Types of Pension

Brief explanations of the different types of UK pensions are given below.

Basic state pension

Although an entitlement for most people, the amount received from the basic state pension will depend on the amount of national insurance contributions paid.

Full state pension allowance

For the year 2011/2012, the full pension allowance for a single person who has made sufficient contributions is £102.25 per week.

A married individual's state pension allowance is currently £61.20 per week if using their partner's national insurance contribution record. The married couple's pension allowance will be £163.45 per week in total (£102.25 plus £61.20).

If both partners have worked throughout their lives and have made sufficient national insurance payments individually, the separate single pension entitlements will apply. This means the total combined state pension allowance for a married couple or civil partnership rises from £161.45 to £204.50 per week.

Weekly state pension allowances (2011/2012)

Single person state pension allowance

£102.25

Married partner's state pension allowance

£61.20

Married couple's state pension allowance

£163.45

Both partners with full individual entitlement

£204.50

State Second Pension

On 6 April 2002, the State Second Pension (S2P), introduced by the Child Support, Pensions and Social Security Act 2000 replaced the State Earnings Related Pension Scheme (SERPS).

Not available for self-employed individuals, SERPS was set up in 1975 by the Social Security Pension Act 1975 and began in 1978. It is independent of basic state pension entitlement and it is based on a proportion of earnings during your working life.

S2P will initially start as an earnings-related scheme similar to SERPS but with three different accrual rates and the build up will vary for each tax year depending on the individual's earnings.

It is predicted however that at some point in the future, this will change to a flat-rate scheme to accrue uniformly over 40 years.
Personal and Stakeholder pensions
Personal pensions, introduced on 1 July 1988, originally aimed to give people who were not part of a company pension scheme their own portable pension, designed on a money purchase basis although since April 2001 certain individuals who are members of company pension schemes can also take out personal pensions.

Legislation for personal pensions and stakeholder pensions are identical (only the charges and product terms are set for stakeholder).


Annual pension allowance

Annual pension contributions have a new limit attracting full tax relief. This limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge.

Lifetime allowance

As well as an annual pension allowance charge, there is a possible lifetime allowance charge if total pension funds exceed the lifetime allowance when pension benefits are taken. The lifetime allowance for 2010/2011 is £1.8 million. Recent government proposals will see these allowances frozen until the end of tax year 2015/16.

The lifetime allowance charge is applied to the excess over the allowance. This can apply in two different ways or both depending on how the excess is taken. The individual charges are;

• 25% if taken as income, and
• 55% if taken as a lump sum

It is unlikely that there will be much difference because, if someone takes the excess as income, he will be charged income tax on top of this tax charge, more than likely at 40%.


Pension benefits
You can take pension benefits between ages 50 and 75. Normally these will be in the form of 25% of the fund as tax free cash, and the rest applied to produce an annual pension, although other alternatives are now available.


Level and bases of, and reliefs from taxation are subject to change.


Occupational pension schemes

Employers can set up an occupational pension scheme for their employees. An occupational pension scheme can be offered to both public and private employees.

Public sector occupational pension scheme
Public sector schemes typically offer pension accrual of 1/80th of final remuneration for each year of service up to a maximum of 40 years plus a tax free lump sum of up to 1.5 x final remuneration.

Private sector occupational pension scheme
Private sector schemes can be either final salary schemes known as defined benefit schemes or money purchase schemes known as defined contribution schemes.

Executive pension scheme

Many directors of small to medium sized family businesses make use of an executive pension scheme. Executive pension plans are similar to occupational pension schemes in that they are subject to occupational pension scheme rules.


Types of occupational pension scheme


Final salary schemes

Final salary occupational pensions schemes offer a guaranteed pension amount, usually based on salary and time served with an employer.

Typically accrual rates of 1/80th or 1/60th of pensionable salary for each year of pensionable service are found.

E.g. Fred Smith retires on a salary of £10,000pa after 20 years in a 1/60ths scheme. His pension is 20/60 x £10,000 = £3,333.

Money purchase scheme

With a Money Purchase occupational pension plan, the pension contributions are invested and the final pension is based on the investment performance of the fund. There is no guarantee.

Individual Contributions

Individuals can contribute as much as they want although there are limits on the amount of contributions that will receive the full benefits of tax relief.

Any contribution that is not paid by the employer is classed as a member contribution even if a third party has made the contribution. Tax relief is given according to the member's situation; i.e. make sure that tax relief at source applies if the member is a non- or starting rate taxpayer. An example of this is a grandparent paying a pension contribution for his/her grandchild.

