Pension guide

Pension information: guide to the basic facts.

You might have one or more different types of pension. Understanding which you have is important because it affects the decisions you need to make as you approach retirement.

• What type of pension do I have?

• Your State Pension choices

• Your pension choices if you have a defined benefit pension

• Your pension choices if you have a defined contribution pension

What type of pension do I have?

What is a pension pot?

‘Pension pot’ refers to the savings you build up in a certain type of pension known as a ‘defined contribution’ pension scheme. You and your employer (if you are employed) pay into the scheme and this builds up a ‘pot’ of money over time, which you can use to give yourself an income when you want to cut down on how much you work, or stop working altogether. It includes workplace, personal and stakeholder pension schemes.

There are three main types of pension:

• the State Pension

• defined benefit pensions, and

• defined contribution pensions

State Pension

Most people get some State Pension. It’s paid by the government and is a secure income for life which increases by at least the rate of inflation each year.

You build up your entitlement to the State Pension by making National Insurance contributions during your working life.

In some cases, you can do this even when you’re not working, such as when you’re bringing up children or claiming certain benefits.

From April 2016 a new flat-rate State Pension was introduced. For the current tax year 2019-20 the full new State Pension is only £168.60 per week.

However, you might be entitled to more than this if you have built up entitlement to ‘additional state pension’ under the old pre-April 2016 system – or less than this if you were ‘contracted out’ of the additional state pension.

To be eligible for the full State Pension you will need 35 years NI record. You’ll usually need at least 10 qualifying years on your National Insurance record to qualify.

Defined benefit pension

You’re most likely to have a defined benefit (DB) pension if you work in the public sector or for a large company. This is a salary-related pension which pays out a secure income for life and increases each year. The pension you get is based on how long you’ve been a part of the scheme and how much you earn.

You might have a final salary scheme where your pension is based on your pay when you retire or leave the scheme, or alternatively a career-average scheme where your pension is based on the average of your pay while you were a member of the scheme.

Defined contribution pension

With this type of scheme, you build up a pension pot which you can draw an income from when you cut down or stop working. But you must be aged at least 55 before you can start to take money out. With this type of pension scheme, you can usually withdraw at least 25 per cent (a quarter) of your pot tax-free.

The amount that builds up depends on:

• the level of charges you pay

• how well your investment performs, and

• how much you and your employer (if you are employed) pay into the scheme

Defined contribution (DC) pensions include workplace, personal and stakeholder pension schemes.

Your State Pension choices

You won’t get your State Pension automatically – you have to claim it. You should get a letter no later than two months before you reach State Pension age, telling you what to do.

You can also defer taking it. If you want to wait to claim your pension, you don’t need to do anything. Your pension will automatically be deferred until you claim it and will increase by 1% for every nine weeks you defer. This works out at just under 5.8% for every full year.

The extra amount is paid with your regular State Pension payment when you finally take it.

Find out your State Pension age at GOV.UK

Your pension choices if you have a defined benefit pension

Most defined benefit pension schemes have a normal retirement age of 65.

If your scheme allows, you might be able to take your pension earlier but this will reduce the pension you get quite considerably. (Typically 5% per annum)

When you take your pension you usually have the option of taking some of it as a tax-free cash sum.

How much you can take will vary depending on your scheme rules, but often you can take roughly up to a quarter of the value of your pension benefits like this.

Reducing the amount of tax-free cash you take might increase the amount of income you receive.

It is possible to transfer your defined benefit pension to a defined contribution pension which would then allow you to access your pension more flexibly.

However, consider this option very carefully as you might be giving up very valuable benefits.

Before going ahead with a transfer from this type of scheme speak to a regulated financial adviser.

Your pension choices if you have a defined contribution pension

Once you reach 55 you have complete freedom over what to do with your pension pot.

However, the longer you leave your pot to continue building up, the more money you will have to live on in retirement.

To understand the choices for using your pension pot, use could use Pension Wise – the free and impartial service backed by government or if you are still unsure of the best option for you, consider taking regulated financial advice.

Source: pensions advisory service

WINN-BROWN & CO.NOVEMBER 2, 2015

Pension options at retirement

At retirement when we take our pension from a defined contribution scheme we have a number of options available to us.

• The open market option

• Tax free cash lump sum

• The frequency of payment

• Escalation in payments

• Spouses provisions

• Guarantee periods

Each of these options can be taken in conjunction with any other. However, some of the benefits will defray the initial amount of pension benefit that you would receive should you take a single life pension with no other provisions.

