Getting your head around pensions can be confusing and scary. Here we’ll start with the basics, helping you decide which options suit you best.
What is a pension?
Put simply, a pension is a tax efficient way to save for your retirement. It’s all saved into a pot, so that when you retire, you can draw money from it or sell it in return for regular income for the rest of your life (also known as an ‘annuity’). Generally, you can access the money in your pension pot from the age of 55.
One important factor of a pension that some people don’t know is that it’s invested in funds, stocks, shares and government bonds. It’s not necessarily invested in all of these, and your pension’s investments often change over time.
Pensions have a number of important advantages over other savings options, which encourage your contributions to grow over your career. These include:
There are a few different types of pension:
Let us take you through each of these in a bit more detail.
Most of us have our first encounter with pensions at work. Many employers offer company pension schemes, and as of April 2017 they are required to do so by law. A company pension scheme can be one of the simplest ways to put money away for retirement. It’s easy, and you’re often auto-enrolled with very little intervention required, if at all.
The biggest benefit to a workplace pension is that your employer will often match your contributions, Your contributions are taken straight out of your pay before it even hits your bank account, so it’s easy to not miss it. If your pension contribution is 5%, and your employer matches it, then each year you have 10% of your total salary put in your pension pot.
There are two different types of workplace pension – a type of a type of a pension, so to speak. An important distinction between them is whether the pension in question is a final salary, or a money purchase pension.
Final salary pensions
These are largely funded by employers, with employees paying in sometimes. With a final salary pension, you’ll get a percentage of your final salary before retirement – or when you leave – as a regular income. The percentage is calculated based on the years you’ve worked at a company. For instance, you might be offered a rate of 1/50th of your salary for every year you worked at a company – which could be 25 years. That’s 25/50ths, or half of your final salary with the company.
Money purchase pensions (defined contribution schemes)
This is the most common type of pension. They save money into a pension pot under an agreement with your employer. When it comes to withdrawing, you can take the cash out or swap it for something called an annuity, which is simply an income for the rest of your life.
What is auto-enrolment?Auto-enrolment aims to make sure that people contribute to their pensions. The auto-enrolment rules mean employers are legally obliged to offer employees a pension scheme. If you do nothing, you’ll be opted in – hence the name. You can, however, choose to opt out if you wish.
A personal pension is one that you set up yourself. You can choose to manage it yourself or hire someone to manage the pension for you. The main benefit to a personal pension is that you can get great tax breaks on it, just like with your workplace pension. The government tops up your pension by 25% or more of your contributions. Ideally, after a long period of time, your money will have had a chance to grow!
Typically, by the age of 55, you’ll be able to withdraw 25% of your pension pot tax free. Anything more than this is subject to regular income tax. Like workplace pensions, you’ll also have the option to purchase an annuity.
Most UK citizens get some State Pension. The State Pension is a secured income for your retirement. The amount is increased each year at the rate of inflation. You can find out how much you expect to receive by checking on the government website. Your state pension comes from your National Insurance contributions which you make throughout your life.
If you haven’t yet reached the state pension age, then you’re likely to be on the new state pension. This differs a little bit from the basic state pension.
The new state pension is for women born on or after April 6 1953 and men born on or after April 6 1951.
To be eligible for any state pension, you need to have at least 10 qualifying years on your National Insurance record. This means that for at least 10 years (not necessarily in a row) you were working and paid National Insurance, you got National Insurance credits, or you made voluntary National Insurance contributions.
Anyone working in the UK who is over 16 and earning more than £183 per week (or self-employed and making more than £6,475 in profit per year) is required to make National Insurance contributions. If you don’t think that you’ll make enough contributions, you can make voluntary ‘catch-up’ payments to get back on track.
Who holds my pension money?
The Government has its own scheme called the National Employment Savings Trust (NEST), which many employers join. Alternatively, your employer may choose another company which manages your investments. You’ll be able to decide on the levels of risk you’re willing to take with them.
What happens with the money when I retire?
As soon as you begin contributing to a pension, it can’t be withdrawn easily. It must stay in the pension pot until the age of 55. Then you can withdraw 25% as a tax-free lump sum. The rest should ideally provide you with enough income for the rest of your life.
It’s up to you to begin planning as you approach retirement age. When your regular income stops, you need to make decisions about how much money to withdraw and how much you’ll be living on.
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