Perhaps you have heard your parents or grandparents talking about their pension and you don’t really know what they are talking about. Or perhaps you see it appear on your payslip of your first job and think, why am I paying into this? This article takes you through the basics of pensions to help you understand what a pension is and what it is used for, as well as the options available in retirement.

What is a pension?

To put it simply, a pension is a form of planning for your retirement. It is money saved away for when you have finished working. It can only be accessed at a certain age and is stored in a special pension account, making it different from a regular savings account at the bank which you can easily access and withdraw money from. 

Paying into your pension

There are some differences between pension plans and providers, however the core concept stays the same.

• You or your employer will set up a pension plan with one of the many pension providers.
• You and/or your employer will then pay money into your pension plan. This is often a regular payment between 3 and 5% of your monthly wage, then your employer will top it up, usually to around 8%, but this can vary. 
• You will receive tax relief from the government on all the pension contributions you make. 

*Please note that you will be automatically enrolled into a pension scheme by your employer if you are over the age of 22, you work in the UK and you earn more than £10,000 a year as it is a legal obligation for an employer to provide a workplace pension. If you do not wish to be a part of it, you can let your employer know that you would like to opt out.  

What happens to the money saved up?

The money that you put into your pension plan will be safely stored and cannot be accessed until you reach 55 (57 from April 2008). The money will be invested into pension funds in the hopes of generating more money. As with any investment, there is a level of risk as your initial amount could decrease as well as increase. Most pension providers allow you to take a short survey or quiz to assess your attitude to risk to determine where best to invest your money. The higher the risk you are willing to take, the higher the potential increase in money, however the chance of losing money is also higher. As a contrast, the lower the risk, the lower the reward, meaning that the chances of you losing money is reduced but never impossible. You don’t just have to invest your money in one fund. If you are unsure, then you could invest the money in some ‘safe’ low risk funds and take a smaller amount of money to put into some more riskier ones. Thankfully, the investing part isn’t your responsibility! That is left to the professionals once they have determined your attitude to risk as they can use data and analysis to decide which funds are best suited to your needs and attitude.

What are the benefits of a pension?

A pension is the best way to save money for when you are retired or when you no longer want to or are unable to work. It alleviates the stress and worry of financing life in your later years. 

Most people tend to start paying into their pension in their 20s as whilst the money won’t be used until the retirement age is reached, or until the age of 55 (57 from April 2008), it is better to start putting money aside early to start building up your pension pot. 

One of the benefits of having a pension is that you can put aside as much as you would like into your pot and it is locked in and invested, not to be accessed again until retirement. This means that you can’t dip in to it as you might a savings account at the bank; it is protected and securely stored. There is no limit on the frequency or amount that you can put into your pension too, so if you happen to gain some extra money and want to put it into your pension, you can do just that by making a personal contribution. However, if you pay more than £60,000 into your pension in a year, then you may be liable for tax charges.

If you have a workplace pension, you get extra contributions from your employer that are not deducted from your pay. Whilst your own pension contributions come from your gross pay, the payments made from your employer are charged directly to the company, so you get additional money paid into your pension without paying an extra penny. You also get the taxed amount repaid to you into your pension by the government, topping up your pot a little further. 

Do I need a big pension pot?

This is a tricky question, and the answer is different for everyone. The amount you need in your pension pot depends on the following factors:

• When you want to start using your pension
• Any other sources of income you would have at that time.
• The lifestyle you would like to have and how much you think you would spend.

To work out how much money you will have at retirement, you need to know, or at least estimate the following:

• How much is currently being paid into your pension.
• At what age you are planning to retire (currently the retirement age is 66 for those born after 5th April 1960 and 67 for those after that date, soon to rise to 68).
• How your pension investments are performing.
• The impact of any pension charges you may face.

It may be worth speaking to your pension provider to find out this information if you are unsure as they will be able to talk to you about any charges on the plan or for the funds you are invested in, as well as the performance of your investments. 

To calculate the amount in your pension pot at retirement, you then need to do the following calculation:

Monthly pension contribution   x   12   x   years until retirement

*Please note that this assumes that pension contributions will remain unchanged until the retirement age is reached, which may not always be the case and so the contribution amount may need to be adjusted accordingly.

So, when can I access my pension pot?

Once you reach your 55th birthday (rising to 57 from April 2008), you can take your pension at any point. You can do this in several ways.

• Purchase an annuity which is considered a guaranteed income for life. You will receive a set amount of money each month for the rest of your life, no matter how long you live. It serves almost like a salary in that a set amount will be paid to you on a regular basis.

• Get income for a fixed term, which is like the annuity option, however it has a limit as it is fixed. You would set an end date for the fixed period and would receive regular, equal payments up to that chosen date.

• Place your pension into what is known as ‘Pension Drawdown.’ This is a flexible option that allows you to choose how much you want to take from your pension and when you want to take it. 

• Cash in your pension and take all of the money in one big lump sum.

Of course, you can combine any of these options to fit what suits you and your needs. No matter what option you choose, the first 25% of your pension pot can always be taken as a tax-free lump sum. This percentage can vary if you have any guarantees or bonuses on your pension plan. 

Not all pension options are available with all providers and so sometimes it is best to shop around when it comes to taking your money. For example, with the ‘Pension Drawdown’ option, it may require you to transfer your pension to a different provider to access this option. 

Just before your 55th birthday, you will receive an information pack from your current pension provider(s) detailing all the options available to you.

For more information or enquiries, please contact us at info@centurionfinance.co.uk