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Pensions, Dividends & Retirement: A Short Guide

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The word “dividend” is mysterious to many people. Yet the idea is quite simple. You invest your money in a company (or set of companies), and these companies hopefully pay you a share of their profits. The amount you get (i.e. your dividend) depends on the level of profit achieved, as well as how many “shares” you own in the business. If you own half of the shares, for instance, then, in theory, you should receive half of the profits.

Where dividends can become confusing even for experienced investors, however, is how they feature in a retirement plan. For instance, are dividends the same as pensions? If not, what are the differences and are there any advantages to one over the other?

In this short guide, our Grantham-based financial advisers will shed light on the answers to these questions. We hope you find it helpful. Please note that this content is for inspiration and information purposes only. It should not be taken as financial advice. To get such advice for your own financial goals and situation, please consult an independent financial adviser.


Pensions: Overview

To understand the difference between pensions and dividends, it’s important to have a basic understanding of how the former work.

In summary, a pension is an income which you receive in retirement. This income might come from the UK government (i.e. your state pension), or it might come from one or more workplace pensions which you have built up throughout your career.

In certain cases, someone might also have a personal pension which they set up on their own, which can also provide a retirement income. The crucial point with pensions, however, concerns the form that the income takes.

With your state pension, this is government payment is put into your bank account (a bit like receiving a state benefit). With personal and workplace pensions, however, you generally receive a retirement income in one of two ways:

  • Via an annuity. This is the name for a special type of financial product which you purchase using your pension fund(s), to provide a lifetime annual income from the annuity provider.
  • Via income drawdown. This is where you keep your pension pot invested, and you take money out of the pot gradually as a retirement income.

The main exception to the above concerns a special type of workplace pension called a final salary (or “defined benefit”) pension. Here, your past employer pays you an agreed income in retirement. The amount you depends on various factors outlined in your pension scheme such as how long you worked there, and how much you earned.


Dividends: Overview

Dividends, however, are different yet there can be some areas of overlap. As mentioned at the beginning, dividends can be thought of as a kind of “payment” from companies you have invested in. It might be, for instance, that you have directly invested in ten or so companies and own half of the shares in each of them. Assuming all of these businesses turn a profit, you should receive half of those profits.

In 2019-20, you can only start taking money from your workplace/private pension(s) from the age of 55. Moreover, you are only allowed to access your state pension when you reach your state pension age (currently set at 65). With dividends, however, you are free to invest in a company from a much earlier age, perhaps through an ISA or similar vehicle.

When you eventually start drawing from your pension, your pension income will be subject to Income Tax rules (e.g. 20% on income between £12,500-£50,000 in 2019-20; remember, your first £12,500 is usually subject to a tax-free personal allowance). Dividends you receive, however, are not subject to Income Tax but to Dividend Tax.

If your dividends fall within £2,000 in 2019-20 then you likely will not need to pay this tax, as it falls within your allowance. However, Basic Rate Income Taxpayers will need to pay 7.5% on their dividends. Higher Rate Taxpayers will need to pay 32.5%. There are certain ways to shield yourself from these taxes, however. For instance, holding your funds or shares in a Stocks & Shares ISA allows you to avoid Dividend Tax on income contained within this special “wrapper”.


Important Considerations

There are certain advantages and disadvantages to pension and dividend income when it comes to funding your retirement lifestyle. It’s important to discuss these with your financial adviser, to ensure you make the best decision for your circumstances and goals. In summary, here are some of the factors you might want to consider:

  • Workplace pensions have the advantage of receiving contributions from your employer, in addition to your contributions. Also, the state will effectively “top up” these contributions via tax relief. All of this effectively amounts to “free money” towards your retirement. However, pensions are subject to an annual cap on the amount you can contribute, as well as a lifetime allowance on the maximum amount you can save into a pension. You also cannot access any of your pension saving until you are at least 55.
  • You can invest in companies and receive dividends as soon as you are old enough to open an ISA. In 2019-20, the income you receive is subject to a lower rate of tax compared to the Income Tax on your salary (7.5% and 20% respectively, for a Basic Rate taxpayer). There is also no lifetime cap on the amount you can put towards dividend investments like there is for pension savings. Moreover, any dividend income emanating from an ISA is free from tax, and you have a £2,000 annual tax-free allowance on dividend income sitting outside of this wrapper. However, dividend income is not guaranteed. It depends very much on the performance of the companies you are invested in, which might underperform or even fail. Your dividend income is also likely to fall in the companies decide to reinvest profits back into developing the business, rather than distributing them to shareholders.

Get in touch today to arrange an initial exploratory consultation at our expense with one of our specialists here at Castlegate via 01476 591022 or