It’s still January. Everybody is eating kale, no one is drinking wine, and I miss pigs in blankets.
While new year resolutions may keep us going for a short time, more often than not these quickly get lost in the fog of the bluest month. But what if you could make just one resolution this year, which would give you many years of happy returns in the future?
This year, resolve to sort out your workplace pension (or pensions plural, as unless you’ve stayed loyal to a single employer you’re likely to have more than one).
Auto-enrolment has swept millions more of us into workplace pensions. The monthly contributions may be coming out of your pay packet, but have you actually engaged with what happens to your money after that?
Most people I speak to don’t know how much is in their workplace pension, have no clue where it’s invested and haven’t given a second thought to what it could be worth when they reach retirement age. Yet it is worth investing some time to gain a greater understanding, as there are few better ways to build wealth.
I’m going to assume that most people reading this article will be paying into a defined contribution pension (also referred to as DC) as this is what the majority of privately owned UK companies offer their staff.
One of the biggest advantages of a workplace pension is that your employer contributes alongside you. There’s tax relief on a combined contribution of up to £40,000 every year for most people, and your savings will grow tax free. In retirement, you can usually take a quarter of your pot tax free.
For all of these reasons, pensions are the most valuable benefit of working. Yet when we consider a new job offer, most of us are probably more interested in the new salary, commute or office canteen rather than finding out about the level of matched funding on our monthly pension contributions.
Make a match
Every company pension scheme is different, and some are more generous than others. Often, employees will be asked to select what percentage of their gross salary they want to pay into the pension scheme. If your employer offers matched contributions, the more you pay in, the more they will too (up to a certain limit), turbo charging your future retirement fund.
As a first step, if you don’t know what level of contribution matching is on offer at your company, resolve to find out. Bear in mind that different matching incentives can be offered for different age groups.
It is also worth considering if there are any other ways you could boost your pension contributions. Paying all or part of your bonus into your pension — provided it doesn’t push your contributions over the annual allowance of £40,000 — can be a tax-efficient way of boosting your pension savings. If you can afford to pay in a bit more every month, consider making additional contributions. Just remember that this cash is going to be locked up until you are age 55 or over.
Look under the bonnet
The average worker never drills into the detail of where their pension is invested. When you join a company pension plan, your contributions are usually invested into the catchily named “default fund”. All employer sponsored pension plans have them, and while most people choose to stick to these, the uplift you could get from being a “self selector” — choosing the funds where your pension monies are invested — could be significant and far more in line with your long-term retirement goals.
Company pension providers are making it easier to find out about the different investment options available to you online. You should aim for a diversified selection of investments and be aware of the level of fees charged on some funds.
If you stick with the default fund, remember that workplace pensions also have a default retirement age. This could be as low as the age of 60, but you can change this if you want to. Why is this important? If you’re invested in the default fund, your investments could be “lifestyled” into less risky assets earlier, meaning you could lose out on investment growth and eventually get less income from your pot.
Marry up your investments
When you’re working out how much you’ll have to live off in retirement, bring your Isa and pension planning together. In recent years, the tapering of the annual allowance for those with adjusted income over £150,000 means pensions have become a less attractive option for higher earners, with their annual allowance gradually reducing from £40,000 to as low as £10,000 a year while receiving tax relief. These individuals have increasingly turned to Isas, venture capital trusts (VCTs) or other vehicles as a way of sheltering money for later life.
But it’s important to “marry” these investment choices with your pension contributions. Couples may find one of them has spare capacity in their £20,000 Isa allowance, and “carry forward” rules could allow you to top up pension contributions from previous years.
Pensions have — perhaps unintentionally — become the ultimate vehicle for transferring wealth between generations.
Money saved within DC schemes does not normally count towards your estate’s value for inheritance tax purposes. Your beneficiaries can leave the money invested without paying any tax on the investment returns or capital gains (although they will be liable for income tax on any withdrawals).
If you die before the age of 75, your pension can be paid tax free to your beneficiaries so long as they take the money or designate it for drawdown within two years.
If you survive beyond 75, they will only pay tax on the money they take from the fund at their normal rate of income tax. Grandchildren with no other income could take £12,500 a year tax free in the 2019/20 tax year.
Other things to consider
Another popular strategy for managing workplace pensions is to consolidate pots from previous employments — administration is easier and it can be cheaper, if the charges of your selected provider are lower than you’re currently paying.
Make sure you check whether any of your existing pensions contain valuable benefits that will be lost if you transfer away. For example, final salary pensions (also known as “defined benefit” or DB plans); guarantees of income or investment returns; early retirement uplift options; a greater entitlement to tax-free cash than the standard 25 per cent and linked life insurance benefits, to name just a few.
For DC pensions worth less than £10,000, another option is to take the whole amount as a “small pot lump sum” from your existing provider. Although a quarter is tax-free, you will pay income tax on the rest. You have to be over 55, and can only do this up to three times.
Taking a small pot will not trigger the dreaded money purchase annual allowance that restricts tax relief on all of your future pension contributions to £4,000 per year. It also doesn’t use up any of your lifetime allowance; a consideration for those whose pensions are pushing up against the current lifetime limit of £1.05m in the 2019/2020 tax year.
Finally, think about who will inherit your pension pot. The paperwork you must complete is called an expression of wish form or beneficiary form. It will take you less than five minutes to complete or update one, yet causes no end of hassle if you die without having done so. Ask your employer or pension plan provider where to get hold of this form — and remember, you need to do this for every pension you hold.
Getting your head around your workplace pension could be the best new year resolution you ever make. It will not only mean a brighter future for you, but for your children, and possibly even your grandchildren.