Employer Contributions

Just like individual contributions, employer contributions are also unlimited. Full tax relief will be available without limit subject to the local inspector of taxes. However, there will be a tax charge on the member where total contributions are above the annual allowance.

Eligibility

Any member of a registered occupational pension scheme can make contributions to it. However, to be eligible to gain tax relief, the contribution must be made by an active scheme member who is also a relevant UK individual. To qualify as a relevant UK individual, the scheme member must meet one of the following criteria:

  • Have relevant UK earnings chargeable to income tax
  • for that tax year
  • Is resident in the UK at some point in that tax year
  • Was resident in the UK at some point during the five
  • tax years immediately before the tax year in question
  • and was also resident in the UK when he/she joined
  • the pension scheme
  • Has general earnings from overseas Crown
  • employment subject to UK tax
  • Is the spouse of an individual who has, for the tax year, general earnings from overseas Crown employment subject to UK tax

Pension Allowances

Annual Pension Allowance

Since A-Day, annual pension contributions have a new limit attracting full tax relief. This limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge. We will explain this in further detail later in this bulletin.

Lifetime Pension Allowance

As well as an annual allowance charge, there is a possible lifetime allowance charge if total pension funds exceed the lifetime allowance at when pension benefits are taken. The lifetime allowance for the 2010/2011 tax year is £1,800,000.

The lifetime allowance charge is applied to the excess over the allowance. This can apply in two different ways or both depending on how the excess is taken. The individual charges are;

  • 25% if taken as income, and
  • 55% if taken as a lump sum

it is unlikely that there will be much difference because, if someone takes the excess as income, he will be charged income tax on top of this tax charge, more than likely at 40%.

Additional Voluntary Contributions (AVCs)

It is now compulsory for companies to offer employees the opportunity to invest additional contributions into their occupational scheme where there is one, in order to boost retirement benefits.

Under existing revenue limits and since A- Day, if you are a member of an occupational pension scheme you can invest up to 100% of your total remuneration or up to a £255,000 in total.

Tax Reliefs & Contribution Limits

To receive full benefits of tax relief , pension contributions have to remain within a certain limit. Currently the limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any additional contribution over the annual allowance will be subject to a tax charge.

Levels and bases of, and reliefs from taxation are subject to change.

Free Standing Additional Voluntary Contributions (FSAVCs)

Free standing additional voluntary contribution schemes (FSAVCs) were introduced in 1987.

These are run by a pension provider rather than the trustees of the employee's pension scheme. The big advantage tends to be the wider choice of investment available.

FSAVCs tax relief and contribution limits 

To receive full benefits of tax relief , pension contributions have to remain within a certain limit. Currently the limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge.

Level and bases of, and reliefs from taxation are subject to change.

SIPP Pension plans

For many people a SIPP pension has become an attractive and Tax efficient method for long term saving.

Pension reform has widened the investment options available to the individual and has relaxed the rules which govern the purchase and sale of assets into a pension plan.

SIPP Pension Benefits

Another major change introduced from April 2006 is in the way individuals can take benefits or draw upon assets within a pension. When an individual wishes to retire, there is greater flexibility and choice when it comes to deriving an income.

Individuals now have the option of pension drawdown as well as the purchasing of an annuity - this gives greater control over the initial level of income derived and income flexibility during retirement.

A SIPP will allow regular and lump sum cash payments, and you will also be able to transfer other pension arrangements into the scheme. If you are employed, your employer can also pay into the plan. In addition SIPPS will allow investments from a wide range of sources including Commercial Property, shares and unit trusts.

Annual Allowance

Since A-Day, annual pension contributions have a new limit attracting full tax relief. This limit is the greater of £3,600 and 100% of salary, subject to the annual allowance (£255,000 in the 2010/2011 tax year). Any contribution over the annual allowance will be subject to a tax charge. We will explain this in further detail later in this bulletin.

Lifetime Allowance

As well as an annual allowance charge, there is a possible lifetime allowance charge if total pension funds exceed the lifetime allowance at when pension benefits are taken. The lifetime allowance is currently £1.8 million (2010/2011 tax year).

State Earnings Related Pension Scheme (SERPS)

The State Second Pension (S2P) replaced SERPS with effect from 6 April 2002. Only those who have been employed between 1978 and April 2002 are entitled to SERPS subject to their National Insurance contribution record. Those who have always been self-employed are not.

