At Clearways Accountants we have had a couple of enquiries about pensions recently. We set out some figures and examples on the new pension regime in our blog on pensions last year. This blog considers your options. Some definitions are given at the bottom of the blog (the first time any term is used it is underlined if we have provided a definition).
Why save for a pension?
If you want to lead a comfortable life when you stop work you will need savings to generate an income. These savings can be from a series of ISA‘s, investments, a pension plan or profits you have left in your limited company.
The earlier you start saving for your retirement the less you will have to save as your investments will have a chance to increase in value and the dividends or interest that are paid on your investments will boost the value of your savings.
Tax benefits on saving
If you save into an approved pension plan you will be treated as making the payment out of your gross income and this will reduce the amount of tax you pay on your earnings. If your company makes a contribution this will not be treated as a benefit-in-kind and therefore it will not be treated as taxable income.
If you save into an ISA or invest your money in shares there will be no tax reduction. The savings are made out of post tax income.
National Insurance benefits
Any company contributions made to your pension on your behalf will not be subject to employees or employers national insurance. This is the basis of many salary sacrifice schemes. In this case the national insurance savings are often shared between the employee and the employer.
Tax when you take your pension from a pension fund
When you receive an income from your pension plan the amount will be taxed in the same way that your salary is taxed. PAYE will be applied and tax will be deducted at source.
The key benefits in saving through a pension plan are:
- If you are a 40%/45% taxpayer when you make the contributions and a 20% taxpayer when you receive your pension income you will have made a gain of 20% (or 25%) on the money. If you are a 20% taxpayer when you make the contributions and a 20% taxpayer when you take your pension then there will be no tax benefit;
- All your dividends and interest on your investments accumulate tax-free.
Tax when you take your pension from investments and ISA’s
Dividend income and interest on savings accounts are taxable on receipt unless you hold the investments in an ISA in which case the income can accumulate tax free. When you take money out of your ISA it is tax free.
When you sell shares you may have capital gains tax to pay.
Tax on profits retained in your limited company
Any profits you take as a dividend will be taxed on receipt. If you are a 20% taxpayer there will be no further tax to pay, if you are a 40% or 45% taxpayer you will have further tax to pay.
Another option would be to liquidate your company. In this case the proceeds will be treated as a capital gain and if you meet the criteria this amount may be eligible for Entrepreneurs Relief; this would reduce your tax rate to 10%.
What happens to the pot of money you have saved?
If you have saved into a pension plan you can take a lump sum out of your fund but in the main the savings will remain in the scheme to provide your income. If you live a long life you will benefit from many years of income. However, regardless of your longevity you will not be able to access your pension pot.
If you have saved into ISA’s you can take out the capital at any time.
If you have saved into deposit accounts or into shares, gilts or bonds you can sell your investments at any time.
What are the options available for a pension scheme?
You can save into a:
- Company pension plan. There are two schemes in general use, a purchase plan in this case your company is likely to make a contribution to your pension pot and your pension is dependant on the value of your pot when you retire. If you are lucky you may have a final salary scheme, in this case your pension is dependent on your final salary.
- Personal pension plan. The value of your pension pot depends on the amount you pay in, the investment decisions you or your plan manager have taken and the fees taken by the plan manager.
- Self Invested Pension Plan (SIPP). You choose how to invest your contributions however certain assets are excluded, for example, buy-to-let residential property. The value of your pension pot depends on the investment decisions you have taken. Fees should be lower than for personal pension plans.
- NEST. This is the new government workplace scheme. Your employer may have already set one up. If not you can start saving now and when your company joins the scheme their contributions can be added to yours. If you have your own limited company you can set up a NEST account whenever you want. This scheme has lower fees than standard personal pension plans and a pre-set investment plan that you can adopt.
Taking your capital out of your pension fund before you reach 55 can be an expensive mistake, see our warning in this blog post: Pension con
If you need help with pensions you can come and talk to Clearways Accountants but please note we are not Independent Financial Advisers.
Pension: income provided for your retirement from any source
ISA (Individual Savings Account): A tax-free account available from banks and building societies. You can add savings and earn interest on a deposit account or invest in certain shares.
Investment: any cash deposit, shares, gilts or bonds that pay either interest or dividends.
Pension plan: an approved pension plan offered by your employer or a personal pension plan.
Profits you have left in your limited company: the profits that remain in your limited company after you have taken your salary and dividends. These profits can be paid out to provide income in your retirement.
Savings/Contributions: used interchangeably to mean the amount you save into a pension scheme, ISA or other investment.