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Retirement income and pensions

New cap on pension pot transfer fees
New cap on pension pot transfer fees

Retirement income and pensions are a big issue at the moment.  On the one hand the experts are saying that no one is saving enough money for their retirement. On the other investment managers and insurance companies are full of the benefits of their various schemes and advertising their investment services.

Annuities, SIPPS, pension drawdown…… the pensions world has never been more complicated or confusing, so here are the basic facts about retirement income and pensions, with plenty of links to other sources of information to help make those all important decisions. From our practical experience the most important subjects are:

You can click on any of the above to take you straight to any topic you choose.

How much is the State Pension?

State Pensions are no less complicated than any other form of retirement income. The exact amount you can expect to receive will depend not only on your age and gender but also your own circumstances and employment history.

So to cut a long story short, the basic State Pension is £122.30 per week, and can be supplemented by pre-1997 and post-1997 additional state pensions and Graduated Retirement Benefit. If your contributions were subject to a contracted-out deduction, pre-1997 additional State  Pensions will be reduced. The “Full Amount State Pensions Scheme” payment is currently £159.55 each week, and is dependent on the National Insurance contributions made during employment.

So, the State Pension scheme is subject to so many additions and deductions and ifs and buts, that the Government has finally woken up to the reality that even experts struggle to interpret the rules and keep up to date. The state pensions advisory service has now been established to provide advice and will also calculate your own personal forecast. This service is currenly provided free of charge.

Looking forward, the new State Pension is at present protected from inflation by the so-called “triple lock”. This means that your State Pension increases each year by whichever is the highest of:

  • earnings – the average percentage growth in wages (in Great Britain)
  • prices – the percentage growth in prices in the UK as measured by the Consumer Prices Index (CPI)
  • 2.5%

What to do now? First, if you have not already reached retirement age, you should check whether you are going to receive the maximum pension. If you have not paid the necessary number of contributions you can make up the difference with a one-off payment, known as voluntary class 3 national insurance contributions.  So for instance a one-off payment of £741 now could increase your annual pension income by £237. Not a huge amount, but as that represents a 32% annual yield, increasing year by year with inflation, voluntary contributions could be the best investment you could ever make! Alternatively, you can make up the difference with a monthly direct debit.

There has been some suggestion that these annual increases are unfair to younger people, and unaffordable in the long run, and so could be reduced by new legislation. These plans were quietly abandoned in the aftermath of the 2017 General Election.

Finally, since 1997 the State pays an automatic Winter Fuel Allowance to all persons of retirement age, currently £200 per household, or £300 if one member is over 80 years old. This payment does not form part of your taxable income.

When will I start to receive the State Pension?

For many years the retirement age, or the age from which you could start drawing down the State Pension, was 65 for men and 6o for women. We are now in the middle of a phased increase in retirement age, so that under current legislation the retirement age for both men and women will increase to 66 by 2019.

A further increase in the retirement age to 68 originally scheduled for 2044 will be brought forward to 2037 according to a recent announcement  by the new pensions minister David Dauke. Treasury planners are forecasting that if you are now in your 20’s you may have to wait until you are over 70 before you become eligible for a State Pension.

New rules came into force in April 2017 that replace the “widow’s pension” that was previously available for widows, widowers and the survivor of a civil partnership.

Under these new rules, the benefits for a surviving marriage or partnership partner have been very significantly reduced, particularly if the survivor has already reached normal retirement age. Additional pension rights are acquired only from a proportion of the deceased “protected rights benefits”, whereas previously the top-up was calculated on the basis of the full State Pension entitlement.

The money you may have paid into a pension if you ‘contracted out’ of the State Earnings Related Pension Scheme or the Second State Pension was called “Protected Rights”.

The saver received a rebate of their National Insurance payments into a personal pension scheme instead, and this money and any growth on it was ringfenced.

This was because certain conditions were attached, including having to buy an annuity that provided for a spouse. It is no longer possible for anyone to contract out.

The new system of state bereavement payments will mean more generous initial bereavement payments, but in many instances – in particular where young children lose a parent – the amounts subsequently paid out will be less.

For those without children, the changes mean a £2,500 lump-sum payment after their spouse dies. This will then be followed by 18 monthly payments of £100 – but the surviving partner no longer needs to be 45 or older in order to claim these ongoing payments.

