It is likely that if you are under 35, retirement is something so far away that you don’t even think about it. However, you should. Since the public system is designed so that current contributors support the pensions of existing pensioners, besides, everything indicates that a simple effect of demography will worsen this ratio.
A pension scheme is a type of savings and investment product that has recently been targeted by many savers. The minimum rise in public pensions by the government and its sustainability in the future is questionable. That has currently made pension schemes to be in a position as one of the most common savings alternatives.
However, these products are complex and, being an investment product, could lead to a risk to our savings. For this reason, we should not hire them without knowing their operation.
Technical measures have already been taken to reform the public pension system. However, these reforms have not yet complete. We cannot see the effects of the change until the end of 2019, when the sustainability factor enters into force, and especially after 2027 when its implementation period ends.
The sustainability factor combines the life expectancy of the pensioner and the situation of the public money boxes to calculate pensions, which is something that will cause reductions in the amounts of public pensions that will be charged by the next generations when they retire.
After analysing the economic problem of pensions in the UK, the question we must ask ourselves is: has the time come to be a pensioner and save to complete the retirement?
Here are some points that you should know about pension schemes as soon as possible:
1. Start saving as soon as possible:
The purpose of a pension scheme is to complement the public retirement pension privately and voluntarily to have financial autonomy. Thus, the sooner it begins, the smaller the saving effort.
A person who starts saving at 30, a modest amount of 50 Pounds a month, will accumulate more than double when he is 65 years old than someone waiting at 45 to start saving if he achieves a 3% revaluation annual. So the key here is to begin before the age of 30.
2. The risk of the pension scheme reduces as the years go by
When asked what pension scheme we choose, there is no valid answer for everyone. There are products more or less appropriate to the personal, economic characteristics and risk profile of each person, and your plan must adapt to them.
However, it would help if you remembered that in the very long term – over 20 years – it is advisable to assume a little more risk. Which is so that as the retirement date approaches, we reduce the risk exposure. Pension schemes that invest in equities are considered riskier, and conservative pension schemes that invest in fixed income, are deemed guaranteed.
3. What figures exist in a pension scheme?
The figures involved in the hiring and management of a pension scheme are the following:
- Participant: natural persons in whose interest we create the pension scheme, regardless of whether they make contributions or not.
- Beneficiaries: In case of retirement, disability or dependency of the participant, the recipient of a pension scheme is the participant himself. In the rest of the cases, they are the beneficiaries designated by him, or in his absence, the legal heirs.
- Promoter: It is the entity that promotes the creation of the pension scheme. In the individual pension schemes, these are the financial entities, while in the employment plans, it is the company.
- Management company: It is the commercial entity responsible for the administration and management of pension funds.
- Depository company: The depositary entity is a financial entity whose mission is the custody and deposit of transferable securities and other financial assets integrated into pension funds.
4. What assumptions does the pension scheme cover?
The most obvious assumption is that of retirement, but it is not the only one. Pension scheme also covers in case of disability – total, absolute, or severe impairment. Dependency – they also include severe dependence or heavy dependence – and death. In the first three cases, the beneficiary of the plan coincides with the participant – the person who makes contributions to the project. If we talk about death, the person designated by the participant will be the beneficiary.
5. Pension schemes are not liquid
In general, you can only recover the money accumulated in them in case of any of the planned events (such as retirement, disability, dependency) or death. There are other cases in which the participants can rescue their pension schemes, such as a severe illness, unemployment after having exhausted the public unemployment benefit, a foreclosure on the residence, and the rescue of the heritage associated with the contributions more than ten years old (from 2025).
6. You can have several pension schemes
The same person can contract several pension schemes at the same time. It is common to have an employee pension scheme, to which your company contributes, and an individual one, in which it is the participant himself who makes the contributions. It is convenient to remember that you can transfer the assets of one plan to another without any cost and without having to pay taxes to the Treasury.
7. It has tax advantages:
- Reduce the tax base of personal income tax: in practice, this tax benefit will be more significant when the income and contributions of the participant are higher. Similarly, it will depend on the community in which it resides, since it defines the applicable marginal rate.
- Defer taxation until the collection start date
- Links taxation, as of the date of retirement, to the amounts collected annually – loans will be included within the general tax base.
