Pension terms explained. PAGE DOWN !
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What is a Basic State Pension ?
You can claim basic State Pension from State Pension age: currently 65 for men and 60 for women (rising to 65 by 2020).
You can get a basic State Pension by building up enough 'qualifying years'. A qualifying year is a tax year in which you have sufficient earnings upon which you have paid, are treated as having paid or have been credited with, National Insurance contributions.
You don't have to claim your State Pension as soon as you reach State Pension age. You can claim it later and get a higher weekly amount or take the option of a one-off taxable lump sum instead.
Additional State Pension
You may also be entitled to an additional State Pension, for instance, if you're in full-time employment and make class 1 National Insurance contributions.
When you retire and claim for a basic State Pension any additional State Pension due will be added.
If you've been a member of a company pension scheme you may have paid a lower rate of National Insurance contributions which will have qualified you only for the basic State Pension. If you do this most, or all of your second pension, will come from you company pension rather than the State Second Pension.
Personal pensions are available from banks, building societies and life insurance companies, who invest your savings on your behalf.
You can start receiving an income from a personal pension from the age of 50. To encourage you to save, you’ll receive tax relief on your contributions. This means that for each pound you put into your pension, the government takes away less tax from the total amount that you pay on your income.
Currently, there are restrictions on the maximum amounts you can contribute to a personal pension scheme, but these restrictions will be raised from April 2006.
There’s no limit on the number of personal pension schemes you can set up, and any contributions you make won’t affect your entitlement to the basic State Pension.
Stakeholder pensions are a type of personal pension. They have to meet certain government standards to ensure they are low charge and flexible.
Stakeholder pensions are open to everyone and may be worth looking into if you are self-employed or if your employer doesn’t offer a company pension. They allow you to contribute as little as £20 a month. You don’t have to be working to contribute to a stakeholder pension, and you don’t have to contribute every month if you’re unable to.
With stakeholder pensions, you can receive at least part of your pension payments from the age of 50.
Company (occupational) pensions are set up by employers for their employees whereby, in most cases, your employer will make contributions to the scheme on your behalf and require that you make regular payments from your salary.
A company pension may also offer a death benefit, which is paid to your spouse or partner if you die before them. Your employer may also provide you with a pension if you need to retire early due to ill-health.
However, if you leave your employer you can't continue making payments into the pension scheme.
Providing you satisfy certain rules it will be possible for you to be a member of a company pension and take out a personal pension as well.
Personal pensions through your employer
Some employers offer access to a personal pension scheme. They may also have negotiated lower administration costs with pension providers and make contributions to your pension themselves.
Your employer will usually select a pension provider (e.g. a bank or life insurance company) and choose a pension scheme which they think will be suitable for their employees. Such an arrangement is called a Group Personal Pension (GPP).
A pension taken out through a GPP is a personal pension and should not be confused with an occupational pension scheme.
If you decide to leave your employer you'll still be able to make payments into your pension, but you may pay higher administration costs
Pensions for the self-employed
If you’re self-employed you make class 2 National Insurance contributions. These will entitle you to the basic State Pension, but not the additional State Pension.
If you want to receive more than the basic State Pension when you retire, you might want to consider starting a personal or stakeholder pension scheme - or even a SIPP. You’ll then be able to make regular payments to build up savings for your retirement.
A SIPP is a "Self-Invested Personal Pension". A so-called, "pension plan wrapper" that enables the pension holder to take control of the investment choices within the plan. Possible investment in stocks and shares, investment funds and even commercial and residential property.
Rules change for SIPPS but there is a limit of £1.5 million that may be held within SIPP from April 2006. A SIPP may provide tax advantages and legal framework for investments redeemable at retirement.
To be introduced April 2006. Regardless of earnings, any individual aged 75 and under, and resident for tax in the UK , can contribute £3,600 to a pension in any one tax year or a higher amount depending upon earnings.
As from April 2006 the maximum contribution will be 100% of earnings up to a maximum of £215,000 per annum. Sipps offer great flexibility and have significant advantages over conventional pensions and yet tax relief of up to 40% on contributions is still granted.
On the basis that we believe they are only suitable for investors with a pension fund exceeding £200,000, Sipps will be most attractive to those who either can build up a fund of this size quickly or those with existing funds which are available for transfer.
One way of building up such a fund quickly is to make use of your annual capital gains tax allowance, presently £8,500, by realizing gains on, say, a portfolio of shares. Not only is this tax efficient so far as avoiding Capital Gains Tax is concerned, but income tax relief of up to 40% would be granted on reinvesting into a pension fund by way of which, should you so wish, you can buyback the same shares. Of course, thereafter, there would be no such capital gains tax payable on future gains.
With Sipps you can gain greater control over the investment of your pension money which, typically, might have previously been invested in insurance companies’ pension funds. All too often these funds under-performed.
Sipps offer far greater flexibility than ordinary personal pensions due to the range of investment options which are available. These include;
- Stocks and shares
- Unit trusts
- Investments trusts
- Managed funds, and
This far the option to invest in property has been restricted to commercial property but, with effect from 6th April 2006 , it will be extended to residential property which will prove attractive to many potential investors.
As well as receiving up to 40% income tax relief on contributions, individuals are also entitled to take a tax free lump sum of up to 25% of their accumulated fund at their chosen retirement age. This can be age 50 and upwards (55 as from 2010). All of the time money is invested within the fund it remains tax free being subject to neither income tax, capital gains tax, nor inheritance tax. Allowing for the fact that you do not have to cash a policy to purchase a pension via an annuity, but simply draw from the fund whilst leaving it invested (subject to certain limits), this is particularly attractive. Effectively your money can remain in a tax free environment for many years during which you have full investment control.
Are you approaching retirement?
Whilst the possibility of being able to draw an income from your pension fund is attractive, we believe that it is very important to have maximum investment flexibility. A Sipp is therefore essential. If you are approaching retirement and would like to use a Sipp to draw your pension please contact us. We’d be pleased to show you how you might be able to use the “Open Market Option” on your existing pension to make this possible.
Improved access to information
In the past details about your pension may only have come by way of an annual statement. Many Sipp providers have up to date valuations which can be viewed securely over the internet 24 hours a day.
How to turn a £160,000 net investment into £481,735 in only seven years.! It sounds a little like a get rich quick scheme doesn't it? However, that is how the property market has worked to some degree over the last few years.
Property is therefore a very attractive option for Sipp investors. The following illustration indicates why (see note):
An individual has a pension fund valued at £100,000 and wishes to top up their fund by a contribution of the same amount. This will be mainly funded by the sale of shares using their annual capital gains tax allowance. The net cost to the investor is £60,000.
The investor is permitted to borrow, via their fund, a further £100,000 making possible a property purchase of £300,000. The property is let at a rate of £1,500 per month and this rent is used to pay off the outstanding loan. This is achieved some seven years later during which time the value of the property has increased to £481,700, assuming a reasonable growth rate of 7% per annum in the property market.
Note: A contribution of this size will only be possible post 6th April 2006
Pension articles and postings
UK Government Pensions Information Site Click HERE|
Inland Revenue Pensions Information Site Click HERE