Pensions can act as a future pay rise for some – but they do mean limiting your budget for the time being.
Saving for a rainy day (or just retirement) is often the sensible choice, although many aren’t clear exactly what paying into a pension pot entails.
While pension schemes have become a legal necessity for workplaces, it’s still worth researching before enrolling.
Read on to find out everything you need to know.
Are pensions taxable?
Your pension is treated as earned income, and could be subject to income tax.
According to the solicitor-sourcing site The Compensation Experts, this is one of the most asked questions about pensions.
The amount of income tax paid pay depends on your gross taxable income.
You won’t pay any income tax if your gross income does not exceed your personal allowance.
The standard personal allowance for (this tax year) is £12,570, and HMRC will tell you if this changes.
However, it is important to remember that you’re usually able to withdraw 25% of your pension pot as a tax-free lump sum as soon as you turn 55.
If you pay the money into your pension yourself, you also automatically get 20% tax back from the Government – which is added to your savings pot. It is worth checking with your pension provider to work out if you need to claim this yourself.
This is also the case with workplace-backed pensions, but the tax saving might not need to be reclaimed as employers tend to deduct less tax from your pay packet as a result.
If you’re a higher-rate taxpayer, you can claim an extra 20% back on top of that. The top rate of taxpayers can claim an additional 25%.
It’s worth noting, however, that 20% tax relief doesn’t mean 20% back on your contribution – it’s calculated from your pre-tax earnings.
So if you’re a basic taxpayer and you invest £80 in your pension, you would have earned £100 pre-tax. So the 20% is calculated from this figure – the tax relief would be £20.
Are pensions worth it?
For lots of people, the tax-deductible part of pension makes it worthwhile.
However, it really depends on your individual situation. Saving for a pension will affect your take-home pay, so you will be giving up disposable income now in exchange for a future payday.
As you’ll be getting less in your packet, it’s something to consider carefully when budgeting.
Most people think pensions are worth this, as it helps plan for a comfortable retirement.
At present, life expectancy at birth is 79.5 years for men and 83.1 years for women, but another measure – healthy life expectancy – shows that you can’t expect to be well for all of that time. The average man will be healthy for 63.4 years and the average woman for 64.1.
Having money saved for this time can take the pressure off in your later years.
Can you inherit a spouse’s state pension, and what happens in a divorce?
If your husband or wife dies, you will be eligible to inherit at least part of their pension plan.
However, you must have been married before April 6 2016, and your partner must have reached state pension age by this date.
If you remarry before you reach state pension age, you will not be eligible to inherit your partner’s pension.
Some financial advisors suggest that making an informal agreement to protect pensions in the event of divorce. If this isn’t in place, a pension transfer might take place – where assets are split between the two parties.
Another option in a divorce is the offsetting of the value of a pension against shared assets.
For instance, you may agree that one of you gets a greater share in the family home in exchange for the other keeping all of their pension.
Can you cash in pensions?
In short – sometimes.
In some circumstances, you can withdraw small amounts, or the whole pension.
However, you can’t take smaller cash sums if any of the following apply:
- you’ve already saved £1,073,100 in pension schemes over your lifetime
- you have some type of lifetime allowance protection
- you’re under 75, and the sums you want to withdraw are bigger than the amount of lifetime allowance you have left
Are private pensions safe?
Private pensions are covered by the Pension Protection Fund (PPF), which covers up to 100% of your payments should your employer goes bust.
Since 2017, all workplaces have had to automatically enrol staff in pension schemes.
Employers are required to pay into your pension pot, too – with the minimum requirement being 3% of your wage.
Legislation passed at the time means that if a company that holds your pension goes out of operation, the PPF will cover the loss.
It’s part of the Department for Work and Pensions, and it manages £36 billion of assets in the UK.
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