By Katie Binns
Everything to know about pensions. Retirement may seem like a long way off in the future but saving into a pension is important if you want to stop working at a certain age and live well.
You may think the state pension from the government will have you covered - but this will only cover basic living expenses.
This article will explain:
- what pensions are
- types of pension
- how you get free money from your employer and the government with your pension
- how much you need to save to retire comfortably
Everything to know about pensions: What is a pension?
A pension is like a turbo-charged savings account. There are four main benefits to them:
- It is invested in the stock market so over time will benefit from higher returns than a bog standard savings account - even if there are falls in the market as in 2020
- Free cash from the government in the form of tax relief
- Free cash from your employer which must pay in at least 3% of your annual salary
- A quarter of it is tax-free when you access it
Types of pension
There are generally three types: the state pension, final salary schemes and defined contribution schemes.
1. The state pension
The state pension is provided by the government when you reach 66. This will rise to 67 by 2028. The new state pension currently pays £179.60 a week, or £9,339 a year.
However, the amount you personally receive is based on your national insurance record. This is essentially the number of years you worked combined with any voluntary national insurance contributions you may have paid.
To receive the full state pension you need to have 35 years on your national insurance record.
2. Final salary scheme
The final salary pension (also known as defined benefit pension) is a bit of a unicorn. These workplace pensions pay you a guaranteed income when you retire based on your final or average salary and years you worked for a company.
Most employers closed their final salary schemes because they were expensive to run, so you’re unlikely to be offered one today. But if you have one from a past employer then consider yourself lucky - they are goldust.
3. Defined contribution pension
Defined contribution pensions are the most common type of pension and essentially pay out what you have paid in.
They work by paying you some of your wages each month alongside your employer’s contribution which is then topped up with tax relief. Basic rate taxpayers get a £20 top-up for every £80 they pay in, higher rate taxpayers get £40 for every £60 they put in and additional rate taxpayers get a £45 top-up for every £55 they put in.
If you are 22 or over and earn at least £10,000 from a job, your employer will automatically enrol you into a pension.
Your money is invested in stocks and shares. You can choose the investments or let the pension provider pick funds for you.
4. Stakeholder pension
You can also set up a private pension on your own. If you are self-employed or not working, then a stakeholder pension is often a good idea because you won’t be automatically enrolled into anything and don’t want to miss out on tax relief.
Stakeholder is another type of defined contribution scheme: you decide how much to pay in and it gets topped up with cash from the government. There’s just no contribution from an employer.
5. Self-invested personal pension
A self-invested personal pension (or SIPP) is a DIY version of the defined contribution scheme. This model gives you a wide range of options when deciding where to invest including investment funds, bonds, gold and even property.
What are the pension rules?
There are pensions rules to be aware of:
- The annual allowance limits your pension contributions to £40,000 (though if you earn over £200,000 this limit is lower)
- The lifetime allowance means you are only allowed to build up £1,073,100 in a pension
- You can withdraw the first 25% of your pension tax free. The rest is subject to income tax
- You can access most workplace and personal pensions at age 55. This will rise to 57 in 2028
How much do I need to retire?
For a comfortable retirement, the insurer Royal London claims you need to build up a pension pot of £260,000.
This should provide an annual income of around £9,000 if you buy an annuity at age 65. If you add that to the state pension (£9,339 a year) this gives you £18,000 a year as a regular income.
To save for that £260,000 pension you need to put aside: £390 a month if you are starting at age 25, £570 a month if you are starting at age 35 or £920 a month if you are starting at age 45.
These figures include tax relief but not employer contributions so if the company you work for adds something then these figures can be adjusted.
The questions to ask yourself include: Is £18,000 a year enough? What kind of lifestyle do you want in retirement? How do you feel about saving more money now in order to have more later?
You can play around with a pension calculator to see how much you need to save for retirement. You can put in how much you save today and it will project how much you could have when you retire. If you want some concrete guidance, consider paying for a financial planner to help you to help you reach your goals. You can find a financial planner at unbiased.co.uk or via CISI.
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