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The Basics

A defined contribution pension is a type of retirement plan where you and/or your employer make regular contributions into an investment fund. The final value of your pension depends on the total contributions made and the investment performance over time.

At retirement, the accumulated fund can be used to provide an income, either through gradual withdrawals or by purchasing an annuity. Unlike a defined benefit pension, the income from a defined contribution pension is not guaranteed and depends on factors like investment returns, charges, and your chosen retirement options.

For more detail, follow this link to the government funded Money Helper Webiste page that provides much more information on defined contribution pensions.

A defined benefit pension, also known as a final salary pension, provides a guaranteed income in retirement based on your salary and length of service with an employer. The amount you receive is calculated using a formula that typically considers:

- Your salary: Often your final salary or an average of your earnings over a specified period.
- Your years of service: The length of time you were a member of the scheme.
- Accrual rate: A fraction (e.g., 1/60 or 1/80) that determines the proportion of your salary you will receive for each year of service.

Unlike defined contribution pensions, your employer or pension provider bears the investment risk, ensuring that your income remains unaffected by market fluctuations. This makes defined benefit pensions a highly valuable and secure form of retirement income.

The Money Helper Website provides a detailed explanation of defined benefit pensions.

An Individual Savings Account (ISA) is a tax-efficient savings or investment account available in the UK. Money held within an ISA grows free of income tax and capital gains tax, making it an attractive option for saving and investing.

Unlike pension income, withdrawals from an ISA are completely tax-free.

The annual ISA allowance for the 2024/25 tax year is £20,000, meaning you can save or invest up to this amount without paying tax on the returns.

The Money Helper Website provides more information on ISAs and other tax efficient ways to save or invest.

The State Pension is a regular payment from the government that you can claim when you reach State Pension age. It is based on your National Insurance contributions throughout your working life.

As of April 2025, the full State Pension will be £11,976 per year. To qualify for the full amount, you need 35 years of National Insurance contributions or credits.

You can get an up-to-date personal forecast of your own state pension at www.gov.uk.

For more information about the state pensions, visit the government funded Money Helper page on this subject.

General Questions

There are three stages to the calculation:

1. Accumulate Funds To Retirement: Your funds are accumulated along with your planned regular contributions and fund growth up to your chosen retirement date.

2. Calculate Maximum Affordable Retirment Income: Payments from your funds in retirement are then simulated multiple times, adjusting the values each time in order to target a final fund of zero. The payment that hits this target is your maximum affordable retirement income. If this is less than your desired retirement income, the shortfall is calculated.

3. Optimise Drawdown Plan for Tax Efficiency: If you have ISA funds to draw from, the split of payments between pension and ISA is then calculated each year to minimise tax due.

If you are already retired, the calculator can assist in managing the drawdown of your funds. The calculator allows you to monitor the sustainability of your savings and income over time. It can indicate whether you can afford to increase your withdrawals to enhance your lifestyle or if you need to reduce them to ensure your funds last throughout your retirement.

The Retirement Living Standards website offers a practical framework to help you estimate the income needed for your desired lifestyle in retirement. Developed by the Pensions and Lifetime Savings Association (PLSA), these standards outline three levels of retirement living:

1. Minimum: Covers essential needs with some allowance for social activities.
2. Moderate: Provides more financial security and flexibility.
3. Comfortable: Affords greater financial freedom and a higher standard of living.

Each level includes detailed breakdowns of expected annual expenditures on housing, food, transportation, holidays, and leisure activities.

For example, as of 2024, the estimated annual expenditures are:

Single Person:
- Minimum: £14,400 (£1,200 per month)
- Moderate: £31,300 (£2,600 per month)
- Comfortable: £43,100 (£3,600 per month)

Couple:
- Minimum: £22,400 (£1,900 per month)
- Moderate: £43,100 (£3,600 per month)
- Comfortable: £59,000 (£4,900 per month)

It's important to use realistic growth assumptions that align with your investment strategy and risk tolerance. Here’s a structured approach to guide you:

1. Understand Historical Returns:

Equities: Historically, UK equities have delivered an average annual real return (after inflation) of approximately 5.4% over the last century.
Bonds: UK government bonds have provided an average annual real return of about 1.8% over the same period.

2. Consider Asset Allocation:

Your portfolio's composition significantly influences expected returns:
Balanced Portfolio (e.g., 60% equities / 40% bonds): Historically, such a mix has achieved around a 4% real return.

3. Factor in Inflation:

To project nominal returns (which include inflation), add an average inflation rate to the real return. For instance, with an assumed 3% inflation rate:
Equities: 5.4% (real) + 3% (inflation) = 8.4% nominal return.
Bonds: 1.8% (real) + 3% (inflation) = 4.8% nominal return.
Balanced Portfolio: 4% (real) + 3% (inflation) = 7% nominal return.

The default assumption for this calculator is a nominal return of 7%.

Please note that using historical returns to set assumptions may lead to overestimating future growth, as past performance doesn’t guarantee future results.

A reasonable assumption for long-term inflation in the UK is typically around 2-3% per year. This range reflects historical averages and aligns with the Bank of England’s target rate.

2%: This is the official target rate set by the Bank of England, aimed at keeping inflation low and stable over the long term. Many pension projections use 2% for a conservative estimate.

3%: This slightly higher rate accounts for possible fluctuations and is often used as a cautious approach, especially if inflation trends above target. Financial planners frequently use 3% as a buffer for unexpected price increases.

