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Get FREE Guides to saving for Retirement• Personal Investment Service • SIPP and SSAS Savings Accounts • Higher-rate tax relief for your pension
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When planning how to provide for your retirement, there are several ways to put money aside:
State Pension (which you contribute to through National Insurance contributions)
Savings
Investments
Personal pension
1. Personal and stakeholder pensions benefit from an Income Tax rebate on any contributions you make. That means every time you contribute to your pension pot, the taxman pays some tax in as well! Here’s how it works:
Basic Rate Taxpayers
Your pension provider claims basic rate tax relief back from HM Revenue and Customs. You don’t need to do anything.
So, for every £100 contribution you make, £125 will be added to your pension pot.
Higher/Additional Rate Taxpayers
Your pension provider claims basic rate tax relief back from HM Revenue and Customs (HMRC). However, the additional 20% that you pay is not claimed back automatically.
In both instances this reimbursement comes to you directly, not your pension provider. So you’d need to either make an additional contribution to your pension as a one-off payment, or if you can afford to, make higher contributions throughout the year.
2. Gains made by your pension are also tax efficient because they are exempt from Capital Gains Tax.
3. When you come to take your pension, at the age of 55 or later, you have the option to take up to 25% of your pension pot as a tax-free lump sum.
Whilst pension contributions and growth aren’t taxed, when you come to take an income from your pension, this will be subject to Income Tax.
The best pensions allow you to hold a range of different investments. You can choose a pension fund based on how much risk you want to take with your money, and hold a number of different funds to spread your risk further.
It’s often the case that you would opt for riskier investments (which also tend to allow the bigger potential gains) when you are younger. This is because:
your money has longer to grow before retirement
your pension pot has longer to recover, if you lose money on an investment
As you approach retirement, you’d then look to move your pension pot to less risky investments to protect the gains you have made over your working life.
You can’t access the money held in your pension pot until you reach your 55th birthday. That’s under current rules – it’s probable that future governments will increase this age as life expectancies continue to rise.
However, it depends on your situation and character as to whether such a lack of flexibility is a good or bad thing…
Advantage
Disadvantage
Lack of flexibility ensures that you have a savings pot locked up until retirement. Chances are that not being allowed to dip into it will mean that this pot will be bigger than if you were allowed to access the money earlier.
Not being able to access your money until you’re 55 means that you can’t call on that cash if you need it earlier – for example if you were struggling with your mortgage.
If you’re worried about lack of flexibility in a pension it might be wise to look at keeping a pot of other savings, possibly in a cash ISA or equity ISA that you can call upon if you have to.
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