Penfold | Tuesday 25th June, 2019
A pension is a great place to put money aside whilst you are working, so that you can use that money to live on when you stop working.
It's a type of financial product that has generous tax benefits because the government wants to encourage people to have one, so they reward you with 25% tax relief on the money you save. There are a few different types of pension, as listed in our glossary. Penfold operates a type of defined contribution pension called a SIPP, which gives you the most control over where your money is invested.
Why do I need a pension?
Could you live on £8,767 a year? That’s currently the maximum amount the government gives you each year under the state pension, after reaching retirement age (currently between 66 and 68). This could be less if you haven’t been paying in National Insurance for more than 10 years.
Most people think that’s not enough and want/need another source of income after they stop work. The most common and tax-efficient way to provide this income this is usually through saving into a pension whilst you are working. After you turn 55, you can convert whatever you have put aside in a pension during your working years, into an annual income for the rest of your life. It could make all the difference in how you spend over a third of your lifetime!
I thought the government gave me a pension?
If you pay National Insurance tax for more than 10 years, the government does provide what’s known as a ‘State Pension’. You can read more about that in our glossary, but the important thing to note is that the government only pays you about £8,750 a year, from your late 60’s.
Lots of people think this isn’t enough to live on, or want to stop working full time a bit earlier, so they choose to build up other retirement savings to live on. One of the best ways to do this through a pension.
What are the benefits of a pension?
The main benefit of paying into a pension is that most of the time when you pay in, the government pays in as well (and if you’re employed, your employer probably does too). This means that paying in even a small amount can result in much more actually ending up in your pension pot. There are almost no other ways of investing like this (where the government and your employer contribute as well).
The government’s contributions are called tax relief. You can read more about how this works in our glossary.
I’m self-employed – what’s different for me?
The big difference is that if you’re self-employed, just like everything else, you’re left on your own to figure out what you need to do, and you won’t get contributions from an employer. (People who are employed are usually ‘auto-enrolled’ in a workplace pension scheme, where their employer manages everything for you and contributes on the employee’s behalf.)
You are still entitled to tax relief (government contributions) on your pension, and as long as you pay National Insurance for long enough, you’ll still be entitled to the state pension when you retire. If you’re self-employed and want a pension, you’ll need to set up a personal or private pension. The good news is – you are exactly who Penfold was built for, and you can set up a pension with us in just 10 minutes.
HOW MUCH TO SAVE & WHEN TO START
How much should I save?
This is the killer question! If you sign up for Penfold, we’ll help you figure this out by applying some helpful rules of thumb and making some assumptions about what sort of life you want to live when you’re a bit older. A quick, popular and simple way of roughly calculating how much to save, is to take the age you start saving into a pension, and divide that by 2. Put this % of your earnings into your pension each year until you retire.
Penfold helps you calculate a more accurate number by deciding how much money you’ll want each month when you are older, and how much you’ll have to have saved in total to make that happen. We then work backwards to come up with a suggested amount to contribute each month! The key thing to note here is that the earlier you start saving, the less you will have to save. This is because of the effect of compound interest.
I can’t afford to save right now!
We hear this a lot, and you shouldn’t panic. Saving anything is better than saving nothing, so getting started by saving what you can afford is a good first step. If you tell us how much you can afford now, Penfold will show you how to increase that over the next few years to get on track. Also, remember that whatever you can afford (even if it’s only £20 a month) should be eligible for tax relief.
Everyone is allowed £3,600 of tax free contributions into their pension each year, but the maximum amount you can pay in and still get these government contributions is either your annual income, or £40,000, whichever is lower.
It’s worth noting that if you re in debt, especially at high rates of interest, you should consider whether it would be better to pay this off before starting a pension.
Can’t I worry about this later?
We think it’s really important to start saving for a pension as soon as possible. The reason for this is something magical called ‘compound interest’. You can read more about it in our glossary. Basically, when your money is in a pension it works for you by generating money from investments. If it makes money one year, there is more money the next year to make even more investments, and so on.
The main thing to understand about compound interest is the younger & sooner you start saving, the more you are likely to get over your lifetime. For example if you put £100 in your pension at age 40 and take it out at 60, it might have ‘compounded’ to be worth £265. But if you put it in age 20 it might be worth £704!*
*This is an illustrative example assuming an assumed annual growth rate of 5%. Compound interest is not guaranteed, but is a reasonable estimate of the effect of compound investment returns on the amount you put aside in a pension over a long period of time, using a widely used growth assumption.
