PROFITABLE PENSIONS
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Old age and retirement may seem a long way away, but it is never too early to start planning. We have a quick guide to the things you need to know.
LThe pensions industry is one of the fastest growing financial sectors in the UK, boosted by extremely favourable tax treatment from the Inland Revenue. Surprisingly enough, however, more than 60% of the self-employed are still without a pension plan. Company directors are usually better provided for, but even many of these are without decent pension schemes. Of those who do have pension plans, many are still not taking full advantage of the tax allowances on offer.
Younger self-employed people in particular — who so often have the most to gain in tax advantages — are the ones who show the least interest in them. It is only when retirement day does not seem quite so far away that most people begin to give them thought.
Yet as a method of planning for the future, pension schemes beat any other legitimate method of saving hands down.
KEY ADVANTAGES
Pension schemes enjoy two key advantages. Firstly, contributions are eligible for tax relief at the full rate — for those paying tax at the higher rate this can be as much as 60p in the pound. Even in the lower tax bands it is still nearly a third of pension contributions: since the abolishment of tax relief on most types of life assurance only pensions enjoy this tax advantage.
Secondly, pension funds are allowed to grow free of tax. This means that the investment funds themselves live in a sort of tax-free haven and wow much faster accordingly. These twin advantages make pension schemes an unbeatable longor short-term investment.
TYPES OF SCHEMES
Literally hundreds of private pension schemes are available. Every major insurance company provides them and many are run in conjunction with the various trade associations. There are two main types of plan to choose from:
0 With-profits plans operate on the basis of guaranteeing a basic minimum pension at the end of a specified period, assuming that agreed contributions are maintained. The funds of these plans are therefore invested cautiously and are attractive to the more conservative person, or to someone nearing retirement age who wants to be sure of the size of his or her pension.
0 Unit-linked schemes are becoming increasingly popular as they are likely to produce a much more attractive pension iii the long term — but there are no guarantees. Pension holders can choose which areas of the stock market they wish to have their funds invested in to achieve the highest gains. They do tend to be more volatile with the possibility of the value of the pension fund going down as well as up, though in the longer term they are generally the best bet.
FLEXIBILITY
A major advantage of the majority of pension plans is that, unlike most life assurance contracts, they are extremely flexible. It is possible, for example, to reduce or increase regular payments. Payments can also be suspended for a while if the policyholder has short-term cash flow problems.
Conversely, most have a facility for accepting single payments of large amounts of money on an irregular basis. This is increasingly popular among those businessmen who like to see what their year-end profits are like before deciding how much to put into a pension, rather than committing themselves to a regular premium at a high level.
Many pension companies also offer loan-back facilities. These schemes allow a policy holder to borrow the value of the pension fund back to use for some other purpose, but this loan must be repaid by the date the pension is due to be paid and therefore security must be offered, usually on the policy-holder's home.
So a pension fund is not quite as inaccessible as many people seem to think, and there are various other ways of using pension funds to creative advantage before retirement day itself arrives.
EXECUTIVE PLANS
Pension plans designed especially for directors are generally called executive pension plans. A typical plan will provide for a maximum two-thirds of final salary as a pension, providing a minimum of 10 years' service has been completed.
A variety of other options can be built into them to provide for widow's benefits and so on. These plans are essentially no different from the ones that exist for the self-employed who are not directors, in that only the money that is paid into the fund can be paid out, but executive plans take full advantage of the different tax treatment of pensions that are set up within limited companies. Also, by directors joining in schemes as a group various other advantages can be enjoyed.
The size of an investment is obviously a personal decision, but generally most selfemployed people pay less into their pension plans as a percentage of earnings than those in employment.
Depending on the age of the policy holder it is possible to invest between 15 and 20% of earnings to quality for tax relief purposes. Very few of the self-employed are paying this amount into pension schemes, so they may not receive such an attractive pension.
Younger people should be thinking in terms of paying in at least 10% of their earnings into a pension scheme, bearing in mind that tax relief will be available on this whole amount. Those closer to retirement who perhaps have never paid into a pension plan before should be thinking in terms of paying the maximum possible to qualify for tax relief.
If you have not paid into a pension scheme for a number of years it is possible to "buy back" your tax relief from previous years. Any pensions advisor can work out how much you may be allowed to put into a pension taking advantage of this method. If, for example, you make very large profits one year you can put a larger portion of it into a pension scheme and qualify for tax relief if you have not been putting money into one in preceding years.
FROZEN PENSIONS
Many advertisements are to be found in newspapers these days concerning frozen pensions. These arise as a result of leaving some previous employ ment where money has been paid into a pension Plan, Different employers operate different sorts of schemes. Some allow for the growth in the size of a pension payable if an employee leaves that employment, but others penalise an employee who leaves the company before a pension is due to be paid. This usually takes the form of freezing the funds available to pay out a pension to an employee who leaves the company at the level the pension fund was at when he left.
In some cases it can be arranged to have these pensions "thawed" by arranging for the funds held by the previous employer to be transferred to a private insurance scheme where it can be allowed to grow again to provide a bigger pension.
It won't always pay to unfreeze a pension fund left with a previous employer. Some companies, like ICI, have provided for very generous treatment of former employees who have left their employment before retirement.
In cases like this the pension is best left where it is, but anyone with a pension held by a former employer should check with an expert to see if they would benefit by unfreezing it. Most insurance companies will do this free of charge and undertake all the complicated work involved in unfreezing it.
LUMP SUMS
All private pension schemes provide for a choice to be made between a reduced pension and a large tax-free lump sum at the date of retirement, or of opting for a larger pension. These lump sums are often used by the newly-retired to buy a retirement home or to pay for a long retirement holiday.
The opportunity to take a tax-free lump sum also offers major opportunities for those taking out pension plans for the first time close to their retirement date. If anyone in this position pays in large sums to a pension plan, taking full advantage of all the tax relief available, then within a few years they might well receive a large portion back of what they have paid in in premiums by way of a lump sum, while still providing themselves with a pension for life.
These are known as free pensions, and they really do work for those nearing retirement who have never had a pension before. Anyone nearing retirement in this position should contact a pensions advisor immediately for a full pensions check up.
WHICH COMPANY?
Insurance companies currently doing well in the with-profits field include Scottish Widows and Equitable Life as well as Norwich Union.
Unit-linked companies doing well at the moment include Legal and General and Target Life but there are scores more doing equally as well.
Whichever plan you choose, don't put off making that pensions decision: the sooner you get started the better.
0 by John McQueen