Pay close pension attention!

Pension Awareness Day looms but it shouldn’t be just one a day a year that we pay ‘pension attention’!

A pension is a great asset when planning for the future. But, while pension planning may seem straightforward – especially if you have a workplace pension into which your employer makes contributions – there are pitfalls that you should be aware of.

So, what do you need to consider? And, with different pension options available, what type should you be securing?

The different pensions
The good news is that you have the option to make payments into a number of pensions, allowing you to save across multiple pots. You contribute to your state pension through National Insurance contributions (NICs), you should be automatically enrolled onto a workplace pension by your employer and make payments to this pot from your salary (your employer will also make contributions), and a separate private pension enables you to build a tax-free savings pot.

Here are some helpful things to know about each of them.

State pensions
While the current financial climate is causing issues for many, one positive is that the annual income of someone on a state pension will exceed £10,000 for the first time. It’s not enough to guarantee you a comfortable retirement but it all counts, and you should qualify if your salary is above £6,396 per year – this is the threshold for NICs. If you were contracted out prior to 2016, you should check your personal tax account for a state pension forecast.

If that’s the case, your state pension is paid out when you reach retirement age. You’ll need 35 qualifying years to receive the full new state pension after and at least 10 qualifying years on your National Insurance record to get any state pension. A qualifying year is one which meets the following conditions:

• A year where you have worked and paid NICs
• A year where you received National Insurance credits – perhaps due to employment, sickness, or parental leave
• A year where you have paid voluntary National Insurance contributions

35 years may seem like a lot but state pension age is currently 66, with two gradual rises set out in legislation to 67 and 68. So, if you enter work at 18, or perhaps after university at around 22, it can be reasonably expected that you’ll clock up at least 10 years (or up to 35 years) without too much effort.

But what if you plan on taking (or have already taken) a career break?

There are several things you can do to ‘make up’ your qualifying years if you are not working, such as claiming child benefits or making voluntary contributions. We recommend seeking advice as the rules surrounding pensions can be complicated.

You may not be sure of how many years you have under your belt but this can be checked easily with HMRC. You can set up a Personal Tax Account online or call their helpline for assistance.

Workplace pensions
Most employed people will have a pension set up through their employer, which they will automatically be enrolled onto. Defined benefit (sometimes called Final Salary) and defined contribution (sometimes called money purchase) are two different types of workplace pensions. It is mandatory for organisations to offer a workplace pension, though employees can opt out if they choose.

The below points focus on the more common ‘defined contributions’ scheme. While this may seem to be another pension tied to your workplace, it is in fact paid into a separate pot to your state pension and the contributions come from your salary, rather than your NICs. The additional real benefit to workers is that their employer will make at least a three per cent contribution under the workplace pension rules based on pre-tax income.

There is also more flexibility to how you draw an income from your workplace pension, whether through income drawdowns, annuities, or through lump sums, whereas the state pension is paid into your bank account monthly (in more scenarios).

Private pensions
Whether you have a workplace pension or opt to set up another private pension, these will grow tax free while you work. Because there are tax benefits to saving in this way, many choose to increase their pension contributions, particularly if they plan on retiring early. However, there are various limits worth noting that can remove the tax benefits and even lead to substantial charges if excess contributions are made across your pension pots (not including your state pension).

These are:

• Earnings limit – individuals may not contribute more than 100 per cent of their relevant earnings in 12 months or more than the basic amount (£3,600), whichever is higher. ‘Relevant earnings’ includes any money gained from employment, trading or furnished holiday lets, for example. This can often cause a problem for those with large property portfolios because rent from owned properties cannot be counted as relevant earnings, unless they meet the furnished holiday conditions. In addition to this, as dividends do not qualify, shareholders who are primarily remunerated by way of dividend may face restrictions due to the earnings limit.
• Annual limit – individuals may not contribute more than £40,000 per year. This includes contributions made by the pension holder, their employer and anything the government may pay in. The annual allowance starts to be tapered once adjusted taxable income is greater than £240,000. There can be substantial charges as well as a loss of tax benefits if this limit is exceeded. Individuals can ‘bring forward’ some of their annual allowance if it was not used in the previous three years under certain circumstances.
• Money Purchase Annual Allowance – If you start to take money from a defined contribution pension put, the amount that you can contribute to your defined pension scheme (whilst still getting relief) is reduced to £4,000 per annum.
• Lifetime limit – this is the maximum amount which can be held within a pension scheme. Currently this is £1,073,100 – if the value exceeds this then a tax charge will be applied. This amount changed in the 21/22 tax year and is frozen until 2026.

Contributions considerations for companies
The other side of the equation to consider is the contributions to pensions made by employers. These are effectively unlimited and will qualify for tax relief if they are ‘wholly and exclusively’ for the purpose of the business. Pension contributions that fulfil this would be treated as an allowable business expense and offset against your company’s corporation tax bill up to the level of company’s profits in the year.

In summary, pensions are a brilliant way to save for the future, limiting your tax liabilities while providing you with financial security. However, fail to plan properly and you could miss out on all the benefits and your pension could even cost you. Careful planning with an independent financial advisor and your tax consultant is therefore essential.

Pension planning can be difficult to navigate, but the team at Monahans are here to help. For more information and advice, please get in touch.

Jessica Hunt