Some defined benefit pensions let you pay extra each month and that is counted as if you had paid into the pension scheme for more years. That boosts your guaranteed pension and is generally better than Additional Voluntary Contributions (AVCs).
Additional Voluntary Contributions
Normally called just AVCs, these are extra contributions you pay to boost your pension at work. They form a separate defined contribution pension pot with your name on it.
The maximum that you can put into a pension in a year is £40,000. It used to be a lot more. If you take a UCPFLS or, in some circumstances, any drawdown, then the annual allowance falls to £10,000, which is still more than enough for most.
Money saved up in a pension fund can be converted into a guaranteed income for life – this is called an annuity. You give an insurance fund the lump sum and it pays you the income for however long you live. At 65 and in normal health, £100,000 will buy you around £6000 a year. Most people have far less than that in their pension pot.
Almost everyone at work is now automatically enrolled into a pension scheme. If you are aged between 22 and 65 and earn enough to pay tax, it is automatic and you and your employer pay into the scheme. You can choose to leave the scheme but you will be automatically re-enrolled every three years or when you change jobs. It is almost always a good idea to stay in. Other age groups can choose to join.
Also called ‘final salary’ or ‘career average’ pensions, you pay into a defined benefit pension at work. When you reach pension age, they promise you a pension which is a percentage of your pay – final pay or the average pay over your career. The pension is guaranteed by your employer who must pay in enough to make sure the promised pension is paid. See Pension Protection Fund.
Nowadays, most work pensions are ‘defined contribution’ schemes. They come with no guarantees. Your contributions and any your employer makes are saved up into a pension pot with your name on it. Over the years those contributions grow. When you reach at least age 55 you can take the money out, though it is usually more sensible to leave it there until you retire.
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If you do not want to buy an annuity or spend all your savings, you can transfer your pension into in a drawdown scheme. It allows you to leave your pension fund invested and take amounts out of your fund when you want but the fund remains yours – unlike an annuity where you give the whole lot to the insurance firm. But there will be annual charges.
Guaranteed annuity rate
Some older pensions – normally begun before the mid 1990s – pay a guaranteed rate of annuity (GAR) when you reach the pension age specified in the scheme. These rates can mean an annuity bought with your fund will be nearly double the amount you would get on the market today. So always check for a GAR before deciding what to do with your fund. If you don’t ask, you might lose it.
From April 2015 everyone aged at least 55 will be able to get free guidance and information about their pension choices. It is branded Pension Wise and will be provided by the Pensions Advisory Service on 0300 123 1047, face-to-face at some Citizen’s Advice offices, and online.
Before you retire, the capital value of your pensions cannot exceed £1.25 million. A defined benefit pension is converted to a capital sum by multiplying by 20. So an income of £20,000 a year is ‘worth’ £400,000 and you reach the lifetime allowance if the pension you are due from work is worth £62,500 or more. Because these rules and limits have changed frequently there are many transitional protections that complicate things.
Pension Freedom and Choice
As of 6 April 2015, most of the rules about what you can do with your pension fund were scrapped. You can do what you want with it – which is why it is called pension freedom.
There can be more money in your pension fund than anything else you own – apart from your home. There are many crooks who will tempt you to invest your money in ‘guaranteed’ products that will make your fortune. Beware of anything that promises more than 6% a year return, especially if it is ‘guaranteed’, is located outside the UK, or is in green or sustainable deals. And never try to take money out of your pension before you reach 55 – you could lose most of it in tax and charges. Always get financial advice, preferably from someone with financial planning qualifications, before embarking on any investment you do not fully understand.
Pension Protection Fund
If your employer goes out of business or the firm is sold then your defined benefit pension will usually be taken over by the Pension Protection Fund. That guarantees you will get at least 90% of the promised pension up to a limit depending on your age. If you are already retired, the pension will be paid in full.
See Guidance Guarantee.
Personal pension plan
You can pay into a personal pension whether you work or not. They are used by self-employed people or those who have little or no pension at work. Charges on older schemes can be high. Some were designed to have very low contributions paid in – called Rebate Only plans – and you may find they are worth very little now.
Retirement Annuity Contract
Also called Section 226 pensions, these Retirement Annuity Contracts were not sold after June 1988. But if you bought one then and are still paying into it, then it might be a very good deal. Check if it has a guaranteed annuity rate – many did.
See also Tax relief. Your employer may offer a bigger boost to your pension through what is called ‘salary sacrifice’. You give up, say, £1000 a year pay and your employer pays that into your pension instead of to you. That means you also save by not paying National Insurance contributions on that £1000. But the lower salary is the one you will have to declare use if you want to get a mortgage.
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Normally you trust a fund manager or someone else to decide how to invest the money in your personal pension fund. But Self-Invested Personal Pensions (SIPPs) allow you to decide how your pension fund is invested. SIPPs are good for those with big pension funds who are confident in making investment decisions. Check the charges carefully.
Any contributions up to the annual allowance that you make into a pension are free of tax. That means every £100 you pay in out of your taxed income is boosted to £125. Higher rate taxpayers can claim back the tax they have paid. See also Salary sacrifice.
Tax-free lump sum
You can kick-start your retirement by taking up to a quarter of your pension fund out in cash which is all tax-free. You can then use the rest to buy an annuity or put into drawdown and any money from them is taxed as income.
Uncrystallised Pension Fund Lump Sum (UPFLS)
As of April 2015 you can leave your fund in a pension and take ‘slices’ out of it – regularly or as you please. Any amount from £1 to all the fund is a UPFLS. Each slice has a quarter paid tax-free, the rest is added to your income and taxed.
The pension rules changed in April 2015, read our guide to find out about the changes and how they affect you.
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