Pensions are, for most people, the cornerstone of a secure retirement – and getting your pension planning right is incredibly important. Because they are so important, however, pensions have been a political football for decades, leaving many individuals confused, with little confidence in the system.
This is unfortunate because, although there has been plenty of tinkering over the years, the basic structures upon which pension schemes are built remain largely the same.
Non-state pension schemes come in two main varieties – increasingly rare defined benefit (usually final salary) schemes and defined contribution, or money purchase, plans.
Under a defined benefit scheme (to which the member may or may not pay a contribution) the employer that sponsors the scheme undertakes to pay out a level of retirement income that is calculated according to the member’s number of years of qualifying service and salary – usually in the run-up to retirement. Employee and employer contributions are (usually, although some public sector schemes are funded differently) invested in a range of assets in order to fund the promised retirement benefits – but the employer guarantees the level of pension that will be paid.
In a defined contribution scheme, by contrast, members (and, if it’s an occupational scheme, their employers) make contributions into an investment pot which is invested in assets deemed appropriate to their age and length of time to go until retirement. During the early years of saving the emphasis is on investing for long-term growth while, as the member approaches retirement, their funds are usually moved into “safer” assets in order to consolidate past gains and minimise the chance of a big swing in fund value just before retirement.
25 per cent of the pot built up in a money purchase scheme can be paid out to the member as tax-free cash (properly known as "Pension Commencement Lump Sum") on retirement, and the remainder is used to provide a retirement income. This has most usually been in the form of an annuity (where a life insurance company agrees to pay you a set income for the rest of your life) although, especially for larger funds, “drawdown” plans under which an income is taken direct from your pension pot are another option. In his 2014 Budget the Chancellor of the Exchequer announced a range of quite radical changes to the tax regime surrounding retirement income which will, by April 2015, make this area much more flexible. In July 2014 further detail was released by the Government, which can be found here.
In general there are four factors within your control that determine how much income your defined contribution pension scheme will produce:
- How soon you start saving (the power of compound interest)
- The level of contributions
- Investing with an appropriate level of risk for your age and circumstances
- Choice of retirement income product
Choice of retirement income can have a major impact on the amount that your defined contribution pension pot provides. To find out more about this complex market please click here.
Defined contribution schemes take a number of forms. Some are occupational, trust-based schemes which are administered by employers, who arrange their own investment management. It is, though, usually worthwhile for members to seek independent financial advice about the full range of retirement income options.
Other forms of defined contribution pension scheme include personal pensions, group personal pensions (popular among medium-sized employers) and stakeholder pensions. The differences between these forms of plan are quite subtle. And, in late 2012, another form of workplace pension scheme – the National Employment Savings Trust (Nest) – was introduced by the government. Clarion Wealth Planning Limited is able to explain how each of these types of scheme can fit into your financial plan.
Another form of defined contribution scheme is the Self Invested Personal Pension (SIPP). SIPPs are popular with company owners and others with larger personal pension pots who want the flexibility to invest in a wider range of assets – including direct investment in commercial property. To find out more about SIPPs please click here.
Pensions are a core part of most people’s financial planning. But successive reforms of the system mean that what is on the face of it a relatively straightforward concept is, in the delivery, rather complex.
To discover more about your pensions and retirement options please call Clarion Wealth Planning's specialist team on 01565 653804 or send us an email.