Currently, the reduction in the general tax base based on annual social security contributions applies to amounts less than 8000 pounds or 30% of work income. Since January 2015, the maximum contribution to the social security system with the right to deduction in the tax base for spouses goes from 2000 to 2500 pounds, which means that the total net income of work or economic activities of the couple has to be less than 8000 pounds.
But not only must the tax advantages be taken into account at the time of contributions, but it is essential to take into account taxation when we make the rescue.
Additional information on pension schemes
Exceeding limits may lead to penalties.
No manager should allow contributions to exceed financial limits – maximum annual dues. However, when we contract several pension schemes, this may occur. We can withdraw excesses before June 30 of the following year without the applying of a penalty. Failure to comply with the limits is punishable by a 50% fine used to excess.
We can also exceed the percentage limit – 30% of work income – as long as it does not exceed the financial limit (8,000 Pounds).
We start with a management committee, which is charged by the managing entity for administering and managing the pension fund. That cannot exceed 1.5% per year on the value of the position account. Then there is the deposit commission, which is the one charged by the depositary entity for guarding the estate.
This commission cannot exceed 0.25% per year on the value of the position account. In the management fees that are applied based on the results, the cap will be 1.25% per annum on equity plus 9% of the result obtained. And depositary entities may receive commissions for the liquidation of investment operations of pension funds.
To attract clients or get current ones to contribute more money to their plans, pension scheme managers pull bonuses and gifts. Coinciding with the last months of the year, they encourage savers to reach the maximum tax-deductible contribution (8,000 Pounds), with the promise of a prize ranging from 1.5% to 5% depending on the entity and, above all, of the commitment of permanence.
When the time comes to collect the plan, the benefits are monetary and can be in the form of:
- Capital (in a single amount)
- Rent (two or more successive payments are received regularly, including at least one payment in each year)
- Mixed benefits (combine capital and income)
- Free, without regular intervals
The rental option, in turn, can be life-long (fees for the rest of the beneficiary’s life) or temporary (periodic payments for a specific time). It is not clear how many pension schemes are there in the UK, but an approximate number is 6000.
How else do pension schemes work?
Pension schemes are an investment product
Pension schemes are a product of savings and investment. These products have a pension fund, similar to an investment fund, where we will invest our money. We will be making more or less periodic contributions to the plan, and spend this money on the portfolio of the pension fund that we have chosen.
In a pension scheme in the UK, we know where we will invest our money.
As we have seen, company pension schemes invest our money in auto-enrolment pension funds. These funds will consist of stocks, bonds, debt, and other types of assets. There are currently thousands of funds from which we can choose according to our profile. It is essential not only to choose “long-term fixed income” as a pension fund but to know the types of assets where our money will be, the sector, the terms, etc.
We understand that with a workplace pension scheme, we can lose money.
As we have seen, pension schemes are investment products, so our money will change with market fluctuations and, if there are downward changes, we could lose the capital invested. Although there are guaranteed auto-enrolment schemes in the market, the vast majority are not, and that is why we must know the basic notions of investment to go to these products.
Active pension scheme management.
Following the topic of the previous section, knowing that our money is invested in a local government pension scheme, we must understand that we should not only contract a pension scheme and leave the same plan until our retirement. On the contrary, we must make an analysis of our money in these products and change them if we believe it is necessary. Remember that transferring our money between pension schemes does not cause any extra expenses or loss of tax advantages.
We will not be able to rescue a pension scheme until retirement.
As stated above, pension schemes are illiquid. Which means that we will not be able to recover the money contributed until the moment of our retirement or in certain situations such as long-term unemployment or severe illness. Currently, we can also rescue pension schemes that will be more than ten years old after 2025. However, we must remember that although they have shortened the term for liquidity, they are still products that do not allow us to get the money when we want.
That’s is all you need to know about pension schemes in the UK before you retire. While retirement is the right choice, one must not take a step in the direction unless, of course, they are pretty sure about everything. They should also be clear about auto-enrolment rates and auto-enrolment thresholds.
Sometimes citizens have the wrong ideas about pension schemes and end up getting a retirement, which does not benefit them at all. In that case, you must understand all the consequences of your withdrawal and what will happen as a result of the employee pension scheme. Failure to do so can be very problematic in the long term financial future of you as an individual in this economy.
Shoaib Aslam is the co-founder of Pearl Chartered Accountants, a UK-based chartered accountancy firm that has multiple locations across London. They are experts in helping startups and established businesses with all aspects of growth, strategy, scaling up, accounting and tax planning.