I’ve heard pensions have performed badly – aren’t there better ways to save than in a pension?
What you’ve heard stems from a bit of a misunderstanding about what a pension is. A pension doesn’t perform badly, because a pension is just a ‘wrapper’ for an investment product (this is explained well in this blog by Martin Lewis from Money Saving Expert).
This ‘wrapper’ effectively means a set of rules set by the government for how you can pay in and and how you can take money out of a pension in order to get tax relief (the main rule being you can’t take money out until you’re 55).
A pension is a tax-efficient way of saving that isn’t in itself risky. The risk (and chance of losing money) comes from the investment choice inside the pension. Any form of investing involves risk, you need to take risk to make money. One of the beauties of pension saving though is how long your money stays invested, which actually reduces your risk of losing money overall and is how might end up making more compound interest over the long term.
How do I claim back tax on my pension?
If you’re a basic rate taxpayer, Penfold does this for you and adds the tax straight into your pension pot. If you’re a higher rate taxpayer, Penfold will claim the basic rate tax but you have to apply for the higher rate tax relief yourself on your tax return, although we can help.
If you have a limited company, the payment you make into your pension is ‘gross’ or before tax, so there is no further tax to claim back. This is because you have not had to pay any income tax on that money before it goes into your bank account, so there is no tax relief to be added.
However, you may then get further tax relief on your company’s tax bill because pension contributions are tax-deductible. Your accountant will need to calculate this when they do your year-end accounts, but if your company is paying corporation tax you should save 19% of every pension contribution off your company’s tax bill. We will be launching a feature soon to help you work out how much tax you could be saving, but in the meantime please get in touch.
Is there a maximum I can pay into my pension?
No, but there are limits on how much tax relief you can get. You can pay 100% of your yearly income into your pension if you earn £40,000 or under per year; where your salary is the maximum you’re allowed to contribute into your pension a year. For example, if you earned £30,000 a year, you can only pay £30,000 into your pension, and receive tax top-ups.
However, if your income is above £40,000, then £40,000 is the maximum amount you’re allowed to contribute into your pension a year that receives tax top-ups. If you pay any more than £40,000 into your pension, you will stop getting tax top-ups from the government.
Therefore, whatever you earn a month you can put into your account on a monthly basis, but this cannot accumulate to an amount that exceeds £40,000 by the end of the year, including the government’s tax top ups.
Do I get tax relief/ tax top-ups from the government, and how much do I get?
The amount of tax relief you receive from the government is dependent on your tax bracket. However, the money you contribute to your pension will automatically receive a 25% tax top up contribution from the government.
1. If you are a basic-rate taxpayer, you will receive this 25% tax top up contribution from the government only. For example, if a basic-rate taxpayer makes a £1000 contribution into their pension, they will receive a £250 tax top up contribution from the government back into their pension.
2. If you are a higher-rate taxpayer, you can claim an additional 41% tax top up contribution from the government, as part of your annual tax return. This means you receive a total 66% tax top up contribution. For example, if a higher-rate taxpayer makes a £1000 contribution into their pension, they will receive a £250 tax top up contribution from the government back into their pension.
On top of this, once this taxpayer has submitted their tax return, they will receive an additional £410 as tax relief from the government back into their personal bank account. This means that a higher-rate taxpayer has received a total £660 tax top up contribution from the government, which is 66% of their £1000 pension contribution.
Where do these numbers come from?
Tax relief is calculated on your pre-tax earnings. Therefore, when a basic-rate taxpayer invests £80 of their take-home pay into their pension, they would have actually earned £100 before tax. This is why the government would add a £20 contribution. Here, the tax relief is 20% of the £100 ie: £20. But of course, £20 is 25% of £80. This is why we say basic rate taxpayers get an additional 25% tax top up contribution, and high rate taxpayers get an additional 66% tax top up contribution from the government.
THE RULES & THE RISKS
How much does a pension cost?