  • Who can invest in a personal pension? Open or Close

    You can get a personal pension whether you're employed, self-employed or out of work as long as you are:

    • 16 or over
    • A UK resident
    • Happy to leave your money invested until you retire

    If you want to retire on more than the state pension but don't have a company pension at work, a personal pension is a great option.

  • Taking your pension benefits Open or Close

    Firstly you can't get your hands on your pension until you're at least 55 years old, which is good because it gives you time to build up a bigger pension, without the temptation to dip into your savings.

    When you take your benefits you can normally choose to take up to a quarter of your benefits as a tax-free cash sum.

    You'll need to use the rest of the money you've saved in your pension to buy an annuity. An annuity is an investment that guarantees to pay you a regular income for the rest of your life, no matter how long you live.

    Please remember, the amount of income provided by your pension will depend on a number of factors, including investment returns and annuity rates when you retire.

  • How much can I save? Open or Close

    A little now makes a big difference later- the golden rule is to invest the most you can afford, and the earlier you start the better. Even a modest amount saved now can make a big difference later.

    You get tax relief on everything you put away, up to 100% of your annual earnings (and also subject to an upper annual allowance of £50,000*).

    Even if you're not earning you can still pay into your personal pension, and get tax relief on up to £2,880 of contributions each year.

    *Please note, you don't get tax relief on payments above £50,000, in fact you will be taxed on them. If you have unused allowance from previous tax years, you may be able to pay in more than this. To find out more, please see Questions & Answers. Also remember, this information is based on our current understanding of taxation law and HM Revenue & Customs practice in the UK. The amount of tax relief you receive depends on your personal circumstances and may change.

  • How much can I pay in? Open or Close

    You can pay in anything from £1 upwards. You get tax relief on everything you put away, up to 100% of your annual earnings (subject to an upper annual allowance of £50,000). If you are able to save more than £50,000 a year, you don't get tax relief on payments above that, in fact you will be taxed on them. If you have unused annual allowance from previous tax years, you may be able to pay in more than this. Please see below.

  • Can I pay in more than £50,000 in one year? Open or Close

    Yes, but any contributions above this will normally be taxed.

    You may be able to avoid this by carrying forward any unused annual allowance from previous tax years. There are some rules around this, you can only go back three years, you must have been a registered member of the scheme in the tax year you are carrying forward from and you can only carry forward up to the £50,000 limit in each tax year.

    Don't forget this includes any contributions from an employer and increases in value of any other pension savings you may have.

    If you'd like to find out more about this, click here to check the latest information on the HM Revenue & Customs website and seek advice from a tax specialist or financial adviser before investing - to ensure you don't incur tax charges you weren't expecting.

  • Can my employer contribute? Open or Close

    Yes, their payments would form part of your total contribution limits.

    If you'd like your employer to contribute, just let us know and we'll send you a form making it easy for them to do.

  • Can I save in other pensions too? Open or Close

    Yes, you are allowed to save in as many pensions as you like. There used to be rules concerning company directors and occupational schemes and salary limits, but these have now been removed.

    If you already have a pension which you could make further contributions to, you should speak to an IFA.

  • Can I transfer other pensions to my new pension? Open or Close

    Yes, you can transfer other pensions into a new pension, however, you would need to make sure it was the right thing for you to do. If you would like more information please contact us.

  • Can I start a pension if I plan to retire within five years? Open or Close

    Yes, you can. But if you haven't started a pension yet and are hoping to retire within five years time, we strongly recommend you seek independent financial advice, so you can decide on the best options available to you at this time.

  • How do I claim the tax relief? Open or Close

    Whether you are employed, self-employed or not employed, we claim basic rate tax relief for you and invest it in your pension.

    If you pay income tax at the higher rate (or additional rate that applies for those with an annual income above £150,000) you can claim any extra tax relief you are due from the HMRC in your annual tax return.

  • What happens if I change jobs? Open or Close

    The first thing is to find out if your new employer offers a company pension, and whether they contribute to it. If so, you should join, so you don't miss out on any payments they're offering. You can also keep your personal pension, and keep paying into it if you wish.

    If you become self-employed or your new employer doesn't offer a pension scheme, it's a good idea to keep paying into your personal pension so your retirement savings stay on track.

    Whatever you choose to do, please let us know if you've changed jobs.

  • What happens if I'm off work? Open or Close

    If you're off work but are still being paid (e.g. paid maternity leave or sick leave), you can continue to pay into your pension and you'll still receive tax relief on your payments (on up to 100% of your annual earnings and also subject to an upper annual allowance of £50,000). If your employer is paying into your pension, you'll need to check with them whether they'll continue to contribute while you're off work.

