boosting your pension
There is no question about it: many people in the UK face a low level of income in retirement. So, it’s important to review the state of your pension planning regularly to check if it is on target to give you the income you need when you retire.
If you need to boost your occupational pension* scheme, there are three main ways of doing so:
- you can pay extra contributions into a pension scheme to build up additional benefits;
- you may be able to start taking your pension later and increase your pension;
- if your employer offers it, you can use what’s known as ‘salary sacrifice’ where part of your pay is in the form of pension contributions.
You also need to check that increased contributions don’t breach the tax limits, and annual and lifetime allowances.
And if you are thinking about boosting your pension it’s worth considering getting financial advice to help you make sense of the choices out there.
Making extra contributions to your employer’s scheme
One common way of making extra contributions is to use an additional voluntary contribution scheme (AVC*) run by your employer. Until April 2006, AVCs were offered by all company schemes. Since April 2006, the rules have become more flexible so that you can pay your extra contributions into any type of pension scheme and now employers who run occupational schemes no longer, by law, have to arrange for their employees to pay AVCs. However, many continue to do so voluntarily.
These ‘in-house’ AVCs work in two main ways – added years scheme and money purchase schemes.
Added years schemes
This option is available only with salary-related schemes and mainly in public sector schemes such as those for teachers and NHS workers.. The pension you get in a salary-related scheme is linked to the number of years you belong to the scheme and how much you earn (see Salary related schemes). These additional contributions are used to buy added years in the scheme which increases the size of your pension. The cost of buying extra years generally increases the closer you are to normal retirement age.
Money purchase schemes
With money purchase AVCs, your contributions are invested to build up a fund which can be used to increase your pension or tax-free lump sum*, or buy other benefit such as life cover. As with money purchase schemes generally the amount of pension you get will depend on the amount paid into the scheme, the investment returns and charges.
Other ways of making extra contributions
If you are a member of an occupational pension scheme, current tax rules mean that you may be able to use a stakeholder pension* or a personal pension* to build up extra pension. You don’t have to use your employer’s AVC scheme.
Instead of taking out an in-house AVC scheme offered by their employer, many people in the past were sold what are known as free standing AVC schemes (FSAVCs) by insurance companies and advisers. FSAVCs are basically the same as personal pensions but often have very high charges compared to in-house AVC schemes.
Now that the rules have been changed so that you can pay extra contributions into any type of pension scheme, the important thing is to compare which type of scheme offers the best deal for you in terms of charges and risks.
Taking your pension later
If you retire later than the normal pension age for your pension scheme, you may be able build up additional pension if the scheme allows it. The way you build up the extra pension depends on the type of the scheme.
For example, if your scheme is salary-related, say a 1/80th scheme, then you may be able to build up your pension at a rate of 1/80th of salary for each extra year of scheme membership.
If it’s a money-purchase scheme you may be able to get a bigger pension if you put off taking your pension beyond the normal retirement age for your scheme because:
- the pension fund is invested for longer and will continue growing if investment returns are in your favour. However, you could be unlucky if the value of your pension fund falls due to poor investment returns. You should take very little risk with your investments in later life;
- extra contributions may be paid into the scheme. But you need to check the rules of your particular scheme to see if your employer carries on making contributions on your behalf after normal pension age.
Salary sacrifice
Another way of boosting your pension is to get part of your salary paid in the form of employer’s pension contributions. This boosts the amount of money going into your pension. So check if your employer offers this option.
Salary sacrifice can offer tax advantages for both you and your employer. However, on the other hand it could affect your entitlement to the additional state pension* as the amount you get is linked to your earnings over the period in the scheme.
Personal pensions
With personal type pensions, you can increase your contributions into your stakeholder or personal pension but as with pension schemes generally check that you don’t breach the tax or annual and lifetime allowances.
The other thing to watch out for is risk. If you are already investing into an insurance company’s personal or stakeholder pension it might be worth considering choosing a different provider’s personal pension scheme for the extra contributions so your eggs are not all in one basket. The crucial point is though that if you are not confident about choosing between different providers or assessing risk, then you should get advice from an independent financial adviser.
Other ways of boosting your pension
There’s nothing that says you have to use a pension scheme to boost your income in retirement (or indeed even use a pension as a way of saving for retirement in the first place at least until the new pension reforms are implemented – see Pension Reforms ).
There are other ways such as investing in individual savings accounts (ISAs), non-pension type investments such as unit trusts or investment trusts, or using property. But it is important to remember that there can be significant tax advantages using a pension scheme.
Individual savings accounts (ISAs)
An ISA is just a tax-free wrapper for savings or longer term, stock-market type investments such as unit trusts or stocks and shares, and insurance. With an ISA you can save up to £7,000 each tax year and not pay tax on the income you receive from your investment - although you don’t get tax relief on the contributions you pay in unlike pension schemes.
There are two types of ISA – a maxi-ISA and a mini-ISA. You cannot invest in both a maxi-ISA and a mini-ISA in the same tax year.
A maxi-ISA can include both cash savings and stock-market type investments such as unit trusts or stocks and shares, and insurance. You can open only one maxi-ISA each year and the total amount you can invest is £7,000 in each tax year - £3,000 of this can be in the cash element.
Mini-ISAs come in two types – cash ISAs and stocks and shares ISA. You can invest up to £3,000 in a cash ISA and £4,000 in a stocks and shares ISA. You cannot invest in more than one mini cash ISA, or more than one mini stocks and shares ISA in the same tax year.
ISAs are not as tax-efficient as pensions but can be more flexible as you can get your money back at any time – however, some may prefer the discipline provided by pensions as access is restricted. You can get more information on how ISAs work from the HM Revenue and Customs website.
You could of course invest in products such as unit trusts outside of an ISA but you wouldn’t get the same tax benefits. However, you could consider this option if you have already invested up to the ISA annual limits.
Property
Property prices in the UK have performed very well over the past 30 years. Perhaps not surprisingly many people have been tempted to rely on property as a way of providing for retirement, or boosting income in retirement. This can be done for example by trading down to a smaller property, taking out an equity* release scheme or investing in other properties through buy-to-let schemes for example.
However, care should be taken. Relying on property to fund a decent income in retirement is a risky strategy. There is no guarantee that property prices will continue to deliver the same returns in future and equity release schemes can be complex and expensive. So, unless you are very confident about assessing the risks associated with using property, you should seek independent, qualified financial advice.