What is a stakeholder pension?A stakeholder pension is a relatively new type of personal pension. They differ from the old Personal Pension plans in that they have been specifically designed to be simple and flexible to use. Stakeholder pensions are also required by regulation to fulfil the following standards:
- Total annual costs must not exceed 1.5% for the first ten years
- No entry or exit charges
- Minimum contributions of £20 per month must be accepted
- The provider must offer and specify a default investment fund
- The provider must send you a valuation at least once a year
Most employers must by law provide stakeholder pension schemes for their employees if they do not provide another type of company pension plan. If your employer does not offer a group scheme then you should consider an individual stakeholder pension.
If you are unsure whether you should take out an individual stakeholder pension then click here for more information.
When you retire
With a stakeholder pension plan, you accumulate a sum of money, and when you retire it provides you with an income. Unless your pension is very large and you wish to invest it yourself you secure an income by buying an annuity. In addition, you also have the option of taking up to 25% of your pension pot as a tax-free lump sum – for most people this is a good idea.
You can buy an annuity from any of the dozens of insurance companies that offer different types of pension annuities. Annuities differ in two main ways: the first difference relates to the size of the payments you receive while you are alive, the second to what happens to the money when you die.
Annuities either pay out on a level basis (in other words payments stay the same each year), or on an escalating basis (in other words payments rise each year by a set percentage or by the rate of inflation).
Escalating annuities tend to pay out less than level annuities in the earlier years to compensate for the fact that your payments rise over time. This can mean that you have to live for longer to make the escalating payments work to your advantage.
Always take expert advice when you come to buy an annuity as once you have done so you are stuck with it for life!
To guarantee or not to guarantee?
You will also need to choose between having a guaranteed and a non-guaranteed annuity. The guarantee does not benefit you but your spouse. Should you die in the first five or ten years, say, after buying your annuity, a guarantee will ensure that your spouse receives some sort of payment from your annuity for a given length of time after your death. Having a guarantee will result in lower payments than a non-guaranteed annuity. Again, always take advice on buying your annuity, as the choice is irrevocable.
Who is eligible to take out a stakeholder pension?
Anyone who is aged less than 75 andUK residentcan take out a Stakeholder plan. If you are a member of an Occupational Scheme but earn less than £30,000 and are not a Controlling Director then you are also eligible. If you are not a UK Resident but do have earned income subject to UK tax then you should be eligible. You can also take one out if you are self-employed or unemployed.
You may contribute to a stakeholder pension scheme as well as to a personal pension or company pension scheme. Children are eligible to have stakeholder pension plans and parents or other relatives may make net contributions on their behalf.
Tax Relief on pension contributions
Basically, a stakeholder pension is a tax-efficient way to save for your retirement. It is well known that the state pension is too small to provide even a basic level of comfort in retirement - the only option remaining is to provide for yourself.
Fortunately, the government is keen to encourage this, so any contributions you make to a stakeholder or personal pension will be ‘grossed up’. This means that the government will add an amount of money to your contributions equal to your income tax rate.
In other words, if you are a basic rate taxpayer (22% tax) and you make a £100 contribution to your stakeholder pension, the government will add £28.20 (£128.20 minus (£128.20 X 22%=) £28.20 = £100).
If you are a higher rate taxpayer (40% tax) things get even better. For the same £100 net contribution you get £166.66 invested (£166.66 minus (£166.66 X 40%=) £66.66 = £100). You do not have to claim the basic rate tax relief; your pension provider will do that for you and will automatically ‘gross up’ your contributions by 22%, as per the maths above. If you are a higher rate taxpayer you will, however, have to claim the extra higher rate relief back through your tax return.
How much can I contribute to my stakeholder pension?
Anyone who has a stakeholder pension can contribute up to £3,600 gross (£2,808 net) without providing any evidence of earnings. If you wish to contribute more than £3,600 a year to your stakeholder (that’s £234 a month net which is £300 a month once it has been ‘grossed up) then you will need to provide proof of earnings when you start the plan- your latest payslip should suffice. The maximum you are allowed to contribute to pension schemes (including any contributions you make to an employer scheme) in any one year is your actual annual taxable earnings.
You can choose to do this in three different ways:
The ‘actual year’ option: To find out how much you can contribute to your stakeholder in any given year simply use the table below. If you are 34 years old and decide that you wish to contribute 17.5% of your £30,000 salary (perhaps because this is the first time you have contributed to a pension) then you will be able to contribute £5,250 a year. However, you will need to provide proof of your earnings to do so, this will normally be a P60, a week-52 payslip or a letter from your employer.
Basis year option: This is where you get to pick one of the last five years’ earnings if using that year would produce a higher contribution amount than the current year. This can be useful if your earnings fluctuate from year to year.
Reference year option: If you have no net relevant earnings in the current year but you have been UK resident and have relevant earnings from some point during the last five years, then you can elect to designate one of those years as the ‘reference year’. Your contribution limits will be set according to your earnings in that year.
How much should I contribute to my plan?
The answer to this is: as much as you can afford. Most people save too little for their retirement. As a rough rule of thumb, you need to accumulate a pension fund ten to fifteen times the annual retirement income you want to draw from it.
Use this calculator to find out how much you need to save to get a selected retirement income.
Check our Stakeholder Pension Plan Best Buys for the best available of the different types.