For those with children, the initial lump-sum will be £3,500 followed by 18 monthly payments of £350. But compared with the current system, where widowed parents can potentially receive £112.55 a week until their children turn 16 (or 20 if they are in full-time education), this is far less generous.

Another big change is that these rules now only apply if the surviving spouse or partner is under normal retirement age. According to former Pensions Minister Steve Webb:

The thinking behind this is that under the new system the goal is for far more individuals, and for more women in particular, to build up a full flat rate pension in their own right, rather than needing to depend on claiming a pension based on someone else’s contribution record.”

In other words, the state wants us all to work longer and for more hours, so that more National Insurance contributions are paid as taxes. This includes both adult partners in a relationship. Quite how a young mother is expected to hold down a full-time job and at the same time care for small children and cope with all the other challenges of running a family home is beyond comprehension.

If you are married, work non-stop throughout your life up to retirement and pay your own National Insurance contributions, and then die shortly after retirement, your surviving partner will receive virtually no benefit at all from all the money that has been deducted from your salary and paid into State coffers to provide an income for you and your partner in your old age.  Is that fair? Of course not, but thats the way the rules work at the time of writing.

The Treasury argues that pensions of this kind are now paid to 220,000 ex-wives living not in the UK, but in other countries, a big increase from 190,000 ten years ago.  The cost is over £400 million a year, but this can never justify such a draconian reduction in pension entitlement.

What is a final salary pension scheme?

In the past workers in office jobs, and many blue collar workers as well, qualified automatically to join their employer’s defined final salary pension scheme.  Each month the employee made a small tax free contribution, typically 5 – 6%, and the employer contributed a similar amount.  The money was paid into a ring fenced pension scheme, and you were then guaranteed a pension on reaching retirement age, which could be as early as your 60th birthday.  Your pension was normally calculated at 1/40th of your final salary for each year you worked in the company.

As well as offering a substantial tax-free benefit, these schemes  encouraged people to stay in the same job for longer.  However, if you decided to change job, you could draw out all the contributions you had made, and pay them into the pension scheme of your new employer.  Alternatively, you could leave your pension where it was, so if you worked for say 4 years and left when you were 30 years old, you could draw a pension of 4/40ths of the salary you were earning when you left, once you got to retirement age.  That way you kept the benefit of the contributions made by the employer.

The system wasn’t entirely fault free, and could be abused or defrauded by an unscrupulous employer.  The publisher Robert Maxwell allegedly plundered the Mirror Group pension scheme, and thousands of former and current employees lost out.

Partly as a consequence of the MG pension scandal, the government of the day set up the Pension Protection Fund  in 2004 to protect pensioners if a pension scheme became insolvent or was unable to meet its liabilities. The PPF is partly funded by a levy paid by all final salary pension schemes, but doesn’t always guarantee that full pensions continue to be paid.

Over recent years investment returns have declined substantially. Pension scheme trustees have to pay the cost of current pensions out of contributions, and build up enough cash to finance future pensions. Many employers have found that their final salary pension schemes have become seriously underfunded. The collapse of British Home Stores revealed a pension deficit of over £500 million, much of which will probably have to be made up out of taxpayers’ money.

Not surprisingly most employers have now closed their final salary pension schemes to new joiners because of the huge deficits incurred and the potential financial risk.  Even so, the total deficit of all UK final salary pension schemes has been estimated at close to £500 billion, and rising.

Over recent years many closed schemes have been passed on to independent specialists by the sponsoring employer. The cost can be quite high, depending on the value of the fund and expected future pension liabilities, but the benefit to the employer is one of certainty, and the transfer of the liability off the balance sheet.

In many ways a final salary pension or defined benefits pension of this kind is the most valuable asset to have in retirement. The rules were set from the outset to be as generous as possible so many offer the option of a partial tax-free lump sum draw-down, provision for a surviving partner, and annual increases in line with inflation. Even at 2% annual inflation a pension would increase by 32% at the end of a 15 year period.

What is an automatic enrolment scheme?

The 2008 Pensions Act launched the automatic pensions enrolment scheme. Under this scheme all employers, even if they only employ one person, must by law operate a pension scheme for any employees aged over 22 years and earnong more than £10,000 per annum. The scheme will be fully implemented by 1 February 2018. Since launch the number of workers without an employment pension has halved.

