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Despite the plethora of acronyms and jargon, the concept of pensions is quite simple. You put money in and the contribution receives tax relief. So for every £80 you put in, if you pay tax at 20%, the government tops it up to £100.
When you reach retirement (from age 55 usually) you can normally take a tax-free lump sum, and a taxable income. The structure of the benefits from your pension depend on the type of scheme(s) you have.
What is the difference between a defined benefit pension and defined contribution pension?
A defined benefit pension (also called final salary pension) is a contractual obligation from a company to pay you a pension, irrespective of market conditions and how the fund has done. These are very valuable and are becoming rarer as more companies close the schemes and switch to defined contribution schemes for future accrual.
With a defined contribution (also called money purchase) your contributions are invested and the amount you will receive in retirement is based on how the funds grow and market conditions at the time.
In general, yes, but you should check that you are not losing important guarantees or other benefits by transferring. If you are still in employment transferring your benefits may also mean that you no longer enjoy employer pension contributions and may impact on other employee benefits.
Since investment returns cannot be guaranteed, it is important to consider the benefits of what you have, and are giving up, against what you are transferring into.
The use of the word ‘frozen’ can be misleading too. If you have a final salary pension, you will have a pension entitlement that, although you will not add to, will probably still be increased in line with inflation between your date of leaving, and when you reach retirement. The scheme will offer a ‘Cash Equivalent Transfer Value’ to transfer to another pension provider which will mean that you will be giving up your final salary pension.
If you have a defined contribution pension, your pension fund will remain invested in the chosen funds and go up or down.
As with a lot of things, if something seems to be too good to be true, it usually is! If someone is doing something for ‘free’ ask how they are going to get paid. If they will only get paid if they move your pension fund, how do you know you’re not in the best place already?
A final salary pension is a contractual right – therefore the company cannot just change it. If you are still an employee and the scheme is still active, they can change aspects such as the accrual rate, and the basis of the calculation, but they cannot retrospectively, change what you have already built up. Since the investment risk of the pension fund falls on the company, the main risk to final salary pensions is the sponsoring employer going bankrupt and being unable to support the pension scheme. In this event, if the fund is not able to support the scheme members, the scheme would revert to the Pension Protection Fund which guarantees 90% of peoples’ pension (albeit with a cap on benefits of around £33,600 gross p.a.) and certain other limitations).
There are limits on how much you can put in, but typically these are 100% of your salary up to £40,000 p.a.
Those who do not work can still make contributions of up to £3,600 and receive tax relief.
It depends on the type of pension fund you have. If you have a money purchase or defined contribution fund, and have not yet drawn on the fund, you may find that the fund will pass to your nominated beneficiaries or estate in the event of your death.
However, as legislation and contractual terms & conditions change, it is vital that these are checked regularly.
If you have drawn any money from the fund, any funds to your beneficiaries will depend on the structure of your benefits.
If you have a final salary pension, there is likely (but not definitely) to be a pension payable to your spouse in the event of your death.
At retirement, you can take out a lump sum – usually 25% which is normally tax free with the remaining 75% providing a taxable income. There are no limits on how much you can draw out.
This is where you swap the pension fund for a guaranteed income. Although annuity rates have gone down over the years, they remain likely to be suitable for anyone looking for a guaranteed, secure stream of regular income who do not want to take investment risk with their pension income.
You can access your pension fund from age 55, but just because you can, doesn’t mean it is always a good idea to do so!
This is likely to be because your pension contains important guarantees that will be lost if you take it out earlier than was intended. Since these decisions will last you the rest of your life it is important to make sure you are fully informed before taking any action.
When you start taking an income or a lump sum from a pension, the benefits are tested against the lifetime allowance (currently £1m). So if you have a pension fund of £200,000 and take the lump sum and an income from it, you will use up 20% of the lifetime allowance.
Possibly, although it depends on how you took the money out. If you have taken a lump sum and income from a fund, you may be restricted to the Money Purchase Annual Allowance for making any new contributions.
We have tried to be generic with these as we appreciate that the subject matter can be quite dry! The information above should not be relied upon as financial advice and we recommend you give us a call to discuss your own circumstances.