Saving for your Retirement

Saving for your retirement is one of the most important financial steps you will ever take. Save too little and you may struggle in retirement. If you have a pension, how can you maximise your pension contributions and make them more effective?

• How the new regime makes things simpler
• How you can maximise your pensions' contributions
• AVC or FSAVC - it's your choice
• Why the stakeholder option may make sense

How the new regime makes things simpler

In place of eight different tax regimes governing pensions, each with its own complex rules limiting the amount you may contribute to a pension scheme and the consequent benefits the scheme can pay out, in April 2006 a new simplified set of pensions rules were introduced.

Each individual now has a single lifetime allowance on the amount of pension savings that can benefit from tax relief. The value of the lifetime allowance for the current tax year (2007-08) is £1.6m and is set to rise as follows:

• 2008-09 - £1.65m
• 2009-10 - £1.75m
• 2010-11 - £1.80m

The lifetime allowance is to be reviewed every 5 years.

Within the lifetime allowance, the limit of your contributions to your pension is no longer linked either to your earnings or your age. The annual contributions allowance was initially set at £215,000. For the current tax year (2007-08) it is £225,000. It will increase steadily each year such that in 2010-11 it will be at £255,000 for contributions to defined contribution schemes (which include money purchase schemes and personal pensions) or increases in accrued benefits in defined benefit schemes (final salary pension schemes). The level of the annual allowance will also be reviewed every 5 years.

Contributions are no longer limited to a fraction of capped earnings. Individuals may make unlimited contributions and tax relief will be given on the higher of 100% of relevant earnings or £2,808. However where the annual contributions exceed the annual allowance there are hefty tax penalties on the excess.

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How you can maximise your pensions' contributions

If you are a member of an occupational pension scheme, your employer may already be deducting a portion of your salary and paying it into the pension scheme. However, it is unlikely that the pension contributions you are paying are the maximum allowable (unless, perhaps, you are a director of a FTSE 100 company, a premier league footballer or a rock star).

The tax rules governing defined benefit occupational company pensions mean that the maximum pension allowed is two-thirds of your final salary. But to get that level of pension you will need to have worked for the same employer for around 40 years and that is very unusual nowadays.

If you are a member of a defined contribution occupational pension scheme or personal pension the size of the pension you will receive will depend on the size of your accumulated pension fund on retirement and the return on offer from any annuity you may purchase with it.

If you wish to pay more into your occupational pension scheme, in the first instance you should approach your employer or the scheme trustees to find out how you can increase your existing contributions. You may be able to do this. If the scheme does not, for whatever reason, allow this, you have the option of contributing to other pension arrangements.

Check with your independent financial adviser whether you can pay more into your pension scheme and whether you should start a Stakeholder Pension (if you haven't already got one).

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AVC or FSAVC - it's your choice

Traditional employer-sponsored schemes are defined benefit, based on final salary, although there has been a distinct shift to defined contribution money purchase arrangements, particularly for new members of staff and/or younger employees.

Up until April 2006 restrictions on how much you could put into a company and personal pension at the same time sometimes meant that Additional Voluntary Contributions (AVCs) sometimes offered the only option for topping up your pension.

However, now you may save as much as you like into any number of pensions schemes (company and personal including stakeholder), including through AVCs and Free Standing Additional Voluntary Contributions (FSAVCs).

FSAVCs are policies sold by insurance companies specifically as a vehicle for topping up a company pension scheme. However, they tend to be more expensive than AVC schemes because your employer may be subsidising the costs of the in-house AVC scheme.

AVCs enhance the benefits available from your main pension scheme, such as by offering "added years" to a defined benefit scheme, increasing the proportion of your final salary that you will achieve as a pension. With money purchase schemes, an AVC scheme acts to increase the size of your pension fund and, thus, the size of any annuity you may eventually purchase. However, your choice of investment is limited to that offered by the company scheme. The advantage of FSAVC schemes is that you have the choice of where your funds are invested.

However, members of occupational pension schemes may now also pay contributions to personal pension schemes as well. In fact the only limits on how much you may save into your pension, and obtain tax relief, are the annual limit and lifetime allowance.

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Why the stakeholder option may make sense

Most people aged between 0 and 75 may take out a Stakeholder Pension. A scheme can be started with as little as £20 and it is not necessary to make regular contributions. People who cannot take out a stakeholder pension are those in an occupational pension scheme who are controlling directors and those earning more than £30,000

Then there are the tax advantages. The annual limit that can be saved in a stakeholder pension is £3,600 gross a year, without reference to earnings (otherwise it is age and salary related), which includes basic rate tax relief, or 100% of earnings. So for instance in the case of the £3,600 limit, you pay in £2,808 and the government makes up the rest. Higher rate taxpayers may reclaim the difference between basic and higher rate tax relief via their annual tax returns.

The Stakeholder was designed to work on its own and alongside other pension schemes as a top-up to a company or private pension, as long as you don't exceed the pensions limits. They are not available to controlling directors earning more than £30,000 a year.

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23 January 2008 © Moneyextra.com

Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.