Most pension companies will charge an ‘Annual management fee’, usually a percentage of the total amount in your pension pot. If your pension is invested well, this fee should be less than the amount your pension grows by, so even after paying your fees, you’d still have more in cash terms than you put in to your pension. Penfold charges an annual management fee of either 0.75% or 0.88%, depending on your fund, for all our customers. Penfold charges an annual management fee of either 0.75% or 0.88%, depending on your investment level, for all our customers.
Some pension companies will also charge you each time you contribute, or for setting up your pension or moving it to another provider. Many SIPP providers will also change a minimum £ fee each year, so if you don’t have enough saved in your pension you will lose much more than the annual management fee. Penfold won’t charge you for any of this.
I’ve got loads of small pensions dotted around – is this ok?
This is a perfectly normal situation for someone who has been employed in the past. However, there are benefits to consolidating them, particularly from an administrative perspective. If they are all defined contribution pensions, with little or no exit fees, it might be a good idea to consolidate them into one place, so it is easy for you to keep track of them. You should consider other factors like the fees charged each year by the different pension providers.
Can I lose my money?
If you put your money into a pension, usually it is then invested. As with any investment, it involves some risk; the value of your pension might go up as well as down, and you could get back less than you put in.
In Penfold's case, once your money is sent to us, it is part of your pension, and is held in your name in a special client money account, so it is separate to any of Penfold’s money. To be extra safe, we use a third party to manage these accounts, who are also regulated by the FCA. Their job is to hold your money and invest it in the plan you have chosen. Those plans are managed by BlackRock, the world’s largest asset manager.
The Penfold Pension is operated and administered by Gaudi Regulated Services Limited, who are authorised and regulated by the Financial Conduct Authority. If something happened to Penfold, your pension would still exist, and Gaudi would get in touch to explain how you manage it in the future if somehow there was no Penfold online portal. You could move your money to a different pension provider for no charge.
Penfold is also FSCS protected, so if something happened to Penfold, Gaudi and BlackRock, your money is guaranteed by the government up to £85,000.
MAKING THE MOST OF YOUR PENSION IN THE FUTURE
When can I withdraw my pension?
From the age of 55, you can begin to withdraw your pension. You can buy an annuity, buy an income drawdown, withdraw all of your cash, or leave it to continue investing.
Can I withdraw money from my Penfold pension whenever I want?
Generally, no. As with all pensions, you cannot access or withdraw any money paid into your Penfold pension until you are 55. If you have suffered a severe illness or accident you may be able to access your money earlier.
You may also be able to withdraw your money earlier than 55 if you incur some fairly heavy tax penalties that would mean you are taking out a fair bit less than you put in, so this is generally a bad idea. You are of course free to transfer your pot to another provider at any time for no cost.
What happens when I retire?
Once the money is in a pension, it attracts tax relief and so can’t be withdrawn until you’re at least 55. (There are some exceptions, like if you were terminally ill). At age 55, you can take 25% of it as a tax-free lump sum (although you don’t have to).
A law introduced in April 2015 means that anyone who’s aged 55 or over can take their pension money however they want, whenever they want, from the age of 55 – there’s now complete freedom.
For most people, accessing pension cash at 55 will be too early, so it can just be left where it is. Yet, if you want to, you can also access all your pension cash at once – the first 25% is tax-free and the remaining 75% will be taxed as income. There are different ways of using your pension cash to generate an income for the rest of your life, either by taking out enough each year to cover your spending money that year and leaving the rest invested, or by buying a product called an annuity that essentially pays you a salary until you die. It’s usually a good idea to take specialist financial advice about what to do with your pension pot when you retire.
Do I pay tax when I withdraw my pension?
You can take 25% of your pension as a tax-free lump sum. After this, the remaining 75% of your pension will be taxed as income at your marginal rate when you withdraw it. For example, 20% tax if you are a basic rate taxpayer, and 40% and 45% if you’re a high or top rate taxpayer respectively.
Of course, tax depends on the individual circumstances and may be subject to change.
What happens if I pass away before 55?
All of your Penfold pension is transferrable and available as a pension to a spouse, civil partner, dependent child or other individuals nominated by you. Your Penfold pension can either be paid as an income or the fund can be used to buy an annuity for the individual you nominate.
With pensions, as with all investments, your capital is at risk and the value of your pension with Penfold may go up as well as down. You may get back less than you put in.