Basic info about pensions being poorly understood!

[Chewbecca]

I'm distressed at the lack of understanding about different types of pensions shown by many posters on the thread about potential marriage to enable a good friend to inherit a spousal pension!

I think there is some really basic knowledge that most people should have but clearly don't, e.g.

State pension (SP)

• entitlement to a state pension comes from your NI contributions (or credits).
• You can find your own personalised record and forecasted SP on gov.uk.
• Current taxpayers pay current pensioners. The payment rules have changed over the years so pensioners get different amounts and start receiving it at different ages and also need different number of years contributions, so never assume what someone else has is what you will have, always check!
• SP is not inherited (some old types were). If it were to be, of course the NI rate would need to be much higher!
• State pension is enough to stop you starving but it provides a very basic standard of living. for example, I need 38 years contributions, it is payable at 67 & is £221pw / £11.5k pa at today's rate.

Personal pensions are therefore needed to top up your SP to your desired level of retirement income, and potentially to enable stopping or reducing work before you reach SP age.

Two main types:
Defined benefit (DB). This is the type you tend to find in the public sector and used to be commonplace in big employers in the private sector but most private schemes closed to new members in the 90s/00s.

• DB is a promise to pay an 'income' to its members from a set age for the remainder of their life, however long or short that may be. The amount paid is usually a multiple of the number of years worked and the salary of the scheme member (typically either their final salary or their average salary).
• pension payments are often index linked (annual rises)
• usually a % of the pension can be inherited by a dependent, usually spouse, sometimes children if dependent.
• contributions into the overall 'pot' are not ringfenced for each individual member. The total fund (if there is one!) needs to be sufficient to pay the pensions of all members (past and present), some of whom will draw for a very short time, others for a very long time. Actuaries work out how much the total pot needs to be to pay all those obligations, so they use data on life expectancy and pay rates etc.
• each DB scheme has its own set of rules on when they can be drawn, how much they will increase, what happens on death of members (including spousal provision) etc.
• many schemes allow a tax free lump sum when the pension starts to be paid, again the amount is determined by the scheme rules
• the risk of living a long or short life is taken by the pension fund, not individuals. The pension fund is like a collective, you share in it together with all your present and former colleagues.

Defined Contribution (DC)

• very common type of pension for private sector workers today
• pots of money held by individuals, invested in funds / stock market over the long term
• saved into by individuals and employers are obligated to contribute to individuals' pots (subject to various rules)
• can start to withdraw when over 55 (will be 57 soon)
• 25% of the pot can be taken tax free (could be in one or more lump, or 25% of each draw)
• you can draw the pension monthly, yearly, ad hoc, however you choose. Individuals need to work out how to time their withdrawals. The risk of living a long / short life is on the individual saver. The remainder is usually left in the pot so continues to (hopefully) grow.
• since this pension pot is the savings of an individual, it is inheritable. It used to be outside of your estate for IHT purposes, but, since the recent budget, it will become part of your estate in future.

Please correct me if any of the above is wrong and add your own key points!!

Well said. Extremely poor, all the incorrect advice given. Op sounded pretty switched on thankfully, and lovely.

I have started to draw my DC private pension this year. I don't need it yet, but if I leave it, I could end up having to draw larger amounts out which may put me in a higher tax bracket, or if there is a large pot left when I die, it may be subject to 40% iht. It's a balancing act but you don't know the ending.
Rather than take the 25% tax free in one lump, I am withdrawing a monthly amount made up of 25%tax free, 75% taxed, at 20%. After 4 months my remaining tax free pot is higher than it was before I started to draw tge money, so by dripping it out I should receive more tax free. As I don't need the money, I am putting it straight into an ISA so it will continue to grow tax free.
There are lots of rules about having to see a financial advisor before drawing the money, and there are loads of videos on youtube explains how private pensions work. Once you get your head round the jargon, it isn't particularly complicated.

That's a great rundown @Chewbecca - i hope it will help a lot of people.

Wow such an informative post, I find it very confusing so that's really helpful.

My NHS pension is also a minefield that I have buried my head in for years!

