People can be put off the idea of starting a pension for many different reasons with less than a third of UK adults currently saving for their retirement. However, pensions aren’t just for older people. It doesn’t matter whether you’re just embarking on your career or are in your late forties – you’re never too old, or young, to make a start.
Although saving into a pension means you’ll have less cash in your pay packet each month, it is being put towards your future. The extra contributions from your employer and the government effectively give you a pay rise – you just won’t be able to spend it until your retire. Saving into a pension doesn’t have to be complicated either but it’s important that you understand the basics in order to ensure you are financially stable in your later life.
Types of pension
There are three main types of pension: state Pension, a company or workplace pension and a personal pension.
The maximum basic state pension is £110.15 a week, the equivalent to £5727.80 each year. If you have been earning anywhere near the average UK salary of over £26,500 then that represents a significant loss in earnings. Many people don’t give a lot of thought to their pension until later in life. However, by allowing the years to pass without saving for your retirement, you could be facing the stark reality of being reliant on state pension without realising how little it pays.
If you want to continue with your current quality of life, or something similar, you will need to start paying into a pension as soon as you get chance.
If you are offered a workplace pension, it would be wise to take it – especially if your employer contributes as well. Depending on the terms of your scheme, around 5% of your salary will be put aside and deposited into the pension. This will then receive a top up from the employer. Usually this is equivalent to your contribution but can often be three times as much. You’ll also get a second top up though tax relief. Not all employers contribute to their company pension scheme at the moment but this is changing due to a new government initiative: auto-enrolment.
Not everyone has access to a workplace pension – mainly those who haven’t been auto-enrolled yet or the self-employed. In this case, the next best option is a personal pension. There are several options available to you so it’s important that you find the best one.
The three types of personal pension are: standard individual pensions, stakeholder pensions and a self-invested personal pension (SIPP).
The standard pension works almost like a regular savings account, with monthly contributions, however if you require a little more flexibility then a stakeholder pension can be a good choice. The savvier investor may be able to make the most of their pension pot with a SIPP but if you’re unsure which is right for you then it might be worth seeking financial advice.
How much to save?
If you are part of a workplace pension, your contributions will be defined by your scheme, although there is still the opportunity to make additional voluntary contributions should you want to save more.
There is no set figure as to how much you should be locking away for your future but there is a simple equation to help guide you. Whatever your age is when you start your pension, halve it and use that figure as the percentage to save. For example, if you’re 20, you should contribute 10% of your salary but if you’re 44 then you need to up that to 22% if possible.
Remember, the younger you are the less you have to put aside because it’s got longer to accrue interest and earn money. If you get a pay rise, try to invest the additional money into your pension – this way you won’t miss any income and you’ll be protecting your future.
One of the main benefits to a pension is the tax relief. All contributions you make to a pension are not taxed (as long as you don’t exceed the annual allowance of £50,000 – set to drop to £40,000 in 2014). This means that basic rate tax payers receive a 20% top up from the government, but higher rate tax payers could get as much as 45%.
Most workplace pensions work out the tax relief for you so you don’t have to do anything but if you have a personal pension, you’ll have to claim the money back yourself.
When you approach retirement, you will have to decide what you want to do with your pension pot. Until 2011 you didn’t get a choice, the only option available to you was to purchase an annuity. You can still do that, with or without the 25% cash lump sum, but there are more options on the table now. Annuity rates have been on the decline for many years, so pensioners have been delaying their annuity and taking advantage of pension drawdown – but there are risks involved.
Whatever you decide to do, you still have to purchase an annuity before the age of 75. Make sure you get the best possible rates by utilising the OMO (open market option) and seeing if you’re eligible for an enhanced rate.