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Credencis Guide to Pensions

This is a guide to pensions, what you are entitled to and how saving into a particular pension type affects the options available to you.

What type of pension do you have?

There are three main categories of pension available, these are:

Understanding defined benefit pensions

Most people who work in the public sector (e.g. health, police, fire and civil service) and for large companies are likely to be paying into a defined benefit pension. This type of pension pays out a secure income for life that increases each year, the amount is related to the salary a person earns.

The defined benefit pension has 2 sub-categories, the first is the final salary scheme whereby the pension payout is based on the pay level that you were receiving when you retire (or leave the scheme). The second category (the more modern version) is referred to as a career average scheme, this is where your pension is based on your average pay whilst you were a member of the scheme.

What choices are available if you have a defined benefit pension

Most defined benefit pension schemes have a retirement age of 65, some schemes offer the provision of early retirement, this usually reduces the amount of pension available to you by a formidable amount.

When first drawing from the pension, there is an option to take a tax-free lump sum as cash, the rules on the percentage allowed will vary upto a maximum of 25% of the entire fund value. Reducing the amount that a person takes in the lump sum will affect the amount that can be drawn as income.

Defined benefit pensions can be transferred to a defined contribution pension as long as several criteria points are met. If the pension to be transferred is £30,000 or more there is a requirement for the request to be signed off by a regulated financial adviser. A person may seek their own financial adviser, however there will be a charge to pay upfront (as stipulated by FCA – Financial Conduct Authority) to the adviser. The move has been made to prevent contingent charging, where advisers only charge a fee if a transfer is completed.

The emphasis is for individuals to stay with the defined benefit pension as they often contain secure and valuable benefits and there have since 2015 been a considerable number of transfer scams that have resulted in people losing lots of money from what otherwise would have been a more affluent retirement.

Explaining a defined contribution pension

The premise for this pension type requires an individual to pay into a pension pot over a period of time to accrue a retirement pension fund. The stipulation for this fund is that you have to be a minimum of 55 years of age before you are allowed to draw from it. A person may also be entitled to draw tax free lump sum of a value not exceeding 25% of the entire value of the pension pot at the beginning of the income withdrawal.

Several factors will determine the amount that builds up:

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How much you and your employer pay into the scheme

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The performance of the invested fund

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Charges that are deducted from the fund

Workplace, personal and stakeholder pension schemes all reside within the umbrella of defined contribution pensions.

Pension choice available if a person has a defined contribution pension.

At the age of 55, a person in this scheme has the freedom to decide what to do with the pension pot. The longer a fund is left to continue building up, the higher the income available to the individual during their retirement.

There are a set of 6 standard options available to people with defined contribution pensions, it is possible for individuals to have more than just one DC pot and so the same set of 6 options are available for each one.

The choices are as follows:

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Leave the fund invested (keep the money where it is)

The fund is untouched after your retirement age, the money is effectively still invested and will continue to grow according to annual performance percentage. The pension fund can be accessed when required at a later date.

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Purchase a lifetime annuity

The pension money that someone has accrued is used to buy an insurance policy that is designed to provide a fixed income for life or a set number of years. There is an option to take up to 25% tax free from the pot before the annuity is purchased.

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Flexi-access drawdown

How much money can a person take and how long will the fund last are the two important factors with flexible income funds. As with most pension options there is a 25% cash free lump available at the beginning of the fund withdrawal, the remainder is then invested to be drawn as a taxable income.

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Phased drawdown

A person can decide to take money out of the pension in chunks as and when they want it, each chunk has the first 25% tax free, with the remaining 75% being subject to tax in conjunction with any further income from work, savings or investments (dividends and bonds).

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UFPLS (Uncrystallised funds pension lump sum)

allows pension holders to withdraw some or all of their uncrystallised funds as a lump sum. Within the limitations of the Lifetime Allowance, 25% of the UFPLS will be paid tax free, with the balance taxed as pension income at the point of withdrawal

Understanding the State Pension

The majority of UK residents who have worked and contributed to the UK economical system will or currently do receive some State Pension. The government pays out to individuals an amount that is linked to inflation as a secure income for life.

As a person makes national insurance contributions, they build up their entitlement to the State Pension throughout their working life. It is possible, in some cases, for individuals to continue making contributions even when they are not working, such as when raising children or receiving certain benefits.

A new flat rate State Pension was introduced April 2016, the present tax year 2020-2021 showed this amount to have a value of £175.20 per week. There are exceptions to this amount based on whether a person has built up more entitlement under the pre April 2016 system or less if they were contracted out of the additional state pension.

With a State Pension, what choices are there?

The State Pension is not handed out automatically, a person is required to claim it. A short time before a person reaches the retirement age (usually 2 months), a letter will be sent out by the government department for work and pensions containing instructions on what to do.

There is an option for a person not claim their pension straight away, the default setting is just this (so no response from the individual will be taken as a deferment). The pension will carry on being deferred until it is claimed, the amount of the fund will continue to increase by 1% every 9 weeks it is left unclaimed. In a year this amount equates to approximately 5.8%

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