Five pension myths you need to stop believing

Written by: David Smith
Despite the best efforts of pension freedoms, pension simplification and other such initiatives, pensions remain anything but simple. Here are five of the most common pension misconceptions.

1) My pension fund is mine

Although the saver is the beneficiary of their pension fund, it is typically owned by a professional trustee or trustees, until such point when the saver takes retirement benefits.

While many may feel this contravenes their wishes, it can in fact be highly beneficial; a pension fund is therefore classed as being outside a deceased’s estate for inheritance tax (saving up to 40%). Ultimately, the trust arrangement is designed to protect your savings, not keep them from you.

2) Other investments are more tax efficient than a pension

Pensions are the most effective tax efficient savings vehicle in the UK.

  • They can provide immediate income tax relief of 20%
  • 20% additional income tax relief for higher taxpayers and 25% for additional rate taxpayers
  • They grow completely free of income tax, dividend taxation and capital gains tax
  • Death benefits can be paid free of inheritance tax
  • Upon retirement up to 25% of the fund value can be paid free of tax
  • Income from pension funds can potentially be controlled and drawn in a tax efficient manner
  • Payments made by an employer obtain relief against corporation tax

Obviously, there are limits to many of these allowances, but it is clear to see the merits of such a plan. There are alternative investment vehicles available that offer worthwhile tax breaks, but they tend to be inherently risky and subject to stringent qualifying criteria.

3) I have to use my pension to provide an income in retirement

Perhaps the biggest downfall of pensions is that for most people, you cannot gain access to your pension fund until you have reached 55 years old. Understandable, considering it is a retirement savings vehicle.

Thanks to pension freedoms though, once you reach 55, there is more flexibility than ever in terms of accessing your pension savings. Gone are the days when you had to use your fund to provide an income subject to limits which may or may not have been sufficient for your needs. Today, you can take income / lump sums in any combination you see fit.

4) I’ll be taxed 55% on my whole fund if I breach the Lifetime Allowance

Much ado has been made of the reduction to the Lifetime Allowance, that is, the maximum amount of pension savings that can be built up over a lifetime (currently £1m) before a tax charge becomes potentially due. Yes, the Lifetime Allowance has continually been reduced over recent years making it a threat to the wider public, especially those with Defined Benefit (Public sector etc.) pensions. And yes, the tax can reach up to a highly punitive 55%.

However, this tax is only due on the excess above the lifetime allowance limit – not the whole fund. Therefore, the concept of turning down an employer pension contribution for fear of this charge may be slightly over the top

There are also other things to consider. With good financial planning, you can control your exposure to a Lifetime Allowance charge through timely drawings from your pension fund.

5) My pension dies with me

This is perhaps one of the most frequently asked questions, as many fear their lifetime savings will disappear in the event of their death. While actual death benefits vary from plan to plan, if death occurs before the age of 75, typically the fund can be paid as a lump sum to any beneficiary / beneficiaries of your choice. Above all, it’s tax free.

If death occurs after age 75, it can still be paid to any beneficiary as a lump sum, but at the beneficiary’s marginal rate of income tax.

However, perhaps the biggest win of the pension freedoms legislation was the ability for beneficiaries to inherit the pension plan itself. They take ownership of the plan, it remains outside of their estate for inheritance tax purposes and can be drawn upon, as income or lump sums when they see fit.

David Smith is regional director of financial planning at Tilney

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