In part 1 of this retirement quiz, we looked at the various options most of us will have to provide for ourselves in retirement. In this second section, we drill a little deeper to bust some of the jargon associated with pensions. We also consider how you may be able to claw back seemingly lost pension-tax benefits and look at the practicalities of drawing an income in retirement, as well as a couple of key imponderables.
So, can you answer these questions?
- What happens to my unused pension tax allowances?
- To what extent can I continue relying on the state pension?
- When will I begin getting the state pension?
- Will receiving the state pension mean I have to stop working?
- Is the state pension paid automatically once I reach the right age?
- When will I be able to access my other pensions, including workplace pensions or SIPP?
- What’s the difference between “defined contribution” and “defined benefit” pensions?
- How many years will I need a pension for?
Now compare your answers with ours below.
1. What happens to my unused pension tax allowances?
Unlike the annual £20,000 allowance you get with an individual savings account (ISA), any part of the £40,000 annual pension allowance can be carried forward into the following three tax years1. For the self-employed, especially, this is a major incentive, given the potentially volatile nature of their earnings. Why? Because if proverbial feast follows famine and your earnings enjoy a strong uplift one year after a few bad years, you may be able to invest as much as £160,000 in your personal pension in just one year and catch up on those years when you were unable to make adequate provisions for your retirement. Just remember to have a pension open in the first place and to have actively contributed something to it in those preceding years.
2. To what extent can I continue relying on the state pension?
In recent years, the state pension has been subject to a "triple lock" that guarantees an annual rise by either the prevailing rate of inflation, the rate at which average earnings increase or 2.5% – whichever is highest. But this was suspended for the 2022/23 tax year due to the unusually high earnings growth seen as the UK economy emerged from the pandemic. There is also some debate as to whether guaranteed uplifts in the state pension are sustainable in the long run, given the growing cost of pensions to the government as people live longer.
Why does that matter? Because without these yearly rises, the state pension may struggle to keep up with inflation, leaving pensioners unable to maintain their standards of living. It is more reason to protect yourself by building a pension pot that can outstrip inflation, while you still can.
3. When will I begin getting the state pension?
The earliest age you can currently begin getting your state pension is 66. However, this threshold rises the younger you are. So, if you are aged 60 or less right now, you probably won’t be able to receive it until you reach 67. And if you were born after 5 March 1978, it’s 68. For a more precise check on your own state pension age, just tap your date of birth into this government calculator.
Why does knowing your state pension age matter? Because if you want to retire earlier, you may need additional funding before your state pension kicks in and would need to plan your finances accordingly.
4. Will receiving the state pension mean I have to stop working?
No. You can continue working for as long as you want and can continue doing so. You may even be able to persuade your employer to let you work more flexibly or part-time, while still drawing the state pension. Something else to think about if you want to ease yourself into retirement both before and after the state pension age.
5. Is the state pension paid automatically once I reach the right age?
No. You have to claim it and are usually invited to do so by letter in the run-up to your state pension age. If not, your pension is automatically deferred. However, on the plus side, the income you would be entitled to increases for every week you defer (assuming you defer for at least nine weeks). This increase works out at just under 5.8% for every 52 weeks and may be something else to consider when planning your retirement finances.
6. When will I be able to access my other pensions, including workplace pensions or SIPP?
The short answer is usually a lot sooner than your state pension – which is another reason to consider topping up your workplace pension and/or making additional provisions through a SIPP. New rules introduced in 2015 allow individuals with a “defined contribution” pension – which includes all SIPPs and, increasingly, a majority of workplace pensions – to access their pension from as early on as age 55 (rising to 57 in 2028). What’s more they can access these funds in a number of ways and get the first 25% tax-free, whether as one lump sum or as a series of lump sums2. Just remember, when doing this, that the money may need to last you 30-plus years.
7. What’s the difference between “defined contribution” and “defined benefit” pensions?
These two terms get bandied around a lot, often without adequate explanation. In essence, what they describe is how a workplace pension is funded – whether it’s the employer’s job to pay you a set income when you retire or whether your income is likely to depend on how much has been paid into your pension in the first place and how much this invested pot of money has grown3. With a defined benefit or DB (aka “final salary”) pension, an employer agrees to pay you a proportion of your salary at a given date. It's often worked out as the number of years you worked for a company or public sector body multiplied by a pre-set fraction multiplied by your salary. A defined contribution or DC (aka “money purchase”) pension, on the other hand, puts more of the onus on you.
Unsurprisingly, given the difficulties companies could face in meeting their obligations as people live (and need a pension for) longer, DB pensions are becoming rarer and DC pensions are increasingly becoming the norm.
It’s more reason to start saving earlier for your retirement and doing so regularly!
8. How many years will I need a pension for?
We can't answer that but if you’re hoping to retire early, you’re clearly going to need an income for longer than would otherwise be the case. Life expectancy, broadly speaking, is also still rising, notwithstanding the slight dip reported in the UK recently due to the Covid-19 pandemic. The latest estimates from the Office for National Statistics show that life expectancy at birth is 79.0 years for males and 82.9 years for females. But this rises to 83.5 and 86 years, respectively, if you make it to 65. What’s more, the most common age at death in 2018 to 2020 was 86.7 years for males and 89.3 years for females. And there were 609,503 people aged 90 or over and 15,120 centenarians. Research also shows that there is a one-in-two chance that one or other of a couple now retiring will still be alive at age 95. And it rises to 60% for people born in 19704.
Your own chances of living that long will depend on your gender, lifestyle and DNA, and when and where you were born. The bottom line, though, is that many people may underestimate how long their pension will need to last them.
If you knew all the answers already, well done – you are a pensions guru and are probably already planning for a prosperous retirement. If you struggled, don't worry. It's never too late to learn and to start investing for your retirement. To find out more, check out the various blogs and educational articles we regularly publish on the Vanguard website or sign up for our newsletter by filling in your details at the bottom of this page.
Play around also with our pension calculator to get a greater sense of where you might be headed and what you might be able to improve your chances of reaching your retirement goal (or sign up to Vanguard Personal Financial Planning and gain even greater insight).
1 As of 2021/22.
2 The rest of your retirement income is taxable, subject to your annual personal allowance.
3 After costs.
4 Cox, P., Helping consumers and providers manage defined contribution (DC) wealth in retirement, Birmingham Business School, February 2015.
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