All new employees are automatically enrolled in the employer scheme as soon as they start work. However, there is an opt-out option, so you can leave the scheme if you want to.  However, by doing so you may lose important advantages, in particular the benefit of employer contributions and income tax allowances.

Total minimum contributions are required by law.  These are phased over the years up to 2019 as follows:

Date effective Employer minimum contribution Staff contribution Total minimum contribution
Currently until 5 April 2018 1% 1% 2%
6 April 2018 to 5 April 2019 2% 3% 5%
6 April 2019 onwards 3% 5% 8%

If an employer pays more than the minimum required, the employee may pay less into the scheme provided that the total minimum is maintained.  Alternatively, by increasing contributions employees will benefit from a greater pension on retirement.

Schemes are managed by authorised pension and investment companies such as insurance companies and other regulated providers.

For further information about the enrolment scheme the Pensions Advisory Service provides full and independent advice to both employers and employees.

What is an annuity and should I buy one?

In simple terms, an annuity is an arrangement whereby an insurer, or other financial institution, undertakes to pay an amount each month into an investor’s bank account in exchange for the up-front payment of a lump sum. All payments cease when the investor dies.  The insurer is therefore taking a bet on the remaining life expectancy of the investor, and the income the insurer can generate from the up-front payment received.

In practice, annuity contracts offer a number of options to the investor. These can include:

  • Payment of a reduced but agreed percentage of the annuity to a surviving partner/spouse
  • Protection against inflation
  • Variation of the annual sum if the investor decides to defer the date when payments start

Not surprisingly, these options, apart from the third, come at a price, which is reflected in the annual payments made. An example of the sort of annuity income you could buy for a £100,000 investment is shown below:

Single Standard Basis
Age Level rate
no guarantee
Level rate +
10-year guarantee
3% escalation
no guarantee
55 £4,058 £4,031 £2,508
60 £4,546 £4,502 £2,982
65 £5,272 £5,168 £3,690
70 £5,818 £5,623 £4,258
75 £6,975 £6,596 £5,091
These rates are typical of market returns available as at the time of writing, and change in response to fluctuating investment and bond yields.
Users should obtain professional advice before entering into any investment commitments. Note our disclaimer below.
Joint Standard Basis
Age Level rate +
50% Joint Life
Level rate +
100% Joint Life
3% escalation +
50% Joint Life
55 £3,825 £3,593 £2,297
60 £4,320 £4,036 £2,750
65 £4,842 £4,449 £3,281
70 £5,290 £4,858 £3,769
75 £6,193 £5,696 £4,496
These rates are typical of market returns available as at the time of writing, and change in response to fluctuating investment and bond yields.
Users should obtain professional advice before entering into any investment commitments. Note our disclaimer below.

Information provided by sharingpensions.co.uk. Valid at time of writing only

The older you are when you take out the annuity the higher your annual payment.  If you suffer from poor health you will also qualify for a higher pension. That’s called an impaired life in the trade. It’s one of the few times when it pays to be a heavy smoker.

Even so, are annuities a good investment? From the table above, you would have to survive at least 19 years after the age of 65 to recover the £100,000 you paid initially. Factor in inflation, and the return in real terms is even poorer. Assuming a conservative 2% inflation rate you would have to live to the age of 90 to get your money back:

     Annual income      Cumulative return
1 £5,167 £5,167
2 £5,063 £10,230
3 £4,962 £15,192
4 £4,863 £20,054
5 £4,765 £24,820
6 £4,670 £29,490
7 £4,577 £34,067
8 £4,485 £38,552
9 £4,396 £42,948
10 £4,308 £47,255
11 £4,221 £51,477
12 £4,137 £55,614
13 £4,054 £59,668
14 £3,973 £63,641
15 £3,894 £67,535
16 £3,816 £71,351
17 £3,740 £75,090
18 £3,665 £78,755
19 £3,591 £82,347
20 £3,520 £85,866
21 £3,449 £89,315
22 £3,380 £92,696
23 £3,313 £96,008
24 £3,246 £99,255
25 £3,181 £102,436


Many people, over 5 million in fact, were forced to convert their retirement insurance fund into an annuity provided by the same insurer. This arrangement was a licence for the insurers to rip of their customers, which with very few exceptions, they were more than willing to exercise. Since early 2016, however, new rules were forced onto insurers so they now have to offer their policyholders the option to cash in their policy and invest the proceeds elsewhere. This did not help the 5 million who were already drawing down an annuity.  Not fair? No doubt about that.

