First things first – what exactly is a pension?
To put it simply, a pension is a pot of tax-free cash that both you and your employer pay into as a way of saving for your retirement. When you do eventually retire, Guy Anker, Managing Editor at MoneySavingExpert.com, says that you can either draw the money from your pension pot, or sell the cash to an insurance company in return for regular income until you die, called an annuity. You can actually access your pension once you turn 55, taking as much or as little as you like.
“You get the tax back on all contributions (subject to an annual allowance) if you’re under 75,” says he explans. “If you paid the money yourself or is taken out of your pay by your employer, you automatically get 20% back from the government as an additional deposit to your pension pot.”
When should you start investing?
The retirement age might continue to increase, but that doesn’t mean you should put off paying into your pension pot. In fact, you should start contributing as soon as you’re old enough to get on the payroll. Peter Bradshaw, Director at Pension Monster, it’s important to start investing at a young age, as you’ll be far more comfortable financially when you get to retirement age.
“Starting in your 20s is ideal – if you start at a younger age you’ll need to save less each month because investments will grow over time,” he says. “If you wait until later in life, you’ll need to save more to give you the same income in retirement. And even then, you could risk not reaching your desired pension pot.”
What happens to the money you pay towards your pension?
The money that you pay into your pension every month is then invested through funds into a variety of assets. “Typically, this will be a mix of stocks and shares, interest-bearing deposits, property and cash,” says Bradshaw. “These funds are managed on your behalf by insurance and investment firms.”
How do you know when you’ve got a good pension through your employer?
Bradshaw says it all depends on the type of arrangement your employer provides. Very few offer what is known as a ‘defined benefit’ or ‘final salary’ scheme, which promise an income for life once you retire – although these are what he calls the “gold standard of employers’ schemes”. But under the law, employers are required to make contributions to your pension.
“Under auto-enrolment’, all employers are obliged to make pension contributions on behalf of their employees,” he says. “The minimum contributions are currently 2% of earnings over £6,032 for this tax year, which will increase in future years.” The higher the employer contributions, the better the deal.
How much should you be putting towards a pension?
There is a legal minimum – currently 3% of earnings over £6,032 – but Bradshaw advises people pay as much into their pension each month as they can reasonably afford.
If you change jobs regularly, does your pension all go into the same pot?
In short, no. But, as Bradshaw explains: “You can consolidate your pension pots by transferring them into a single pot. Spreading risk across a number of pension pots has benefits, providing they are regularly reviewed. However, consolidation may be helpful if it means ongoing charges can be reduced. Consolidation means the underlying investments and asset allocation can be brought into line, making it easier to keep track and make adjustments to the investment mix.”
How do you take your pension and can you take it early?
Good news: no matter what age the standard retirement age is, you can take your pension as early as 55. This can be taken in a variety of ways: tax-free cash, a regular or ad-hoc income (known as a drawdown), or a guaranteed income by taking an annuity.
Can you have a pension that’s not linked to your work?
Yes, you can, but as Bradshaw points out, your employer might not agree to make contributions to it. According to the Pensions Advisory Service, personal pensions are individual contracts between you and a pension provider that is set up by you. You can have a personal pension whether you’re employed, unemployed or self-employed.
Other people can also contribute to personal pensions, so you could contribute to your partners, or they can contribute to yours – you could even start a pension for your child, helping them to start building up those benefits from an early age.
Plus, there’s no restrictions to the amount of pension schemes you can belong to – this means you could have a personal pension, even if you’re enrolled in a workplace pension scheme. Most personal pensions are pretty flexible, so if you change jobs or stop working, you can usually still contribute to a scheme.
Are there any pension alternatives?
Bradshaw advises that there are other saving plans, like ISA, “but they don’t benefit from the same tax breaks that pensions benefit from – these include relief on contributions paid on and the growth in investments before retirement.”
Whatever you do, they key takeaway is to start saving as soon as possible – your future self will thank you for it.