    If you have time away from paid work, remember you can stop payments into your personal pension if you need to. You can start saving again whenever you wish. If you do make payments into your pension you'll still receive tax relief on up to £2,880 of payments each tax year, even if you have no earnings for that tax year. You can pay in more than that if you wish but you won't receive tax relief on the extra amount.

  • What happens if I stop work altogether? Open or Close

    Even if you're not earning you can still pay into your personal pension and receive tax relief on up to £2,880 of payments each tax year. You can pay in more than that if you wish but you won't receive tax relief on the extra amount.

    If you can no longer spare the money you can stop your payments into your pension. You can start saving again whenever you're ready.

  • What happens to my savings if I die before I retire? Open or Close

    They will be paid to the beneficiaries you named on your application. If you need to update your beneficiaries at any time, please contact us.

  • What is the earliest I can retire? Open or Close

    The earliest you can currently take your pension is your 55th birthday.

  • What happens when I 'cash in' my pension fund? Open or Close

    You can normally take up to a quarter of your savings as a tax-free cash sum. The rest is used to buy you an income in retirement, called an annuity.

  • Are there any risks I need to know about? Open or Close

    Investing in stock market shares is not without its risks. They can rise significantly in value over many years, go into periods of decline, or fall suddenly in value, with no guarantees you will get back the full amount you invest.

    The key point to remember is that saving into a pension is a long term investment, and the longer you remain invested in the stock market the better you tend to do.

  • Annuities explained, the guaranteed annuity Open or Close

    A conventional annuity is a contract whereby the insurance company agrees to pay to the investor a guaranteed income either for a specific period or for the rest of his or her life in return for a capital sum. With a guaranteed annuity, income is paid for the annuitant's life, but in the event of early death within a guaranteed period, the income is paid for the balance of the guaranteed annuity period to the beneficiaries.

    The capital is non-returnable and hence the income paid is relatively high.

    Annuity key points

    Income paid is based on the investor's age, i.e. the mortality factor and interest rates on long term gilts.

    Income is paid annually, half yearly, quarterly or monthly.

    Annuities can be on one life or two. If they are on two lives the annuity will normally continue until the death of the second life.

    If the annuitant dies early, some or all, of the capital is lost. Capital protected annuities return the balance of the capital on early death.

    Payments from pension annuities are taxed as income.

    Purchased life annuities have a capital and interest element - the capital element is tax free, the interest element is taxable.

    Types of annuity

    Types of annuity include the following - Immediate; guaranteed; compulsory purchase; open market option; deferred; temporary; level; increasing or escalating.

    Immediate annuity

    The purchase price is paid to the insurance company and the income starts immediately and is paid for the lifetime of the annuitant.

    Guaranteed annuity

    Income is paid for the annuitant's life, but in the event of early death within a guaranteed period, say five or 10 years, the income is paid for the balance of the guaranteed period to the beneficiaries.

    Compulsory purchase

    Also known as open market option annuities, these are bought with the proceeds of pension funds. A fund from an occupational scheme or buy-out (S32) policy will buy a compulsory purchase annuity. A fund from a retirement annuity or personal pension will buy an option market option annuity - an opportunity to move the fund to a provider offering better annuity rates.

    Deferred annuities

    A single payment or regular payments are made to an insurance company, but payment of the income does not start for some months or years. This may be suitable for an investor funding for retirement or school fees.

    Annuity certain/deferred annuity certain

    Often used for school fees purposes. The annuity is paid for a fixed period either immediately or after a deferred period, irrespective of the survival of the original annuitant.

    Temporary annuity

    A lump sum payment is made to the insurance company, and income starts immediately, but it is only for a limited period - say five years. Payments finish at the end of the fixed period or on earlier death.

    Level annuity

    The income is level at all times. This of course does not keep pace with inflation.

    Increasing or escalating annuity

    The annuitant selects a rate of increase and the income will rise each year by the chosen percentage. Some life offices now offer an annuity where the performance is linked to some extent to either a unit linked or with profits fund to give exposure to equities and hopefully increase returns.

  • Remember... Open or Close

    You can't access your pension savings until you retire. Under the current rules, even if you retire early, you are not able to claim your pension before the age of 55. Also, the amount of pension income provided by your retirement fund will depend on a number of factors, including investment returns and annuity rates when you retire


The guidance and/or advice contained within this website is subject to the UK regulatory regime and is therefore primarily targeted at customers in the UK.

Jonathan Hales

Independant Financial Advisor

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