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

Final salary pensions - the facts

The FCA confirm that transferring out of a final salary pension is unlikely to be in the best interest of most people.

A guaranteed salary-related pension that lasts lifelong, and is unaffected by the ups and downs of markets, is likely to be the best pension for most people.

However some people will want extra flexibility or want to ensure that they can pass on some of their pension wealth for whom a transfer might be the right answer. It is vital to take, and listen to, professional financial advice before making a big decision of this sort.

FIVE REASONS WHY A PENSION TRANSFER MIGHT BE SUITABLE

1. Flexibility – instead of taking a set pension on a set date, you have much more choice about how and when you take your pension. Many people are choosing to ‘front load’ their pensions, so that they have more money when they are more fit and able to travel, or to act as a bridge until their State Pension or other pension becomes payable.

2. Tax-free cash – some Defined Benefit (DB) pension schemes may offer a poor deal if you want to convert part of your DB pension into a tax-free lump sum. Although the tax-free cash is in theory, 25% of the value of the pension, you can often be penalised more than 25% of your annual pension if you go for tax-free cash; in a Defined Contribution (DC) pension, you get exactly 25% of the pot as tax-free cash.

3. Inheritance – generous tax rules mean that if you leave behind money in a DC pension pot, it can be passed on with a favourable tax treatment, especially if you die before the age of 75. In a DB pension, while there may be (but not always) a regular pension for a widow or widower, there is unlikely to be a lump sum inheritance to children.

4. Health – If you suffer or have suffered from ill health and therefore anticipate a shorter life you might do better to transfer if this means there is a balance left in your pension fund when you die, which can be passed on. Those who live the longest get the most out of a DB pension. Please note that HM Revenue & Customs may challenge this for those who die within two years of a transfer.

5. Employer solvency – while most pensions will be paid in full, every year some sponsoring employers go bankrupt. If the DB pension scheme goes into the Pension Protection Fund (PPF), you could lose 10% if you are under pension age, and may get lower annual increases; if you have transferred out, you are not affected.

FIVE REASONS WHY A PENSION TRANSFER MAY NOT BE SUITABLE

1. Certainty - with a DB pension, you get a regular payment that lasts as long as you do. With a DC pot you face the risk of living too long and your money running out, known as the “longevity risk”.

2. Inflation - a DB pension typically has a measure of built-in protection against inflation but with a DC pot you have to manage this risk yourself, which can be expensive.

3. Investment risk - with a DC pension, you have to manage the ups and downs of the stock market and other investments: with a DB scheme, you don’t need to worry - it’s the scheme’s problem.

4. Provision for survivors - by law, DB pensions have to offer a minimum level of pension for widows/widowers, etc., whereas if you use a DC pension pot to buy an annuity, it dies with you unless you pay extra for a “joint life” annuity, as you are effectively buying two pensions from the same pot.

5. Tax - DB pensions are treated relatively favourably from the point of view of pension tax relief. Those with larger pensions could be under the lifetime limit (currently £1,030,000) inside a DB scheme, but the same benefit could be above the limit if transferred into a DC arrangement and in such cases the tax repercussions can be difficult to manage.

TIME FOR A PENSION REVIEW?

Before considering transferring your pensions, it’s essential that you receive impartial professional financial advice about your particular situation.

ACCESSING PENSION BENEFITS IS NOT SUITABLE FOR EVERYONE. YOU SHOULD SEEK ADVICE TO UNDERSTAND YOUR OPTIONS BEFORE AND AT RETIREMENT.

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.

Defined benefit/final salary schemes

Defined Benefit Pension also known as a Final Salary Pension or Superannuation Scheme

A defined benefit pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum or combination thereof on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns. Traditionally, many governmental and public entities, as well as a large number of corporations, provided defined benefit plans, sometimes as a means of compensating workers in lieu of increased pay.

These schemes have become rarer in recent years as the employer/sponsor’s have no indication of the eventual cost to them in providing the scheme. Further the company’s directors may be held liable for any shortfall in the pension scheme’s funding. For this reason many employers have moved away from offering DB schemes in order to limit their liability.

A defined benefit plan is 'defined' in the sense that the benefit formula is defined and known in advance. Conversely, for a "defined contribution retirement saving plan", the formula for computing the employer's and employee's contributions is defined and known in advance, but the benefit to be paid out is not known in advance.

The most common type of formula used is based on the employee's terminal earnings (final salary). Under this formula, benefits are based on a percentage of average earnings during a specified number of years at the end of a worker's career.

In the private sector, defined benefit plans are often funded exclusively by employer contributions. For very small companies with one owner and a handful of younger employees, the business owner generally receives a high percentage of the benefits. In the public sector, defined benefit plans usually require employee contributions.

Over time, these plans may face deficits or surpluses between the money currently in their plans and the total amount of their pension obligations. Contributions may be made by the employee, the employer, or both. In many defined benefit plans the employer bears the investment risk and can benefit from surpluses.

Pension Sharing Orders

What is a pension sharing order and how do I apply for one?

• What happens next?

• When is pension sharing a good idea? Divorce is a stressful time. The end of any relationship is difficult, both emotionally and practically. Dividing up the assets you share as a married couple is one of the toughest parts of a separation.

