Today’s Blog is inspired by a conversation I had with a self-employed client last week about pensions. The client ‘Roger’ told me two things during the meeting; firstly, that he had turned 40 that very morning and secondly, because times were hard, that he had decided to suspend making payments into his pension scheme for at least a year or two.
I wished Roger Happy Birthday and then delved a little deeper into his pension plans and was surprised to discover how little he knew about pension in general, both state and private. I was also shocked at the number of misconceptions he had, especially about the state pension and how private pensions operated in practice.
The state pension explained in brief
The Pensions Minister recently announced that on 6th April 2023, the full new state pension will rise to £203.85 a week and the full basic state pension will go up to £156.20 per week. They’re both described as ‘full’ state pensions, the only difference being that one is ‘new’ and the other is ‘basic’. So, why are there two different state pensions I hear you ask.
The answer is quite simple, the old scheme only affects individuals born before April 1951 when 30 years of NIC contributions were needed to get the full amount. Anyone younger is on the new scheme, where 35 years contributions are needed to get the full amount.
You can increase the amount you get by working past the normal retirement date (currently 66 but rising to 67 in five years’ time and 68 five years’ later). But you don’t have to claim your State Pension when you reach State Pension age, instead you can defer it. If you do, it will increase by 1% for every 9 weeks you delay claiming it (5.8% for each year) with the extra amount dependant on how long you defer claiming it,
Do you need a second pension?
As always, the answer is it depends on what you expect your needs to be. I am a member of Which? and they recently published data which showed that that in 2022, couples needed a minimum income of £18k a year to cover spending on essentials (groceries & household bills). The figure increases by £10k when leisure activities are included. For people living alone, these figures were £12k and £19k respectively.
The sad fact is that if you are on the new state pension and are single, there will be a gap of nearly £2,000 just to cover the basic essentials. So, if you don’t want to spend your retirement wrapped in a duvet, relying on food banks and never going out to save on bills, you have to ask yourself, is it worthwhile taking out a works/private pension? The answer is a resounding yes; so, what are your choices?
These fall into two types, final salary schemes and money purchase schemes. Apart from a lucky few, who are almost exclusively in the public sector such as civil servants, the armed forces, police and NHS staff, the vast bulk of individuals will be in a money purchase scheme aka a defined contribution pension.
The money purchase scheme does what it says on the tin with the contributions you make building up a pot of money over many years, to be held in investments until you reach your chosen retirement age. You can choose when you retire, but the minimum retirement age is 55. There is an opt out provision, but this is not a good idea.
For most PAYE workers, workplace schemes involve a minimum contribution of 5% from you (reduced to 4% after tax relief), plus a minimum of 3% from your employer, however most employers tend to match any contributions by their employees, partly because they get tax relief too.
So, if you can increase your contribution by even a modest amount and if you start early in your career, it is likely to make a significant difference to the size of your pension pot by the date of your retirement.
These are pensions taken out by the self-employed and the directors of close companies (i.e., businesses controlled by 5 or fewer directors/shareholders) and in theory, there are no limits on how much an individual can pay into his or her pension. However, the tax treatment on contributions does vary and you will only receive tax relief up to a maximum pension contribution value of £40,000 a year (or 100% of your annual earnings, whichever is lower).
You also have much greater control over where your pension pot is invested, which can include higher risk investments and even commercial buildings. However, if decide to go down this path, rather than a grouped investment scheme, my strong advice is to appoint a competent independent financial adviser. The modest cost is well worth it.
Flexible Pensions: Beware of scammers
The current era of flexible pension arrangements has spawned a new breed of fraudsters, the pension scammers, These unscrupulous individuals attempt to exploit people’s easier access to their built-up pension nest eggs and lack of knowledge on pensions. The scams come in many forms, but by far the most common are scams in which individuals are persuaded to transfer their savings from the safety of regulated safe or low risk pension schemes into high-risk or even non-existent investments schemes.
For further information, including details of a number of sad cases where the scammers were successful, I suggest you visit: https://www.which.co.uk/news/article/i-feel-humiliated-depressed-and-angry-the-devastating-impact-of-pension-scams-aF1926i37zoj
Tax Accountant’s view
My message today, in these inflationary times, is if you’re finding life hard financially and need to cut back on something, put your pension arrangements at the very bottom of the list.
P.S. Do you remember Roger? Well, you’ll be pleased to know that after we’d had a little chat, he decided that it would be foolish to suspend his pension scheme. Instead, Roger decided to cut out one of his two weekly visits to the pub, admitting that he needed to lose a little weight in any case.