deliver good value.

Following the Retail Distribution Review (RDR) in 2012, financial advisers are prohibited from charging commission on products that could be broadly described as investments. This includes pensions.

Advisers may take payment in a number of different ways. Always agree fees before engaging an adviser

Use the contact us page to see how we can help