Introduction to Pensions
Enjoying a long and happy retirement is important for many of us; especially as we are living much longer than ever before. And, with us spending an increasing number of years in retirement and with people wanting to do a wider array of things when retired, it’s important to start saving for retirement as soon as possible and to have it in the right place to achieve our goals.
There are many ways to start saving for retirement and a pension is a great place to begin investing in your future. Even if you think that you don’t have much to spare right now, the key is to start as soon you can with whatever amount you can commit to and to build a retirement pot over time.
What is a Pension?
A pension is a long-term savings plan that you can pay into throughout your working life to create an income during your retirement years.
As the pension itself is designed to provide you with money in your later life, most often when you’re reducing or stopping work, you can’t access your money until you’re in your mid to late fifties – or even older depending on the particular scheme you’re paying into.
Pensions are a tax-efficient investment as you will receive tax relief on any money paid into them.
20% of the amount you pay in is added by the government ‘at source’. If you are a higher or additional rate taxpayer, you will receive 20% at source but can also reclaim the additional tax (20% or 25% respectively) through your tax return.
Whilst there are limits on the maximum contributions that you can make and still receive tax relief as well as a lifetime allowance that imposes a maximum in the total size of your pension pot, pensions are an extremely attractive long-term savings tool and should be the corner-stone of your retirement plan.
A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.
What types of Pension are there?
Aside from the state pension, there are two main types of pension available: defined benefit schemes and defined contribution schemes.
There are benefits and considerations to each type and the choice may be dependent on your personal circumstances and what is available to you at the time.
To learn more about how to check your State Pension entitlement, go to https://www.gov.uk/check-state-pension or else contact us to speak to an adviser who will be able to talk you through the process and how your state pension impacts your retirement plans.
Defined Benefit Pension
A defined benefit pension, commonly known as a final salary pension, is a workplace pension set up by your employer. This type of pension promises to pay you a specified income for life, as well as a one-off tax-free lump sum.
The pension income will last throughout your life and, when you die, it will usually then continue to pay an income to your spouse, civil partner or potentially your dependents.
The income and lump sum offered by the pension is determined using a number of elements, such as the length of time you worked for the employer, your salary at retirement, and the accrual rate (the proportion of your earnings that you’ll get as a pension for each year you are in the scheme) as opposed to relying directly on the underlying performance of the investments.
This type of pension is becoming increasingly rare as employers are struggling to meet the financial burden of the pension liabilities upon them because the responsibility for making up any shortfall sits with the employer.
Defined Contribution Pension
A Defined Contribution pension (or money purchase scheme) is a pot of money that can be accessed from age 55 or higher (depending on the scheme) in a variety of ways.
It is not guaranteed to provide you with a set amount of income when you retire.
Defined Contribution pensions can be a private or workplace pension and both yourself and/or your employer may contribute towards your retirement savings.
Unlike a defined benefit pension, which promises a specific income, the amount you can draw from a defined contribution pension depends on a number of factors including, the amount you saved up, investment performance and the choices you make at retirement. The pot itself is not endless and can run out at any time depending on how much you withdraw and the performance of the underlying investments.
