Pensions: Our Essential Guide to Saving for a Richer Retirement
Pensions, they are not really the subject of get-togethers with friends on a Saturday evening, and can often feel like a subject we can put off. After all, retirement could be several decades away for some, or life and its expenses could be getting in the way of thinking you have enough spare to hit the pension pot each month, but making the most of a pension scheme is your best chance of securing a decent income when you retire.
After our working years are over, we still need to pay for bills, food, perhaps a mortgage or rent still, and of course the odd treat, maybe a cruise anyone? How will you afford a comfortable retirement if you have not planned ahead?
What is a Pension?
A pension is a financial product, which you can build up over years, to use once you retire. You’ll receive tax relief on pension contributions, which increases the amount that goes in. This effectively means that you are investing into your pension out of untaxed income.
Once retirement arrives, you can then access your pension to buy yourself an income or draw on it. Some companies offer a defined benefit scheme, also known as a final salary. This is when your employer promises you a set income in retirement for life and pays into it for you.
Once you start working, it is wise to start a pension. There are work pensions, but you could also set up and manage your own through a personal pension.
There are two main types of pensions:
Defined Benefit – this is when an employee pays a certain amount per month into their final salary pension (for example 5% of their earnings), and in return their employer will pay them a set amount of their salary every year they have worked for the company (for example one fiftieth).
Defined Contribution – This is when an employee agrees to pay a set amount into their defined contribution pension scheme. Their employer then matches this, so if the employee pays in 5% of their earnings, their employer would match this to pay in a total of 10% of their earnings each month. This money is then invested in stock market funds and the pension pot grows over the working years. Once the employee reaches retirement, he/she must take their pot and either buy an income with it or draw on it for one.
Pensions don’t just come through the workplace, you can also set up your own personal pension through a bank or building society instead of, or in addition to a work pension.
When should I start a Pension?
The earlier you start investing in your pension, the better. Put simply, when it comes to your pension, time is your friend.
Time allows you to regain lost ground if your investments fall in value, and can also allow you to double your investment pot. For example, if you were to invest £100 per month for 20 years with 5% growth per year would deliver £41,000. But save for just ten years longer at the same rate and your pension will be worth twice as much at more than £83,000.
When can I access my pension?
The earliest you can access a pension fund is currently set to age 55. Although that can seem a long time away, especially if you are only in your twenties or thirties, it does keep your investment safe from being spent too early.
However, you can take a 25% lump sum tax-free, which you can then either buy an annuity or keep the rest of your pension invested through a process called drawdown and take money out when you want, with tax at your usual income tax rate.
On the other hand, you could forgo the 25% tax-free lump sum in one big chunk and keep the rest of your pension invested and draw on it as you choose, with the first 25% of each withdrawal tax-free and the rest taxed at your usual income tax rate.
For more help and advice on starting a pension or making the most of pension schemes available, give us a call today. The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.