Don’t want to subsist on £160 a week? It’s Time to Consider These Retirement Savings Products

The UK’s maximum State pension allowance for the present tax year is £159.55 a week and over the past 5 years, there has been a 26% increase in the number of pensioners who do not have any personal savings to supplement their State pension allowance.

The number of single pensioners in the UK solely dependent upon their State pension hit 1.1 million earlier this year, with 330,000 retired couples in the same boat.

The Joseph Rowntree Foundation sets the benchmark for an acceptable standard of living for a pensioner living in the UK at £186.77 a week. That is an income that is considered as sufficient to meet basic living needs and not to provide any additional comforts or luxuries beyond that. Against that benchmark, the State pension falls short by 15.7%.

It’s a bleak picture and unless something drastic and wholly unexpected changes, the situation is not likely to improve in coming years.

The UK already faces costs of around £100 billion per annum to meet State pension commitments, a sum that is rapidly spiralling as life expectancy increases and our population ages.

The safest supposition to make would be that of all the potential State pension scenarios, the most likely is that the belt is tightened further in future.

However, it’s not all bad news.

In recognition of the impending pensions crisis, the British government introduced a number of pension and savings specific products that offer extremely generous tax breaks, encouraging as many people as possible to save for their retirement and have a supplement to their basic State pension income.

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Time is a Pension’s Friend

And the sooner you start saving towards a pension, the better.

With any returns usually reinvested into the pension pot, the power of compounded returns really helps add to the pot over a longer period of time.

While it is never too late to start saving into a pension product, early starters will be able to either build up a bigger pot or be able to make smaller monthly contributions.

Tax-Free Pension Savings

Savings into official pension products come exempt of tax up to an allocated allowance, which has gradually been raised over several budgets up to a £40,000 per annum ceiling for the current 2017/18 tax year. This means that any funds paid into a pensions product are subsequently topped up by the State by way of a refund of income tax already paid.

As such, £10,000 paid into a pensions product by someone in the basic income tax band of 20% would be topped up with an additional £2000. If the individual pays the higher or additional rate income tax bands of 40% or 45%, the top up would respectively rise to a refund of the £4000 or £4500 tax paid.

As well as being income tax-free, pension savings also benefit from any returns being exempt of tax. This means that for savings invested in equities or funds, returns from profitable investments are not subjected to capital gains or income tax as long as they remain invested in the pension.

The tax-free allowance on pensions savings also rolls over for three years as long as the saver’s personal income for the year is at least equal to the sum paid into pension products, unused allowance from any of the previous three tax years can be rolled into the current year.

Pension Restrictions

As generous as pension savings tax breaks are, and despite regulations being relaxed in recent years to allow for greater flexibility, there is, of course, no such thing as a completely free lunch and pension products do come with some restrictions.

These are, however, perfectly reasonable and in place to ensure that pensions savings that have been exempt from taxation are subsequently used for their intended purpose – as an additional income stream used during or immediately prior to retirement.

Pension savings are locked in until the holder reaches the age of 55. While they can be withdrawn prior to that point if needed, this would result in a refund of the reimbursed income tax top-up contributed by the State.

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Contributions paid into a pension savings product can be of higher value than the annual £40,000 allowance, plus any unused allowance from the previous three years.

However, the income tax top-up paid in by the State only applies to the first £40,000. For contributions beyond that (or above the individual’s annual income for that year) income tax is not refunded.

Pension Savings Products

So, which are the main pension savings products that allow you take advantage of these tax breaks?

Workplace Pensions: auto-enrolment, introduced in 2012, means that everyone in the UK over the age of 22 in employment and earning over £10,000 per annum must now pay into a pension savings product unless they specifically choose to opt-out.

In the current tax year, auto-enrollment means that 1% of gross earnings are paid towards a workplace pension product, or private pension product if requested and the employer offers that option. The employer is obliged to also match payments.

Between April 6th 2018 and April 5th 2019, the minimum auto-enrolment contribution from the employee rises to 3% with 2% being added by the employer and from April 6th 2019, 5% from the employee and 3% from the employer.

Employees can also choose to pay additional funds into a workplace pension, above the mandatory levels under auto-enrolment. These will not benefit from additional employer contributions, unless this is an incentive offered as part of a bonus package, but will still be eligible for the usual income tax top-up.

Most employers will have a chosen workplace pension products provider that will offer a range of funds of varying risk profiles. As a general rule, the higher the risk profile the better the returns should be. The flipside to this is that higher risk funds will be invested in assets more exposed to market downturns.

Pension fund managers will also standardly reduce the risk profile of the assets pension funds are invested in the closer the holder gets to retirement age. This protects against any potential market downturn that would not leave sufficient time for recovery of losses as markets recover.

Private Pensions: for those who are self-employed, are not content with the workplace pension choices on offer via their employer or simply want to diversify their pension savings over a wider range of investments, making contributions into a private pension is a good alternative as an addition to auto-enrolment contributions.

Private pensions fall into two main categories:

  1. Stakeholder Pensions
  2. SIPPs (Self-Invested Personal Pension)

Stakeholder pensions are very similar to workplace pension products. The holder chooses from a range of funds of varying risk profiles and either make regular monthly or ad hoc contributions as they can afford (or a combination of both). The main difference is that the pension holder can choose their provider and is not limited to the employer’s choice.

A SIPP is slightly different in that it is a ‘wrapper’ rather than a particular investment product. A wide range of different investment classes can be held within a SIPP wrapper, from equities to funds, robo-advisor investment portfolios, bonds and alternative investments such as peer-to-peer lending.

Some SIPP wrappers are more flexible than others in terms of the kind of investments that can be held in them and depends upon the SIPP provider. As a general rule, more flexible SIPPs will have higher annual administration fees. Residential property is not eligible to be held within a SIPP.

All a SIPP really does is define the assets held within it as pension savings, making them eligible for pension tax shelter. SIPPs are suited to DIY investors who feel comfortable making their own investment decisions and who want to allocate capital between a number of different asset classes and financial instruments.

There is no limit to how many SIPPs can be held at any one time. Standard asset classes such as equities and funds can be held in a cheaper SIPP and alternative assets separately if administration fees are a higher percentage of the SIPP’s invested capital.

Last updated: December 8th, 2017

John Adam

John Adam co-founded iNVEZZ.com, a news, analysis and comparison portal for retail investors. iNVEZZ was acquired by Investoo in 2017.

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