Anything you have under a shared name must be considered. Your assets could include property, money in the bank, and pensions. Since divorce pension sharing was introduced in December 2000, pensions must be included in a divorce settlement. In other words, pensions are part of the total value of marital assets you share.

However, pension sharing isn’t always the first thing divorcing couples think of. Typically, most people focus on what will happen to the family home. But pensions are a huge asset and important when planning your future – so deciding what to do with them is extremely important.

 There are three options for dividing up pensions as part of a divorce:

• Sharing - Pension sharing is a formal agreement to divide your pension assets at the time of divorce. The courts work out exact percentages and the receiving party can become a member of the pension scheme or transfer the value to a new pension provider

• Offsetting - The value of the pension is offset against other assets. For example, one spouse keeps their entire pension, and the other is given alternative assets (e.g. property or cash) of the same value

• Earmarking - All, or part, of the pension is earmarked to be paid to one party when the other starts to draw pension benefits. There is no legal transfer of ownership

This guide will talk specifically on pension sharing. It’s a good option for many people because you can make a clean break from your ex-partner. Once pensions are divided up or a new pension is created for the receiving spouse, you don’t have to worry about it again.

What is a pension sharing order and how do I apply for one ?

If you’ve decided pension sharing is the right option for you, it’s important to know it can only happen with a court order. The pension sharing order sets out how much of a pension(s) will be given to you or your ex-spouse. This makes pensions different to other marital assets, such as the family home – which can be transferred to one spouse or the other. This may be agreed between both parties and recorded through solicitors without going to court.

So why can’t the same be done for pensions? Well, pension providers or pension schemes cannot carry, divide or transfer any pension without instruction from the court. That doesn’t mean you’ll spend any time stood up in a courtroom, though.

Once your marital assets have been assessed, the court will award a percentage of one party’s pension value to the other person. The amount awarded is referred to as a pension credit, and the amount deducted from the other party is known as a pension debt.

Most cases aren’t contested, as people come to an agreement through their solicitors. That means you only need a consent order from the court for the pension scheme provider to be able to make the necessary changes. In these cases, the application for a financial court order is usually concluded quickly and the pension sharing order granted.

What happens next?

The exact amount of the pension credit won’t be known until the court order is finalised. When this happens, the amount to be transferred should be a percentage of the cash equivalent transfer value (CETV).

This is where it can get a bit confusing, as the CETV can change over time – even within the time it takes to finalise a divorce. It changes in value because of moves in the stock market, making it important when negotiating a pension share to work from the most up-to-date valuations. Someone will work all of that out for you.

However, what you need to know is that the ex-partner will always be entitled to a pension credit equal to the value of the pension debit. In other words, there’s no difference in what is lost and what is gained. But the pension won’t be shared as an exact 50/50 split. Normally, the aim is to ensure equal incomes in retirement, taking into account the other assets.

There are two ways a pension share can be received:

• The receiving party can become a member of their ex-spouse’s scheme in their own right (internal transfer)

• The receiving party can transfer the value to another pension arrangement in their own name (external transfer)

Whatever you decide to do, after the sharing order comes into effect, the receiving party owns the pension in their own right and can manage it how they want.

When is pension sharing a good idea?

Pension sharing might be a good option for you if:

• One party has high value pensions, compared to the other assets

• You’re close to retirement age and will find it difficult to build up similar pension benefits in a short time

• You’re thinking of remarrying soon, as the pension sharing order cannot be changed at a later date

• The divorcing couple is older. Under current rules, you can take benefits from the pension credit from when you’re 50, rather than waiting until your ex retires

• You’d like to be able to nominate potential beneficiaries of any death benefits if you were to die before taking retirement benefits

Overall, pension sharing offers a clean break and provides greater flexibility and choice to the divorcing couple. The involvement of the courts also assists in making sure there’s a fair settlement of marital assets.

However, pension sharing might not be the best option if keeping the family home is a key priority for you. Pension sharing means you might have to share other assets, including the home, meaning it might have to be sold. Also, it might not be the first choice for those with an adequate pension already. If you’re unsure what to do, contact us to discuss your requirements.

 It’s also important to remember not all pension can be shared:

• Occupational pension schemes (including AVCs) – Yes

• Personal pension schemes – Yes

• Stakeholder pension schemes – Yes

• S.32 policies – Yes

• Retirement annuity contracts – Yes

• Statutory pension schemes – Yes

• Free-standing AVCs – Yes

• Employer financed retirement benefit schemes – unapproved schemes – Yes

• Contracted-out benefits, State Second Pension (S2P) and State Earnings Related Pension (SERPS) – Yes

• Pensions in payment from any of the above – Yes

• Schemes in which the only benefits are equivalent pension benefits – No

• Basic state pension – No

• New state pension – No

• Pensions the member is receiving as a spouse, civil partner or dependant – No

• Pensions already subject to an earmarking or sharing order – No

Source: Pinington Law

Should you receive a Pension Sharing Order in a divorce settlement it would be advisable to seek professional financial advice as you may need to set up a “pension shell” for your pension settlement to be paid into.