Over the last few decades there has been a monumental shift in the pensions landscape from Defined Benefit (DB) pensions (e.g. final salary) to Defined Contribution (DC) pensions, where contributions are made to an individual’s personal pension ‘pot’. Individuals now have control over their own pension, but many do not take advantage of it.
Final salary pensions were often generous and some required little to no input from the employee but, ultimately, they were just a promise by an employer to pay a sum of money every year in retirement, often many years in the future. High profile bankruptcies such as Enron in 2001, where past and present employees lost their pension benefits, raised awareness of the issue that the promise might not always be met. Many companies that have DB schemes have underfunded pensions, which means they have not set aside enough to fulfil their promises, often prioritising short-term profit maximisation over pension contributions.
As a result, there has been a shift to Defined Contribution (DC) pensions, whereby the current contribution is defined and paid into a personal policy now. The employee is in charge of their own pension and is free to invest it how they wish and choose what happens to it when they die. The ability to pass on your pension in full to your chosen beneficiaries is particularly attractive given that the old DB pensions would often cease upon death or pay a reduced rate to a spouse, before vanishing upon their death and leaving nothing to the next generation.
Pension contributions from your employer are generally income tax free and personal contributions attract tax relief. Investments within your pension grow with no income tax or capital gains tax (CGT) and if you die before you have exhausted your pension, your pot goes to your chosen beneficiaries with no Inheritance Tax (IHT). 25% of your pension, up to the Lump Sum Allowance of £268,275, can be taken tax free from the age of 55 (increasing to 57 in 2028) and the remainder is taxed at your marginal rate of income tax, which is likely to be lower in retirement than before.
For those who are unfortunate enough to die before the age of 75 with funds remaining in the pension, there is a silver lining in that the capital in the pension can be distributed to beneficiaries free from income tax when the benefits are passed down within the pension wrapper, rather than being paid out. A tax-free lump sum can be paid to beneficiaries to the extent that it remains within the Lump Sum and Death Benefit Allowance (LS&DBA) of £1,073,100. If the lump sum exceeds the LS&DBA, income tax will be payable on the excess only. For those who die over the age of 75, income tax will be paid at the beneficiary’s marginal rate as and when they withdraw the funds. This is a generalisation and there is a whole host of minutiae that mean bespoke advice is highly recommended. The allowances above are correct at the time of writing, but subject to change with the political tides.
The time value of money is the conjecture that there is greater benefit to receiving a sum of money now than receiving the same sum of money in the future. People therefore place more emphasis on the funds they have access to than the funds that they cannot withdraw for many years. This, combined with a general lack of understanding of the generosity of current pension legislation means that many people pay little regard to their pension until they need it.
If the combined value of your pensions is over £150,000, you may find that there are considerable benefits in terms of growth, costs, flexibility, and convenience by combining your pensions into one pot and having it professionally managed in a way that suits you.
Self-Invested Personal Pensions (SIPPs) are individual pension policies which enable an individual to consolidate their pensions into a single investment portfolio and either manage it themselves or appoint an investment manager such as LGT Wealth Management. We then create a bespoke investment portfolio based on factors such as age, wealth, family circumstances and attitudes to risk, and incorporating the client’s views on topics such as sustainability.
For the young investor in their 30s or 40s, their pension is a valuable asset with the luxury of a long investment time horizon and the ability to accept short-term volatility in favour of higher long-term returns. For those in their 50s and 60s, who are starting to think about the most efficient way to fund their retirement or pass on their assets, a SIPP can offer flexibility, control and the convenience of a single pot and a single point of contact. Expert advice is key to making the most of a generous system.
This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Wealth Management UK LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Wealth Management UK LLP, employees and associated companies for any direct or consequential loss arising from this document.
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