Top ten tips to building your pension pot

WITH so many companies closing their final salary pension schemes and payouts falling, more people than ever before are having to take personal responsibility for their retirement funds.

Richard Johnston, a chartered financial planner with Murray Asset Management, offers his top ten tips on setting up the pension scheme that is right for you.

EMPLOYER CONTRIBUTION

Find out whether your employer offers a pension scheme to which it will make contributions, as this could add up to a substantial benefit compounded over many years. To not take advantage is akin to rejecting a pay rise. Nowadays, however, the scheme is most likely to be centred on a personal pension plan (which will probably be less generous than a final salary scheme).

HOW GENEROUS?

Typically, an employer may offer to make contributions of 5 per cent of salary if you match this with contributions of 3 per cent. In this scenario, a basic rate taxpayer may increase their pension pot with contributions of 8 per cent in return for a 2.4 per cent reduction in take home pay (the employee contribution receives 20 per cent income tax relief, reducing the effective cost). Some employers may offer higher contributions if you agree to match them, significantly improving the funding level.

STAKEHOLDER PENSIONS

An employer with five or more employees is currently required to provide access to a stakeholder pension, although there is no requirement for it to contribute. Stakeholder pensions are not for everybody as they can lack flexibility and investment choice, but they do present a simple and convenient home for pension contributions.

AUTOMATIC ENROLMENT

Under new legislation coming into force from October, effectively all employers will be obliged to make contributions on behalf of employees. It will take effect gradually over the next four years, with larger organisations participating first. Employers without an existing suitable scheme may decide to enrol employees in the National Employment Savings Trust (Nest), a government scheme being set up to assist in the implementation of the new rules. Employees will be asked to contribute as well and, by default, they will be enrolled in the scheme, but can elect to opt out of it.

BONUS SACRIFICE

This is an extremely tax-efficient way of boosting a pension pot. For example, a basic rate taxpayer who recently received a Christmas bonus of £1,000 might actually have seen only £680 (ie £1,000 minus 32 per cent in tax and National Insurance). For their part, the employer’s cost would have been £1,138 (£1,000 to the employee and £138 to the Treasury as employer’s NI). Had the bonus been paid as a pension contribution directly by the employer, however, there would be no tax or NI to pay so the whole £1,138 could go to the pension pot. Not all employers may agree to this and, if they do, some may decide to retain some of the tax saving for themselves.

SALARY SACRIFICE

Similar to bonus sacrifice, this works by reducing your ongoing salary but is more complicated and may require a change in your contract of employment. Your existing salary can continue to be used notionally for the purposes of obtaining a mortgage, calculating employer benefits (such as life insurance).

TAX RELIEF

Pension contributions receive income tax relief that means a basic-rate taxpayer can boost their pension pot by £1,000 with a payment of £800 (ie 20 per cent tax relief). For a higher rate taxpayer, the same contribution may cost just £600 and the relief can increase even further for certain other individuals to a point where it becomes extremely cheap to fund a pension pot. The government may review the relief available in the near future, however, and so higher-rate taxpayers, in particular, should consider their circumstances now rather than later.

CONTRIBUTION LEVEL

It is important to try to ascertain the level of income needed for a reasonable standard of living in retirement, but working out what income the pension fund might provide, based upon a certain level of contribution, might not be so easy. Nevertheless, do review your level of contributions from time to time to get an idea as to whether these are sufficient to meet your pension “target”.

SET-UP AND ADMINISTRATION

The charges on pension plans can usually be summarised thus: those relating to the plan itself; to the investment funds held within the plan; and to advice obtained from a professional (eg an independent financial adviser). The old adage, “you get what you pay for”, can be as true of pensions administration as of any other service industry and, in many cases, higher charges may be negated by a superior level of capital growth, increased tax saving or flexibility. Equally, however, it is possible to pay too much for your pension.

DRAWING BENEFITS

Upon retirement, many people use their pension fund to buy an annuity, which provides a guaranteed income for life. Annuity rates have fallen in recent years and more retirees are opting for “income drawdown”, whereby sums (up to a certain limit) can be drawn from the pension fund each year while the remainder continues to be invested.