10 things you should know about personal pensions
Think you know everything you need to know about your pension? Think again. Alan Wardrop gives us the lowdown on drawdowns and other useful pension facts.
- Tax relief
Many people are unaware of the tax relief applied to pension contributions. The government offer basic rate relief of 20 per cent on all premiums effectively taking for example a £100 premium to £125 invested. The tax relief is claimed by the pension provider which is normally the insurance company under personal pensions. Higher-rate taxpayers can claim additional relief on the balance via their own tax return.
“Annuities are effectively giving up your investment value in return for an income”
- Death benefits
The death benefit rules are split between pre-retirement and post-retirement. Pre-retirement the fund value is paid to the person nominated as the beneficiary on death. Make sure you tell your pension provider who should receive the benefits, as it is their decision if you haven’t nominated anyone on the beneficiary form. Post-retirement death benefits are a whole separate article, so I will leave it for another day.
- Tax-free cash
At retirement one of the many options is to take a tax free cash which on a personal pension can be a maximum of 25 per cent of the fund. Final salary schemes have a different formula based on the length of service.
- Open-market options
At retirement there are a number of options available under personal pension rules. There is no requirement to purchase an annuity to provide income as drawdown rules allows the deferral of the purchase of an annuity. However, it is rarely in your best interest to accept your current providers annuity offer. The purpose behind the “open-market option” is to allow you to shop around for the best annuity rate available on the market.
It seems absolutely incredible, but as many as 60 per cent of people who have a personal pension accept the offer made by their existing provider without shopping around to find out if they could have received any more income losing up to 30 per cent of additional income.
Historically, after taking the tax-free cash under personal pensions rules the remainder of the fund has been used to purchase an annuity for life. Effectively you are giving up your investment value in return for an income.
- Guaranteed annuities
Although there is a campaign to encourage people to shop around for an annuity under “open-market option“ rules, real consideration should be paid to the existing providers historic benefits. Many older personal pension plans have guaranteed annuity rates built in to the plan. These guaranteed rates are often far superior to the current annuity rates. Current rates are in the region of 5 per cent whereas many older guaranteed rates can be up to 11 per cent, offering more than double the pension income in retirement.
- Impaired annuities
Health issues should also be taken in to consideration as a new annuity market has evolved offering people with poorer health a better rate. The principal behind this is the annuity company don’t believe they will be paying out the income for the same period as an average health annuitant. Smokers also get higher rates.
It’s not all about annuities as there is now no need to purchase an annuity, as an income can be “drawn down” from the fund. The income is allowed between a minimum and maximum figure dictated by the Government Actuarial Department (GAD).
- Flexible drawdown
New rules have been introduced recently which allow people in receipt of a pension “secured income” in excess of £20,000, the opportunity to withdraw their entire pension fund, built up in another personal pension. ”Secure Income” is represented by state pension, annuity income and final salary pensions but not drawdown income.
- Triviality rules
There’s nothing trivial about this rule as it allows people with smaller pension funds access to withdraw their entire fund. But, there is a maximum fund value of £18,500 allowed to qualify.
As you can see from the information above advice is essential. Most importantly, the decisions made cannot be reversed so it’s essential to choose the right options as there are no second chances.
For further details on your pension and retirement find a financial adviser to discuss your options and take a look at our Cost of Delay tool, to work out how waiting to start your pension could cost you.
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