Annuity payments change continually according to Bank of England interest rates, stock exchange share values and the economic outlook. Once you have entered into an annuity contract you are locked in for life, so you need to take great care and obtain good professional advice before taking the plunge.

What is a pension pot, and what can I do with it?

In general terms your pension pot is the total amount of money you have invested in anticipation of your retirement. However, any ISA investments are excluded from your pot, as is the State pension. If you are a high-earner, you need to know the notional value of your pension pot.  In principle, payments into your pension pot are deducted from your salary or earnings before income tax is calculated.  However, but there are limits and restrictions to curb abuses, so it is important to obtain professional advice from your accountants to ensure these are not breached.

For many years pensioners had very little flexibility over how their pension savings were managed.  In April 2015 new rules came into force so once you reach the age of 55 you can now take the whole of your pension pot in cash. However, if you draw out more than 25% of the total you may end up with a large tax bill. It essential to get good advice before you commit, both to confirm the tax consequences and to ensure you have sufficient funds for your retirement.

According to a report published recently by HMRC over half a million people have taken advantage of the new rule and withdrawn over £9 billion since the rules were changed. The money can be invested with a different pension provider or indeed for any other purpose.

Pension providers were obviously anxious to avoid a wholesale reduction in funds under their management, so tried to discourage pension drawdowns by charging high exit fees, in some cases up to 6% on top of other administrative costs.

So in 2017 the Financial Conduct Authority introduced new regulations for pension providers limiting the charges they could make.  In principle if you want to take your pension pot away from your existing pension provider’s fund, the maximum charge you will incur will be 1% of the amount transferred. An increasing number, including Scottish Widows, LV and Royal London are progressively eliminating exit fees all together.

The cap only applies to private pensions, and not to occupational schemes such as those offered by employers. However, that is likely to change in October if the Department of Work and Pensions follows through with current plans.

Whatever your circumstances it makes sense to obtain confirmation on exit fees from a pension provider before applying to withdraw your pension pot, and also before making any investments.

Meanwhile, the £12 billion a year annuity market has shrunk by over 40% since the rules were changed.

Will I have to pay tax on my pension?

Successive governments have in the past encouraged people to save for their pension by offering generous tax breaks for contributions made out of income. These benefits have been reduced over recent years but are still a powerful incentive to save.

Once you start to draw a pension as income you will become liable to pay income tax.  This includes all income, whether from the State Pension, annuities, ongoing employment, or any other sources. Your entitlement to personal allowances will continue as though you were still employed, and your State pension will be paid every four weeks without deduction.

However, your State pension will be deducted from your personal allowance, and the balance is taken into consideration when calculating your personal tax code.  Each pension provider deducts income tax at source according to HMRC tax codes, and you will receive a P60 end of year tax certificate showing the amount they have deducted in respect of your income tax liability. In effect you will continue to pay tax on a PAYE basis, even though you may no longer be in employment. It is important that you keep copies of P60 certificates of tax deducted,

If you have other taxable sources of income you may have to complete a full income tax return each year.

How can I earn more money to top up my pension?

If you have more than enough income from your pensions to finance your lifestyle, then earning extra money will not be your highest priority. However, a recent survey by Scottish Widows concluded that barely half the respondents were saving enough for their retirement, and 3 in every 10 people of retirement age had no pension provision whatsoever. In the under-30’s age group only 30% are putting enough aside for their retirement.

http://www.scottishwidows.co.uk/images/about_us/retirement-report-infographic-mindful-2017.gifInfographic by Scottish Widows Ltd

So if you are among the half of the population who are concerned that their pensions may not be sufficient to support them in old age, any additional sources of income will be more than welcome.

Retirement imposes a reality check on what we can expect to receive to live on, and how we can manage income and expenditure to stay within our means.

However, there are many ways to boost your retirement income. There are plenty of websites offering ideas about how you can earn extra money after retirement. To find out more about some of the obvious ways, and some of the not so obvious ways, have a look at our page on boosting your retirement income.




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