The Open Market Option

The Open Market Option (or OMO) was introduced as part of the 1975 United Kingdom Finance Act and allows someone approaching retirement to ‘shop around’ for a number of options to convert their pension pot into an annuity, rather than simply taking the default rate offered by their pension provider.

 The term OMO is now generally used to support a campaign, often led by the pensions industry and the media, to make sure people know the benefits of shopping around. The majority of people still don’t use the Open Market Option in large part because they don’t know they can or don’t realise the benefits of doing so. Retirees who don’t use the OMO and settle for the default deal offered by their pension provider, may be missing out on up to 20% more income from an annuity. This is especially important as retirees cannot change their annuity once it has been purchased.

 One of the main reasons that people can get more from an annuity if they shop around is that they may qualify for what is known as an Enhanced Annuity (sometimes known as an Impaired Life Annuity) which pays a higher income to people who suffer from a range of health conditions – anything from asthma to a serious heart condition. There are also other products available that may suit peoples retirement needs better than the default deal offered by a pension provider. One suggestion to make the most of the Open Market Option is to speak to an independent financial adviser who will explain the different options available at retirement.

Tax Free Cash Lump Sum

At retirement you are permitted to take 25% (a quarter) of your pension fund in as a Tax-Free Cash Lump Sum. In certain circumstances it could be more than this. The Tax-Free cash can be paid by the ceding scheme or the new scheme should you take advantage of your Open Market Option. The remainder will be considered as earned income by HMRC. The amount of tax you pay will depend on your prevailing tax status at the time that you take the pension.

Frequency of Payments

Most pension providers will allow you to take your pension at different Frequencies of Payments, such as annually, quarterly and monthly, sometimes in advance or arrears. Once you have made your decision that is generally how you will continue to receive your income for the rest of your pension annuity.

Escalation in Payment

You can elect to have your pension paid to you at a flat rate for the rest of your life or have it increase in different ways, through Escalation in Payment, typically by 5%, 7.5% etc. Should you choose this option then the initial pension you receive will be significantly reduced but at least you can ensure that your pension retains some degree of inflation proofing. 

Spouse’s Provisions

Typically people will purchase a single life annuity but you can elect to provide a pension for your spouse, through a Spouse's Provision should you wish to do so. This at least ensures that should you die in the short term your spouse will continue to benefit from your pension. Spouses pensions can generally be provided at different rates as a percentage of your own, for example 33%, 50% or even 100%. As with all other pension options its best to check what the pension provider is able to offer.

Again this particular option does reduce the amount of initial pension annuity because you are effectively buying two pensions from the same amount of money.

Guarantee Periods

At outset, as with all these options you can elect to take a guarantee period against the pension. 

A Guarantee Period can be of different duration, again typically 3, 5 or 10 years. This means that the pension will be paid out to your spouse (or in the event of your spouse predeceasing  you, your estate) for the remainder of the term should you die within the guarantee period. For example if you were to take a 10 year guarantee period and then die in year 6 your spouse (or estate) would continue to receive the pension for the remaining 4 year term, after which time, (unless you had provided for a spouses pension) the pension would cease and no other payments would be made.

These options are not offered at the outset of your pension plan as you have no indication at that time what your marital status may be at the time of vesting, the prevailing rates of inflation and your need for tax free cash. Nevertheless the decisions that you make in relation to these options are of great importance both to you and your family should you have one. Moreover once you have made your decisions they cannot be unwound, there are no “U turns”. It is therefore essential that you give consideration to taking professional financial advice at this pivotal and critical time in your financial planning.

Should I consolidate my pensions?

If you've accumulated numerous workplace pensions over the years from different employers, it can be difficult to keep track of how they are performing. There is a danger that long-forgotten plans will end up festering in expensive, poorly performing funds, and the paperwork alone can be enough to put you off becoming more proactive.

Over your career you may work for many different employers, and so may build up quite a collection of different pension pots and/or pension schemes . You might also have personal pensions , especially if you’d spent time self-employed. At some point (not necessarily near retirement) you’ll have to decide what to do with these – combine them into one, or leave them (or some of them) where they are. 

Working out the best thing to do will depend on a number of factors, including what type of pensions they are, how much they are worth, and whether they currently have any special guarantees attached.

Things to think about and discuss with an adviser:

Can I save money by consolidating pensions? 

Every pension pot you have will be managed separately, meaning each one has its own annual management fees. Some of these fees may be higher than others - for instance, some may charge 1 per cent or even more, but others may charge only 0.5 per cent. Combining your pots into the one with the smallest management fees can reduce this kind of waste, but take advice to make sure it's the right decision. 

