The Real Benefits of a Stakeholder Pension
There are many different kinds of private and personal pensions that UK workers are free to participate in during their careers. One of them is the stakeholder pension. The stakeholder pension is considered a personal pension in that it is established separately from an occupational pension. Although such pensions can be offered through employers, no employer is currently obligated to provide the option to workers.
Some workers choose to invest in stakeholder pensions rather than their occupational plans because they believe they can improve their financial positions by doing so. There are some benefits to stakeholder pensions that may make investing in one preferable to putting your money into a workplace pension. But as with any other kind of plan, the stakeholder pension is not for everyone.
Also, understand that you have the freedom to invest in multiple pensions simultaneously. You may choose to remain in your occupational plan while at the same time establishing a stakeholder pension or SIPP. It is entirely up to you. Whatever works best for your financial goals is the right way to go.
Stakeholder Pension Defined
A stakeholder pension is a personal pension established on the defined contribution model. This means that you make contributions throughout your working career with the understanding that your money is being invested by your pension operator on your behalf. When you eventually retire, the amount of money you will receive by way of monthly payments is directly related to the performance of your investments.
A stakeholder pension can be established under one of two models:
- Trust Schemes – Under this model, a group of trustees is given legal responsibility for the pension. Those trustees make decisions together on behalf of pension members; they have a fiduciary responsibility to always work to achieve the best interest of members.
- Non-Trust Schemes – It is possible to set up a stakeholder pension as a non-trust scheme. Under this model, a single entity manages the scheme rather than a group of trustees. This entity can be an individual, bank, building society, or any other entity approved by the FCA. The approved entity acts as the manager and administers the scheme on behalf of members.
It helps to think of stakeholder pensions as groups schemes that involve multiple members working for different companies. It is similar to an occupational pension in that it derives strength in numbers, but different in terms of flexibility and investment options.
Requirements for Stakeholder Pensions
The government has put strict requirements in place for determining whether or not a pension scheme qualifies as a stakeholder pension. These qualifications exist for the protection of both members and the schemes themselves. No scheme qualifies as a stakeholder pension unless all of the following conditions are met:
- Limited Charges – Stakeholder pensions or not allowed to charge more than a 1.5% annual administrative fee through the first ten years. At the 10-year mark, annual administrative fees must be reduced to 1%.
- Minimum Contributions – Every kind of pension has a minimum contribution requirement. The stakeholder pension cannot have a minimum requirement of more than £20.
- Contribution Flexibility – Stakeholder pensions must allow members to contribute on their own schedules. A member can contribute weekly, monthly, annually, or even a single lump sum.
- Free Transfers – Stakeholder pensions cannot charge for either in or outbound transfers. This is an important benefit for someone who might want to exit a workplace scheme in favour of a stakeholder pension.
- Default Fund – Members of stakeholder pensions are given choices as to the specific funds they want to invest in. Every scheme must have a default fund available to members who do not want to choose.
It should be clear from these requirements that stakeholder pensions can be more attractive than workplace pensions in some cases. Bear in mind that these are minimum requirements. There may be some stakeholder pensions offering even more benefits than what has been listed here.
As just one example, your employer is legally allowed to contribute to your stakeholder pension if those in decision-making positions choose to do so. It might be beneficial for you to forgo your workplace pension entirely if your employer is willing to contribute to your stakeholder plan. Obviously, you would have to work out the details between yourself and your employer.
You can also invest in a stakeholder pension if you are self-employed or unemployed. It really does not matter. If you have the money to contribute, you are free to invest as you so choose.
Claiming Your Stakeholder Pension Benefits
As defined contribution schemes, stakeholder pensions are typically afforded the same sort of flexibility as similar occupational pensions. That is to say, you will have multiple choices to use your money beginning from the age of 55. Assuming you will either purchase an annuity or enter a drawdown contract, how much you get from your pension will depend on:
- the value of your total contributions
- the amount of time each contribution was invested
- the investment growth of your pot over time
- the amount of money spent on fees and charges.
The fees and charges are the most important thing you need to know and consider about pension investment. Even though stakeholder pensions are limited in terms of their annual management fees, pension operators can still access a variety of charges that may be associated with taking advantage of some of the extra benefits they offer. Most stakeholder pensions do not assess excessive charges in order to remain competitive, but you never know. You always have to check before you begin investing.
Your options for using the money in your stakeholder pension are as follows, beginning at age 55:
- Annuity – You can convert your pension pot into an annuity that guarantees you income for life. If your stakeholder pension provider is an insurance company, it is quite likely they will have several annuity options for you to choose from.
- Drawdown Contract – You may elect to access your stakeholder pension through a drawdown contract. Prior to pension reform there were multiple kinds of contracts; for all intents and purposes, there are only two types of contracts now.
- Lump Sum – You could choose to take your entire pension pot as a single lump sum taxed according to the 25/75 rule (more on that later).
- Bank Account – Lastly, you can use your stakeholder pension as a bank account from which you would withdraw funds only when they were needed.
All of your options for accessing pension funds are subject to a certain level of taxation from the age of 55. Although there are different ways to apply the formula, it basically works as follows: the first 25% of your pension pot is completely tax-free in the year you receive it. The remaining 75% is added to your regular income and taxed at your marginal rate. This is something to be careful of. If you take your entire stakeholder pension as a single lump sum, it could push you into a higher tax rate.
Also, be aware that accessing your stakeholder pension before the age of 55 is almost always considered an unauthorised transaction by the government. There are only two exceptions to this rule. Should you conduct an unauthorised transaction, you could be subject to taxes and penalties that add up to almost 75% of your pension pot. It is not worth it.
The stakeholder pension is but one choice for saving retirement income. We encourage you to look into the benefits of stakeholder pensions, at least so you know the details in case you decide you want to use this important retirement resource. You can invest in a stakeholder pension exclusively or as part of a portfolio that includes multiple pensions and other investments.
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