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State Pension

The amount of state pension you will receive depends on your National Insurance record.

As of April 2025, the full State Pension is £11,976 per year.

To qualify for the full amount, you need 35 years of National Insurance contributions or credits.

You can get an up-to-date personal calculation at www.gov.uk.

The calculator assumes you will be eligible for the full state pension.

The current state pension age in the UK is 66 for both men and women. However, this is set to increase gradually:

- To age 67: This will occur for those born between 6 April 1960 and 5 March 1961, with the increase beginning in 2026 and completing in 2028.

- To age 68: Those born after April 1977 are currently expected to have a state pension age of 68, although the timing of this change could vary based on government review.

You can get an accurate calculation of the exact age that you will receive your state pension at www.gov.uk.

The calculator approximates your birthday based on your current age input and then uses these rules.

The state pension has a triple-lock which increases the amount each year by whichever is the highest: prices, earnings or 2.5%.

The calculator uses a single assumption for future inflation, the initial default value being 2%.

You can change the assumption for future inflation used by the calculator.

The projected increases are calculated to be the higher of this value and 2.5%.

Defined Benefit Pensions

A defined benefit (DB) pension is a type of group pension scheme that provides a guaranteed income in retirement, usually based on a formula involving factors like your salary and length of service with your employer. Unlike personal pensions, which have a fund that depends on investment returns, a DB pension provides a predictable guaranteed retirement income, paid for life.

In a DB pension, your retirement income is usually calculated based on your "final salary" (or career average in some schemes) and the number of years you've worked for your employer. For example, a common formula might be a percentage of your final salary for each year of service. This means the more years you work and the higher your salary, the more your pension income will be.

Defined benefit pensions don’t have individual funds for each member. Instead, there is a central fund managed by the scheme to meet the future pension payments of all members. However, if you leave the scheme, you may have the option to transfer your benefits to a different pension scheme, which would involve calculating a "transfer value" of your accrued benefits.

Yes, many defined benefit pension schemes allow you to take a portion of your pension as a tax-free lump sum when you start receiving your benefits. This may reduce the amount of regular income you receive, as it’s generally exchanged for a smaller pension, but it allows for a one-time, tax-free payment.

The age at which you can start receiving your defined benefit pension is usually set by your scheme’s normal retirement age, often between 60 and 65. Some schemes allow you to take benefits earlier, but this might result in a reduced pension due to early payment.

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Tax

The calculator determines the tax on your pension income by first applying your personal allowance — the amount you can earn each year without paying tax. It then assesses your total pension income, including the State Pension and any other pensions, and applies the appropriate tax bands (basic, higher, and additional rates) based on your taxable income.

If you choose to take a tax free lump sum at retirement (also known as the Pension Commencement Lump Sum (PCLS)), up to 25% of your pension can be withdrawn tax-free. The calculator also accounts for any unused portion of your PCLS, effectively applying it as an additional tax-free allowance on future pension income.

Additionally, if you select the Scottish Tax Regime, the calculator uses the specific Scottish tax rates bands to accurately calculate your tax payments.

The mix of pension and ISA income can significantly impact the amount of tax you pay in retirement.

Pension Income
  • You can usually take 25% of your total pension pot as a tax-free lump sum.
  • The remaining 75% is taxed as income at your marginal rate.
  • Your pension income is subject to Income Tax, but your Personal Allowance (currently £12,570) applies first.
ISA Income
  • Withdrawals from ISAs are completely tax-free.
  • This includes interest from cash ISAs, dividends and capital gains from stocks & shares ISAs, and all ISA withdrawals.
  • ISA income does not count towards your taxable income and does not affect your Personal Allowance.
Tax Efficiency Through Blending
  • By blending pension and ISA withdrawals, you can reduce your overall tax liability in retirement.
  • Using ISAs to top up pension income allows you to stay within lower tax bands.
  • This approach can be particularly useful to minimise tax in early retirement or when your income needs are higher than your tax-free allowance.
What The Calculator Does

The calculator automatically opts for pension income up to your personal allowance so that the full tax free amount is utilsed each year. The rest of your income is topped up from your ISA each year until your ISA funds run out.

The premium version allows you to alter the mix of pension and ISA income over and above the personal allowance. This will affect the overall amount of tax you pay in retirement, so it is worth experimenting with different mixes to try to minimise your overall tax rate.

The calculator works out how much State Pension you are due and when it will start to be paid. You can enter the details of a defined benefit pension, and the calculator will add this to the retirement income mix at the appropriate age. Once these kick in, it is likely that your income will exceed your tax-free allowances, so any additional desired income will initially be taken from your ISAs as this will minimise tax due.

Limitations of the Calculator

The results of the model are based on deterministic economic assumptions for fund growth and inflation. It is assumed that these are fixed and do not vary from a single value over time. In reality they will fluctuate up and down.

You can adjust the values of the assumptions in the model to see what effect changing them has on your plans. But it is important to note that the results are only a guide to help you understand what might happen under certain scenarios.

The calculator projects values forward based on your age, starting with a full year. It therefore essentially assumes that today is your birthday. (Happy Birthday!)

Increases to the state pension occur on April 6th, but the calculator applies the increases at the end of each projection year. Therefore the calculator also essentially assumes that your birthday (and today) is April 6th.

The effect of these approximations on the timing of the increases to your state pension should only have a very small effect on the overall calculation.

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