Saving Towards a Pension

Everyone who has earnings from a job or who is self-employed can contribute to a pension scheme full with tax relief on the contributions.

Once contributions are invested any capital gains and income in the pension fund are tax exempt apart from dividends on shares (and dividends from unit trusts and OEICs derived from shares) which are taxed at 10%.

When you start to draw the pension, you can take a quarter of your pension fund as a tax free lump sum. Since 6 April 2006 there have been new rules about how you can take the rest but this is generally in the form of an income which is taxed as earnings. You don't have to decide which way to receive your proceeds until you are ready to take them.

Because these tax advantages are good, anyone investing towards retirement should do so through one type of pension scheme or another. Only people not eligible for a pension scheme should consider other types of investments. These other methods are summarised at the end of this Chapter.

Currently you get the State pension at age 65 for men and 60 for women. You can defer your retirement for up to five years in which case your pension will be 7½% higher for each year you delay (maximum increase 37½%) when you start to draw it. State pensions depend on contributions throughout your working life. Some married women who opted for reduced rate contributions in the past may not be eligible for a full or any pension.

The State retirement age is to be equalised at age 65 in 2020. The new retirement age for women will start to be phased in from 2010 and will rise by 6 months in each year between 2010 and 2020.

It has also been announced that the state pension age for both men and women will rise to 66 in 2024, to 67 in 2034 and 68 in 2044. Each rise will be phased in over two years. However this is such a long time into the future, the proposals may be modified before these dates.

There are two parts to the State pension. The first is the State flat rate or basic retirement pension which depends on the contributions made by employees and the self-employed. The pension (for 2007-2008 since April 2007) is £4,539 a year for a single person or £7,259 for a couple where the spouse doesn't work and hasn't earned her own State pension. The pension rises each year in April in line with increases in the Retail Prices Index to the previous September and sometimes by a bit more. The Government has promised that from an as yet unspecified date, the pension will in future rise by the Average Earnings Index which usually rises at a faster rate than the prices index.

The second part, the State earnings related or additional pension (SERPS) is available to employees only. The previous Conservative government made a concerted effort to encourage people to opt out of SERPS through a personal or job pension; it also significantly reduced the amount of pension earned under the scheme.

A SERPS pension can be inherited by a husband or wife when their spouse dies. Anyone who is widowed before 6 October 2002 or reaches pension age before that date inherits the full additional SERPS pension. For people widowed after that date, the survivor will inherit a reduced amount of 90% where the contributor reaches State pension age between 6 April 2002 and 5 April 2004, 80% (2004-2006), 70% (2006-2008), 60% (2008-2010) or 50% after 5 April 2010.

Job, company or occupational pensions are currently optional. That doesn't mean you should necessarily opt out. The decision to leave depends on your age, whether you will stay with the company until retirement, and how good the job pension scheme is. You can get free advice on what to do and what your rights are from (links only work if you are on-line now) the Pensions Advisory Service which is an educational charity. There is also information at DSS Impartial Information about Pensions. If you have a complaint about a pension scheme consider contacting the Pensions Ombudsman and/or the Occupational Pensions Regulatory Authority.

If you decide to stay with your job pension scheme, you can boost the pension you get on retirement by investing in additional voluntary contributions through a Pension In-House Top Up Plan or taking aPersonal Pension or a Stakeholder Pension in addition.

If you think you are entitled to a pension from a company you used to work for, but the company has moved or gone out of business, you will be able to use the Pensions Scheme Registry. Around 10,000 people a year ask the Registry for help and it succeeds in tracing about 88% of these people's pension scheme.

From 6 April 2006, you can start drawing your job pension but do not need to retire from your job. So you might be able to reduce yuour hours and go part time with no reduction in income.

Since 6 April 2006 anyone can take aStakeholder Pensionor a Pension Personal Pension issued by a life insurance company, building society, bank or unit trust group, even if they already belong to another sort of pension scheme. A stakeholder pension is essentially the same as personal pension but with a scale of maximum charges and minimum standards imposed by the Government.

However, once you have committed yourself to a personal pension, you cannot get anything back until you are 50 (the limit will rise to age 55 by 2010). You can start to draw your pension under 50 (or 55) if you become permanently disabled. You cannot continue to pay contributions or start to receive benefits after the age of 75.

If you are already age 50 (rising to 55 by 2010) you can get an instant pension provided you still have eligible earnings.

Until 6 April 2006 contributions were restricted to 17½% of your net relevant earnings (i.e. earnings which are not counted for an occupational pension scheme) in the tax year if you are 35 or less. The limits were higher the older you are rising from 20% at age 36, to 40% at 61, see table for the old limits in full.

Since 31 January 2006, contributions paid in one tax year can no longer be claimed (fully or partly) against your taxable income in the previous tax year instead of the current one.

The schemes accept single contributions as well as regular contributions both count equally for tax relief. Personal pensions are covered in Part 2 under the heading Pension Personal Pension .

Since 6 April 2006 you can pay an amount up to 100% of your full earnings into a pension scheme and received tax relief on all the contributions. However if your contributions exceed your earnings or exceed £215,000 a year in 2006-2007 (£225, 00 in 2007-2008; £235,000 in 2008-2009; £245,000 in £2009-2010; £255,000 in £2010-2011) then you pay extra tax.

If you have no earnings, you can contribute £3,600 a year. Basic rate tax relief is given by deduction so you pay £2,808 and the scheme will be credited with £3,600.