Thank you. Are there YouTube videos you recommend?
I wasn't aware you needed to have a financial advisor to start drawing the money, only if you want to transfer out of a DB scheme.

There is no mandatory need to see a FA before drawing from a DC pension. Perhaps it is a term the posters pension company have imposed?
Often people are advised to have an appointment with Pension Wise before drawing, it's a free, impartial government service. They don't give advice but they do explain your options quite clearly so are considered to be pretty good. They can't discuss DB pensions though, only DC. (Presumably because DB schemes all have different scheme rules).

Personally I don't worry too much about IHT, believing people save into pensions to provide a more comfortable retirement, so pension income should be the priority financial goal Vs inheritance. If I happen to die younger than planned and my beneficiaries end up paying some IHT, so be it.

NHS pensions - agree, they are a minefield of different schemes!

Just to mention that there's a very helpful FB group about NHS pensions - NHS & Public Sector Pensions.

And that NHS pensions are very good, and worth understanding properly.

Most people don't understand their own pensions (I don't), much less partner's.

That if you have a DC pension your provider will send you a statement of how much you could receive in retirement, but you need to understand how that is calculated. Mine is based on an annuity, so it tells me that for every say, £25,000 I have in my pot if I buy an annuity (guarantee) I will receive £400 per year (increasing with inflation) for life. I found that pretty depressing.

However it doesn’t tell you about the drawdown option where you keep your money invested and take on the risk of your pot going down, but might then be able to draw out double that or more per year. That has massively incentivised me to save into my pension, as there’s a chance of getting a reasonable amount.

Ooh, yes, good point about annuities.

In the past, if you had a DC pot, you had to spend it on an annuity, i.e. exchange your whole pot of saved pension for a promise to pay for a term (either life or a set term). Again, it was putting the risk back on insurance companies and removing it and the decision how much and when to draw. You buy an annuity from an insurance company and the amount of annual income your pot buys varies from person to person (depending on age and health) and company to company, and year to year. You can buy ones which are inflation linked (and will get less per year to start), that pass to a nominated person if / when you die (again, you will get less), there are loads of variables.

Now we have 'pension freedom', we have the choice to buy an annuity with all the DC pot, part of the DC pot, or no annuity at all. Annuity rates have been poor lately so on the whole, people have not bought annuities and just made withdrawals from their pots. Rates have improved recently so they are looking more tempting. It's a big decision! Buying one gives you certainty of your future income.

I think in DC pots you can mix and match: take drawdown for a few years, then buy an annuity later on.
Plus, if you have multiple DC pots you can treat them differently. So use one for an annuity and the other for drawdown if you want extra money.
All this is with the caveat that the government reserve the right to change the rules!

Youtube channels I like, in no particular order.
https://youtube.com/playlist?list=PLRjwfVU_qq2bRnpcC-QkKSHp8LUnC0g0b&si=JE1JDlSk0kveLwdY

With regard to seeing a IFA to withdraw funds, I had 4 different pots which I needed to combine into a drawdown account, 3 no problem, 1 I had to confirm I had taken advice. I am pretty sure it was the company's way of covering their back

Very informative. I taught myself everything there is to know about pensions during COVID as we had a bit of extra money from holidays we couldn't take and a flippant comment from a friend 'put it in your pension' made me become more clued up. Glad I did. I've grown our pensions hugely in the last 4 years but a lot of that is understanding the tax relief aspect of it. I now channel a huge amount of my salary into my (very good) work pension scheme. DH a lot less as his work pension scheme is crap (a capped NEST one) but we view pensions as a combined thing when we retire.

Tax relief - another really important point!

When you pay into your pension, you get tax relief, i.e. if you contribute £80, £100 gets added to your pension. If you are a higher rate taxpayer, even more is added.

