Here are a few typical questions relating to pension costs.
How much do I need to save for a pension?
This is a big question that really depends on how much you need to be able to retire comfortably and how much you can afford to pay. It gets more expensive to purchase pension benefits the older you get therefore it is important to start saving as early as possible.
Members of DB schemes normally pay a percentage of salary as per the scheme rules, with the employer funding the rest of the cost of providing the pension. If the member thinks they will need more than the estimated pension at retirement, they could pay Additional Voluntary Contributions to the scheme (if permitted) or pay contributions to a personal pension scheme.
For DC schemes this is particularly important and there are several options that can be considered.
Annuity Purchase
If the member intends to use some or all of the pension fund to purchase an annuity, the table shows figures for a male using the Age UK Pensions Calculator to give an indication of costs.
| Age | Retirement Age | Retirement Income p.a. | Pension Savings needed per month |
| 25 | 65 | £13,666 | £243 |
| 25 | 60 | £10,258 | £243 |
| 30 | 65 | £13,666 | £300 |
You can see that a 25 year old would need to save £243 per month to get a pension of approximately £13,666 per annum at age 65. If he decides to retire at age 60, that same amount would only produce a pension of £10,258 per annum. Alternatively if he waited until age 30 to start contributing his savings would need to increase to £300 per month to provide the same pension at age 65.
Whilst for young people retirement may be too far off to think about and then there are other financial commitments such as children and the mortgage etc. pension savings should not be forgotten. It’s never too late to start!
Flexi-Access Drawdown
Where a member does not intend to purchase an annuity with their DC funds they can consider this alternative where funds are drawn down and used as income. The member needs to ensure that the fund is big enough to provide the required level of income.
What do I need to consider?
The basic questions for people to consider are:
A company pension makes saving easy as contributions are deducted by the employer before the net pay is received.
The scheme rules will state how much a member needs to pay and it is normally expressed as a percentage of salary. The member contribution is often matched by the employer, in fact the employer usually pays a lot more!
What is the maximum amount of contribution I can pay?
A member can pay as much as they like into a registered pension scheme. If certain conditions are satisfied, tax relief on member contributions will be available up to 100% of their relevant UK earnings or £3,600 if higher. If, however, the Annual Allowance (currently £40,000) is exceeded (see description of Annual Allowance below), there may be a tax charge payable by the member.
The Annual Allowance is the maximum amount of pensions savings an individual can have each year that benefits from tax relief. Pension savings include monies paid by the member, employer or a third party. For DC schemes, the pension savings are the contributions paid in the period however, for DB schemes, the pension savings are the increase in the value of the member’s benefits during the period.
Since 6 April 2015, there has been a Money Purchase Annual Allowance (MPAA) of £10,000 for members who flexibly access money purchase benefits. If a member has money purchase input after flexibly accessing money purchase benefits, they would pay a charge on the money purchase input that exceeds £10,000. If they also have DB benefits then an alternative allowance also applies to those inputs which is currently £30,000 i.e. £40,000 - £10,000.
Since 6 April 2016, the Annual Allowance has been tapered for those members whose income exceeds £150,000. For those affected, the allowance is reduced by £1 for every £2 of income above £150,000 per annum. Anyone earning over £210,000 will have their annual allowance capped at £10,000.
How does tax relief work on the contributions?
There are two methods:
Relief at source – this means that pension contributions are deducted from pay after tax and national insurance contributions have been deducted. The pension scheme provider then claims the tax back from the government at the basic rate of 20%.
For example a member contributing £100 will only have £80 deducted from their salary but £100 will be invested. It works the same way for higher rate tax payers. In the case of higher rate tax payers, the member has to reclaim the tax relief on their higher tax rate above the 20% on their annual self-assessment return to HMRC.
Net pay arrangement – in this case the employer takes the pension contributions from a member’s gross pay before tax is deducted which effectively means full tax relief is given.
For example for a basic rate tax payer, if a £100 pension contribution is deducted from their gross salary and paid to the scheme, their net pay would only be reduced by £80.