An adviser may also help you find a fund with lower fees. A management fee of just 1 per cent can reduce the total size of your pot by more than 20 per cent over the course of a working life. So one little change made early enough could save you tens of thousands of pounds in the long run. 

Are some of my funds performing better than others? 

Fund performance can be another important factor. If you have several pots, it’s likely that one will have outperformed the others. This is another factor to consider when deciding which fund to select when combining your pensions. Alternatively, your adviser may recommend a whole new fund. 

Do I have any defined benefit (final salary) pensions? 

If you have a defined benefit (or final salary) pension, you may be offered the option to transfer it into a defined contribution pension (the most common type). You should think very carefully before deciding to do this. Such transfers involve trading a guaranteed lifelong income for a finite sum of money in the form of a pension pot. It is usually a legal requirement to seek independent advice before transferring a final salary pension, as this is a big decision and cannot be reversed. 

Do any of my pensions have guaranteed annuity rates? 

Some pension schemes offer a guaranteed annuity rate (GAR), which may enable you to buy an annuity with a much higher annual income that you would otherwise be offered. It may not be clear from your pension documentation whether you have one or not, but your adviser should check for you. Having a GAR is usually a good reason not to transfer out, as by doing so you would lose it. 

Are there any penalties for transferring? 

Check to see whether your pension’s transfer value is the same as its current value. If it is lower, then this may be because there are penalties for transferring. If there are, your adviser will need to check the nature of the penalties and whether they can be removed. 

How do I decide about combining my pensions? 

Your adviser will go through all your pension paperwork with you and liaise with your providers, to help you build up a clear picture of your current pension arrangements. The adviser can then give you clear and unbiased recommendation, based on what you want from your retirement. There is no universal right answer when it comes to transferring pensions, which is why tailored advice is so important. 

Remember, you can also top up your pension before retirement by making additional contributions - for example, transferring savings into your pension pot.

Should I transfer my defined benefit pension?

If you have a defined benefit (DB) pension, you may be offered the option to transfer it into the more common type of pension (defined contribution). But be careful as this is a “one-way street with no u-turns”. This is a big decision and an irreversible one, so it’s important to understand exactly what this means, and what the pros and cons for you might be.

What is a defined benefit pension scheme?

A DB pension (also known as a final salary pension or superannuation scheme) is an excellent type of workplace pension. Instead of building up a pension pot over time, it provides you with a guaranteed annual income for life, based on your final or average salary (hence the name).

DB pensions are often seen as more generous, because it would take an above-average defined contribution (DC) pot to be able to buy an annuity that pays you the same amount as a DB scheme.

So why would I transfer from a DB scheme?

Despite the attractions of a DB pension, in some ways it is not as flexible as a DC pension pot. You can’t vary the income you take from it, nor draw out larger lump sums (apart from the tax-free lump sum offered by some final salary schemes). Also, and more importantly to many, this kind of pension cannot be inherited by your beneficiaries.

Your pension’s ‘transfer value’ is the size of the pension pot you would receive in exchange for giving up your DB pension. Some providers will offer generous transfer values, and this may be seen as a strong incentive to switch (in so doing it reduces the employer’s financial commitment to the scheme). The choice you face is essentially this: having more money to spend now, versus having a guaranteed income for the rest of your life – which may work out as more money or less, depending on how long you live. Generally speaking none of us know the answer to how long we are going to live, which is why there is a risk involved in switching from a guaranteed income for life pension

Are all DB pensions transferable?

Not every DB pension is transferable. Private sector schemes, and some public sector ones, will be ‘funded’ – that is, supported by a central fund. This is the only kind from which you can transfer. Other public-sector schemes (such as the NHS pension) are ‘unfunded’, meaning they are supported directly by the taxpayer. You can’t transfer out of this kind of pension.

What are the possible benefits of transferring?

Transferring your DB pension to a DC pension pot means you can access your pension flexibly, and also pass on any unspent pension to your loved ones when you die. For smaller DB pensions with transfer value of just a few thousand, there may be a stronger argument for transferring them – as in such cases the guaranteed annual income may not be very much.

What are the risks?

If you transfer your pension you won’t be able to transfer it back, so tread carefully and do your sums before making your decision. You will expose yourself to the risk of your pension one day running out, or of failing to achieve as high an income as you would have received from the original scheme. Ultimately, you are trading certainty for uncertainty.

How to decide

Having money to spend now may be very appealing, especially if there is a pressing demand for it. However, if your pension’s transfer value is over £30,000, the law requires you to seek financial advice before the transfer can be made. Some providers further insist that you get advice on smaller transfer values as well, to protect themselves if you later decide you’ve made the wrong decision.