(When you withdraw your pension, you do continue to pay income tax, and you continue to have a personal allowance. The personal allowance is pretty much used up with the SP these days. You don't pay NI on SP or pension withdrawals though)

Can we add to the list of the myths the belief that a SIPP (self-invested personal pension) is the same as a personal pension? The self-invested bit is just how the fund is controlled i.e. you decide exactly where you put your money. It's probably not a very good option for most people unless they have some knowledge about investing and are able to actively keep an eye on their portfolio. You can also have a personal pension where you invest the money and pay a fee to have it managed for you. It's probably more suitable for most people.

Excellent post Chewbacca, misunderstandings around the pension abound, such as thinking that anyone retiring after 2016 gets £221.5 a week, or that people retiring before then only get £169.5. when the situation is far more complex.

Thank you OP!
Can you recommend what is a good course of action if you have a history of moving between jobs and being out of work for a couple of periods? Is there a lot of admin involved in tracking down pensions you may have been paying into (small amounts) e.g. in your early 20s?

I worked for a private company for a couple of years when young, then moved on to various public sectors. I probably have records of all except the early private company.

That's not a situation I have experienced @LoveIndubitably but you raise a good point that it is a very good idea for everyone to maintain a file or a list of all previous pensions and keep adding to it as you go through life (start now if you haven't already!).

There is a lost pension finder function on gov.uk
www.gov.uk/find-pension-contact-details

Here is a podcast about exactly that subject, combining pensions
https://meaningfulmoney.tv/2024/11/27/helpful-basics-combining-pensions/

Can I get a head check on my pension plans @Chewbecca ?

I have a defined benefit, final salary public sector, of £2.4k per annum (todays rate) due at retirement age.

Full state pension due at retirement age.

Roughly a pot that will give a £20k per annum annuity (at todays money value) in a sipp.

I'm not planning on saving extra than what is invested as I figured it would just get taxed on the way out in retirement.

So my plan is to pay off my mortgage early with any disposable money between now and retirement age. 🤔

I'm way not expert enough to comment tbh. The posters on the pension board on MSE are very good at critiquing people's plans.
What I would question if I were you is:

• how much do you estimate annual outgoings to be in retirement? Do you have enough projected income to cover that? If not, where will it be funded from? Personally I would prefer to pay tax and have a bigger income but am also using ISAs to top up
• you're missing out on tax relief on contributions, then growth on your contributions including the tax relief (could be very valuable & worth more than what you are saving on mortgage interest)
• don't forget 25% of all withdrawals are tax free too (if you haven't taken the max tax free amount at the outset)
• do you want to retire earlier than SPA - if so, how will you fund those years?

Combining pensions requires a lot of advice. There may be benefits attached to one that you give away by combining. The exception seems to be with local authority pensions. Certainly never move a company pension into another, or to a personal one without asking your company pensions department/actuary what benefits are there.

.

1. You can get free clarification and options information from: www.gov.uk/government/organisations/the-pensions-advisory-service They offer a face to face consultation but not specific advices as to what to do. Unfortunately, there is no real help on public sector pensions (I have been trying for years to find out how mine is calculated)
2. Your previous and current companies may have a pensions actuary who can also tell you what benefits, and they are obliged to provide you with a projection of what might come in payment
3. If you are under state pension age, you can check that here https://www.gov.uk/check-state-pension (if your retirement date is earlier then you may be on classic pension and that is a huge minefield of rules)
4. If you are asked to top up your state pension, and are married, then think carefully if you need to, as your spouse's contributions may give you entitlement.
5. If you are on a lowish income and have no other pension, you will get pension credits, which opens the door for housing benefits and council tax help.
6. If you are disabled, then you will also get other benefits on top (they are not means tested)
7. If you have contracted out scheme previously, this will affect the amount of contributions that are calculated for your state entitlement, and your calculation will show this
8. If you think you have pensions missing, you can trace here, even if the company you worked for is no longer running: https://www.gov.uk/find-pension-contact-details
9. Do not withdraw your pension to put in a savings account, most pensions are performing better
10. Even if you are only 18, start keeping track. Just have a folder and stuff in your basic pension details,contacts, start and end dates in it. (No, your computer will change several times, as will the file formats)
11. If you are offered a company pension, well worth considering as they will contribute. If you are refused, then persist and ask why because you should be entitled to a stakeholder pension