Boosting private pension
Conventional wisdom says that the more you pay into your private pension while you're still working, the better. But why is this? And when should you stop adding money to it – or should you keep boosting your private pension until the month you retire? And how does tax relief work?
Why should I top up my pension?
Every penny you pay in now will make a difference to the amount you'll get when you retire. That's why it makes sense to pay as much as you can into your pension scheme, even during the year you plan to stop working full time.
If you're paying a higher rate tax now, but expect to pay basic rate tax in retirement, then it's particularly worthwhile. Why? Because you'll get tax relief at the higher rate on your contributions. So effectively, for a £60 contribution (when you've reclaimed an additional 20% via self-assessment tax return), your pension pot will grow by £100. You will then only pay the basic rate of tax on the income you take in retirement.
So how much can I pay in?
If you're a UK resident under the age of 75, you can contribute an amount that's equal to as much as you earn and receive in tax relief each tax year. There is an overall limit for this known as the 'annual allowance', which for the tax year 2016/17 stands at £40,000.
It's also worth keeping in mind that you may have to pay a charge if you'd like to contribute more than a certain amount. If you don't top up by this amount in a three-year period though, you can 'carry forward' the allowance remainder and use it in your annual allowance for the current tax year.
If your income is over £110,000 – and when adjusted to include pension contributions is over £150,000 – your allowance is lower. This is called the ‘tapered annual allowance’, which can be as low as £10,000.
Additionally, if you chose to access your private pension your annual allowance could also drop to £10,000, even if you are not affected by the tapered annual allowance. This is known as the ‘Money Purchase Annual Allowance’ and can’t be increased by 'carrying forward' from the previous tax year.
Should you choose to carry over an allowance from the 2015/16 tax year, it's important to remember that there are additional steps to take, as the 2015/16 tax year was split into two mini periods (called the pre- and post-alignment tax year), with different allowances. You can find out more about this by clicking here.
And that's not the only allowance that could affect you
The other allowance to be aware of, is the lifetime allowance. Although this won't affect many people, the lifetime allowance is a limit on how much tax relieved pension benefits you can receive during your lifetime. For the tax year 2016/2017, the limit is £1m.
As you can see, it's a complex area of finances. Our strongest recommendation if you're not absolutely sure about the limits and allowances – but would like to top up your workplace or private pension – is to seek professional advice.
OK, but how else can I boost the value of my pensions?
First of all, review them – ask a professional adviser to help you understand more about the funds your money is being invested in. On closer inspection, you may feel comfortable moving into funds with higher risks but the potential for greater returns – but remember, it is important to bear those risks in mind, and any charges for swapping funds, too.
And if you bring all of your pension pots together, it may simply save you money. This is quite common; you may have worked for more than one company in your career and have two or three or more small pensions – all working independently of each other. The process of bringing them all together is called consolidation. For some, it can make sense for several reasons because:
- You'll only have to deal with one pension provider – that makes life easier.
- You could pay less in administration charges on one pension, than you've been paying on several pensions.
- If you decide to buy an annuity when you retire, you'll get just one payment each month – that could make life easier too.
- You could get a better annuity rate, if you're able to offer a single 'bigger pot' to the annuity providers.
As always though, there are some things to think about:
- Penalties – some providers levy a fee if you transfer your pension, have restricted investment choices, or have higher fees for certain schemes. So make sure you are happy with every detail before you make a decision.
- You don't have to consolidate your pension pots into a single annuity payment. Sometimes this may not be right for you, as it could potentially restrict your options and mean less flexibility for your retirement income.
- Some companies offer 'Guaranteed Annuity Rates', which you may lose rights to if you consolidate your funds (the rates are usually much higher than today's annuity rates).
Again, it's best to seek professional advice. And of course, even if you don't have lots of pensions to consolidate, or aren't going to pay more in contributions, you could think about adding savings to an ISA (the benefit being you can take an income without paying tax, and take out as much as you like, when you like; the drawback being you won't receive tax relief on the money you put in).
Anything else I should think about?
If you are working for a company, it is always worth talking to your pensions administrator face to face. It's an opportunity to understand what contributions the company is making on your behalf in more depth, and perhaps negotiate a higher contribution as part of an annual review.