There is an overall lifetime value of pension fund or "total payable benefits" of £1.6 million (in 2007-2008) at the time you start your pension, which if you exceed it, will trigger extra taxation. This limit will rise to £1.65 million in 2008-2009; £1.75 million in 2009-2010; £1.8 million in 2010-2011.

The figures for earnings are good for five years, so if your earnings fall in a year, the contribution limits relate to your highest earnings in any year out of the past five.

**Stakeholder and Personal Pensions - old limits applying before 6 April 2006**
Age at start of tax year		Maximum contribution
Any age	No income	£3,600
35 or less	17½% of income	£17,010
36 to 45	20%	£19,440
46 to 50	25%	£24,300
51 to 55	30%	£29,160
56 to 60	35%	£34,090
61 to 74	40%	£38,880

The following investments are worth considering if you are not eligible for a pension scheme because you are not working:

For lump sums not needed for 7-10 years or more consider (the latter part of the list is alphabetical):

Personal pensions are an ideal way of accumulating money towards a pension. You can start to draw your pension between age 50 (or 55 from 2010) and 75. You don't have to retire to do so.

Since 1995 you have had the opportunity to draw an interim income from your Pension Personal Pension without committing yourself to a fixed pension annuity rate. This is called income drawdown. The maximum is similar to the figures for a fixed pension (examples shown in the table below); the minimum is approximately half that figure. All the income withdrawn is taxed as earnings. But you are then committed to drawing the income and cannot stop receiving payments or make extra contributions to the same personal pension. However, if later you want to take your cash lump sum, you can do so but at the same time you must convert the remainder of your fund to a pension annuity, using the open market option if you wish.

Since 6 April 2006 you are allowed to continue or start an income drawdown at the age of 75. The draw down income will be taxed as earnings. Any balance left on your death will form part of your estate.

When you finally want to draw your pension (or you reach age 75 when you have to), you should shop around, using the open market option to reinvest your pension money with the life insurance company offering the best pension annuity rates (sometimes called compulsory purchase annuity) available at that time.

However, before you do so, check whether your company has a guaranteed minimum annuity rate for your contract. If it does, you may find this is a lot higher than the rate being offered both by the company itself and its competitors; make sure the company does not penalise you in some other way if you request this guaranteed minimum.

Open market option annuity rates vary according to the age when you start them. You can get the annuity guaranteed for 5 or 10 years - in which case you get less to begin with.

You have the option to take 25% of the accumulated pension fund as a tax free lump sum which you will probably want to invest separately elsewhere to obtain a better return. Even a Life Insurance Annuity gives a better return than a pension annuity because part (and possibly all) of a Life Insurance Annuity is regarded as a return of capital and is tax exempt.

If you have several retirement annuities or personal pensions with different companies, you can start to receive pensions from them at different times. Some companies offer personal pensions as segments where you can start to draw a pension from each segment at different times. See also protected pensions below.

Another option to consider is an increasing pension annuity, either by a fixed amount, linked to the Retail Prices Index or on a with-profits basis. The different incomes you would currently get from these at different ages are shown in the table below. The actual return of all these types of pension varies depending on the level of interest rates at the time you start to draw the pension.

Finally if you are not in tip-top health when you start drawing your income, some companies offer impaired lives annuities or if you are not so ill, life style annuities. Life style annuities are easier to obtain because you just have to fill in a form whereas for impaired lives annuities, you will probably have to have a medical. In these cases, unlike life insurance, the life the insurance company thinks you are, the better rate they will give you. Life style annuities are available if you have smoked 10 or more cigarettes a day for 10 years or more, you suffer from hypertension, high cholesterol, obesity, diabetes, stroke, heart attack, kidney failure, certain cancers, by-pass operation or multiple sclerosis. Around 40% of people aged 60-65 can qualify for an increase of 5% to 10% on the rates they would otherwise get.

Since 6 April 2006 if you don't like the idea of having a lifetime annuity, you can protect your pension if you die before age 75 with an annuity protection lump sum death benefit.

You will also be able to use part of your fund to buy a fixed term annuity lasting up to five years. After which you can buy another fixed term annuity or a life time one. This option is available up to age 75.

Finally if you have reached age 75 and have not yet bought an annuity, you can draw an income from your fund instead of having an annuity. There is a maximum level of income. This is called an alternatively secured pension. In this case you would be sensible to draw the 25% lump sum as a lump sum as the proceeds of that are tax free while the balance is taxable as earnings just like an annuity payment from a pension would be.

If the total of all your pension funds is less than £15,000, you can convert all the pensions to a cash lump sum when you are aged 60 or over. You have to cash all the policies within a six month period. A quarter of the proceeds is tax free and the rest is taxed as income.

Age when you start pension	Fixed	Increasing at RPI
Man	£	£

55	755	452
60	738	552
65	879	700
70	1,073	921
75	1,307	1,238
Woman

55	775	428
60	756	502
65	771	605
70	901	745
75	1,067	930
Joint Man, Woman
No reduction on first death
60,55	567	355
60,60	598	388
65,60	608	403
70,65	689	469
75,70	792	562

Based on the best rates available at March 2003 with payments guaranteed 5 years for fixed annuity and without guarantee for RPI linked. Since that date all figures have fallen by about £150. If you have a medical condition or are a smoker, better rates may be available. Source: Life & Pensions Money£acts.

Last updated 1 January 2008

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Saving Towards a Pension