Pensions are one of the most important, yet least understood parts of personal finance. Research (1) shows that two-fifths of younger workers have either reduced or stopped their pension contributions in 2020. This is a worrying statistic as a pension pot can form an essential part of your retirement planning and the sooner you start to contribute, the better. If you want to take control of your retirement, it’s important to understand how pensions work. Here’s a guide to help you get familiar with the world of pensions.
The basics…
The basic principle of a pension is that money is paid in, it’s invested, and once you reach retirement age, your money is paid back to you, either monthly or as a large lump sum.
In comparison to other savings and investment products, pensions differ as once you pay into it, you can’t get it back until your retirement age (there are certain exceptions to this).
Another difference is that you receive tax back on the money you put into your pension from the government. Tax relief is paid on your pension contributions at the highest rate of income tax you pay:
– Basic rate tax payers get 20% pension tax relief
– Higher rate taxpayers can claim 40% pension tax relief
– Additional rate taxpayers can claim 45% pension tax relief
How much you get when you are ready to retire and take your pension will depend on how much you save, how your pension investments perform and how long you’ve invested for.
What are the different types of pension?
There are a few different types of pension available.
– State pension
Everyone will receive this as a regular payment from the government (assuming you have at least 10 qualifying years on your national insurance record). Use the Gov.uk state pension forecast calculator to find out the date you will be eligible and how much you will receive here.
– Workplace pension
If you are employed, aged over 22 and earning at least £10,000 a year, you’ll also be auto-enrolled into a workplace pension. Contributions will be taken directly from your salary, as well as employer contributions which will be added to your pension pot. If you choose to opt out of the workplace pension, you are effectively turning away extra money from your employer. However, the downside is that you are restricted to the pension scheme that your employer has chosen.
It is also worth remembering that workplace pensions don’t have to stop if you leave an employer. Although the previous employer’s contributions will stop, your pension will continue to grow, even if you are no longer contributing. You can also transfer your pension, however, there may be fees involved in moving your pension pot to a new provider.
– Personal pension
You may also decide to open a personal pension where you choose the provider and make arrangements for your contributions to be paid. When choosing a personal pension, it’s important to shop around for the best deal. Consider the following before making your decision:
– Fund choice
The pension that offers the most choice isn’t necessarily the best. Look for the pension that will offer the funds that you want to invest in. Most providers now offer ethical funds, so make sure this option is offered if this is something which is important to you.
– Minimum monthly contribution
Some providers will require you to make a minimum monthly or annual investment to your pension or to each fund within your pension. Be aware that if you don’t meet the minimum contribution requirements, you may be charged a penalty fee.
– Fees and charges
Many pension plans will charge an annual management fee as well as fees if you invest in certain funds. There will also be a fee if you wish to transfer your pension to another provider. It is recommended you research all possible fees before making an application and comparing them between providers.
– Past performance
You may find it helpful to use past investment performance to help you decide which provider to use. However, if you’re comparing past performance, ensure you are looking at data from a period of at least 5 to 10 years as investments can fluctuate in the short term. Always remember that past performance is in no way a guarantee of how successful a firm will be in the future.
Why do I need a pension?
Essentially, you need to save up a portfolio, or pot of money, to last what could be 30 years or more in retirement. This is then paid to you as a monthly salary when you choose to retire.
When you’re thinking about your retirement and how much you need to save, consider what you can actually afford but don’t lose sight of how far off your retirement is. The question is often not what age you want to retire, but at what income.
It’s useful to consider the following when determining how much you need to save for retirement:
– How much you already have saved into your pension
– The number of years you have left to work before retirement
– How much you can afford to contribute to your pension, considering your other financial commitments
– Are you expecting to increase or decrease your pension contributions in the future?
– Do you have other investments, and will they grow between now and your retirement?
– How much will your employer contribute to your pension?
When can I access my pension?
Currently, you can claim the state pension from the age of 66, but this is scheduled to rise to 67 between 2026 and 2028. A benefit of having a personal pension is that you can usually start taking money from the earlier age of 55. However, the Government have recently confirmed that from April 2028, this age will increase to 57, the same year in which the retirement age increases to 67.
If you’re a member of a workplace pension scheme, you generally require the consent of the employer, or ex-employer, to take benefits early, but it is possible if you need access to the funds.
Will I have enough saved for the retirement I want?
Your income in retirement ‘should’ come from several sources, whether this be money in savings, investments, ISAs etc. It is important to consider your overall financial position, which will complement your state pension and any workplace or personal pensions you may have.
The earlier you start investing, the more you are likely to have when it comes to retirement. For example, if you invest £100 a month for 20 years with 5 per cent growth per year, this would deliver £41,000. If you save for another 10 years at the same rate, and your pension pot would be worth more than twice as much at over £83,000. This is because your pot will have benefited from compounding, where returns build up on returns that you have already received.
For a more accurate way of calculating how much is enough in retirement, try using the Money Advice Service’s pension calculator here.
Should I consider taking advice?
With a complex array of pension legislation and products available, it is more important than ever to seek professional and independent advice to ensure you are making the right decisions for your future. Contact our wealth management team (01254 679131 / wealthmanagement@pmm.co.uk) who will happily arrange a meeting at no cost to help you achieve more from your pension and long term financial plans.
1 – Poll by Royal London of 2,000 non-retired UK adults. ‘Younger’ workers refers to 18-34 year olds.
