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Pension planning is more important than ever

Henry Brennan
Private pensions are playing an increasingly vital role as the UK state pension lags behind those of other developed nations. (Source: Charles Stanley)

Research from the Organisation of Economic Co-operation and Development (OCED) has shown the UK to have the least generous state pension of all advanced economies. Private pensions are playing an increasingly vital role in providing an adequate income in retirement.

The OECD published a report in December which claimed that the UK state pension is equivalent to 29 per cent of an average male worker’s income. This is the lowest in the OECD and on a par with Mexico. The average was found to be 69 per cent.

The effect is one of higher poverty rates among pensioners. The report finds that “…poverty among older people is high in the United Kingdom: among those aged 75 and over 18.5 per cent have incomes below the poverty line, most of them women. The main reason is the low level of the state pension.”

Charles Stanley Chartered Financial Planner, Anne McClean, says: “There is ample research to suggest that individuals are not making enough provision for their retirement and state pensions only scratch the sides of most people’s expenses. One statistic that always startles me is that six out of seven working higher rate tax payers will become basic rate taxpayers in retirement.”

The OECD report notes that “private pensions could help fill the gap, adding around 30 percentage points” to the replacement rate. The role of private pensions is set to increase in importance as people live longer and consequently spend longer in retirement.

This is in part due to the fact that pensions are among the most tax-efficient savings products available. Voluntary contributions to personal pension products, such as a Self Invested Personal Pension (SIPP), can make a difference in the long run.

UK residents under age 75 can make contributions of up to 100 per cent of their annual earnings before tax, subject to their available annual allowance, and receive 20 per cent tax relief. Further tax relief may be available for higher-rate and additional-rate taxpayers. Those with no earnings or who earn less than £3,600 each year can still make gross contributions to a personal pension of up to £3,600 each year and receive basic rate tax relief.

It is also worth noting that the pension freedom rules give flexibility in respect of how a money purchase pension can be accessed. Typically, no tax is paid on the first 25 per cent and the rest is taxed at the appropriate rate of income tax.

Following the introduction of auto enrolment in 2012, workplace pensions have become increasingly effective at helping people save for retirement. The auto enrolment minimum is initially 2 per cent, of which at least 1 per cent must be paid by the employer. From April 2019, employers will be required to make a contribution of 3 per cent, with a further 5 per cent coming from the employee.

However, auto enrolment should be viewed as a means of bolstering income in retirement, not defining it, as McClean also notes. “Auto enrolment may give a false sense of security. Saving 3 per cent of your salary into a pension, for example, is unlikely to give you a comfortable retirement.”

The OECD is also positive on the UK’s efforts to raise levels of financial literacy and promote awareness of the need to save for retirement. Seeking financial advice can make a significant positive difference when it comes to formulating a practical and holistic plan for retirement.

The taxation of pensions depends of your personal circumstances and is subject to change in the future.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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