Pensions - things to consider
For more information you should speak to an Independent Financial Adviser or a Specialist Pensions Adviser.
Tax and your pension
Pensions are one of the most tax efficient ways to save and invest. For every £1 you invest the government tops this up with 22 per cent tax relief. What this means is that if you invest £1 into your pension it will only really cost you 78p, as the taxman tops it up by 22p to £1. If you are a higher rate tax payer you'll need to claim tax relief yourself, topping up the tax relief from 22p to 40p for every £1 you invest.
The money you invest in pensions also grows free of income and capital gains tax and when you take out your pension you can take a tax-free lump sum. The only tax you pay is income tax on the regular income your pension pays out when you retire. There is an allowance before you pay tax. To work out how much tax you'll have to pay, the Inland Revenue adds up:
- All your pensions - the basic State Pension, State Second Pension, and any Personal or Company Pensions.
- Other sources of income - like from bank or building society accounts.
If the total is more than your personal allowance, you have to pay tax. The allowance is the amount that you have to receive as income before you pay tax. For current personal tax levels visit www.inlandrevenue.gov.uk/rates/index.htm
Inflation and your pension
When prices rise, you get less for your money. In simple terms, inflation reduces how much your money is worth. Let's take an example. If you had £1,000 now, and inflation ran at three per cent for the next 25 years, in 25 years time your £1,000 would be worth £467. So if you're living off a pension, inflation can be worrying. However there are ways that your income can be protected from the effects of inflation.
- The Government usually increases the basic State Pension each year. This is done in line with any increases in the retail prices index (RPI), which measures any increases in High Street prices.
- The State Second Pension also increases at the same rate as the RPI. i.e. inflation.
- When you take the pension from your private plan - either a Personal Pension, or a Stakeholder Pension - you can choose to have a pension that increases in value each year. This can be either by a set amount, such as five per cent a year, or by any increase in the RPI. Company Pensions usually increase automatically by a pre-set percentage each year.
- While Company Pensions tend to be inflation-linked, if you have a Personal or Stakeholder Pension you will have to pay for inflation-proofing, when you buy your annuity (an annuity must be bought with your pension fund by the time you are 75 to provide you with an income for life). The greater the protection you have against inflation, the lower the initial pension.
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