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Pensions can seem complicated (and let’s be honest, a bit dull) – but they’re absolutely vital to a financially secure retirement.
The trouble is we’re tempted to use the money we’ve got for the ‘right now’ instead of stashing it away for decades. However, setting up a pension and paying in regularly – even small amounts – helps you reap the rewards when it’s time to retire.
In this ‘all you need to know’ guide to pensions, we will explain:
It’s an obvious question but one we’re often too scared to ask. We know our employer pays something for one. We know the Government pays something called a State Pension. But, do we really know what they are and how they work?
A pension is a lifetime saving pot that’s released to you when you retire. You can’t access a pension until a certain age: at the moment, it’s 55, and that goes up to 57 in 2028. That means you’ve got money tucked away to fund your retirement.
When you retire, you won’t have an income from your job any more. But, there are still bills to pay! And you’ll probably want to take a few well-deserved holidays in your newly-acquired downtime, too. You could look at other investment types – and in fact, we encourage it – such as buy-to-let property or artwork, but a pension is the most reliable thing for your future. It’s heavily regulated – and pensions advisers have to follow strict rules, too.
Definitely not! The State Pension is paid to everyone who paid National Insurance. To get the full amount, you need to have paid in for 35 full years. If you’ve paid less, you could choose to top up your National Insurance contributions – or you’ll receive a lower State Pension. Check your State Pension forecast to find out how much you could get – and when you can claim it.
It’s not enough, though, to survive in your older years. The State Pension is available – at the moment – from the age of 66. A maximum payment is £185.15 per week – or £9,627.80 a year. A report by Which revealed that a retired couple needs at least £17,200 a year just to pay basic bills, and £25,000 for a frugal-but-comfortable retirement. If you want to go on holidays or anything like that, around £40,000 a year is required.
There’s also no guarantee when you’ll get the State Pension, as seen by the 1950s women who planned on taking it when they turned 60. With no real notice, the age was raised to 66 – meaning they had six more years to find an income before they could claim. Similar things could happen in the future – we never know – and the State Pension age could rise to 70 and beyond for those currently in their 20s and 30s.
You need to pay into your pension as early as possible. You can even set up – and pay into – a pension for babies as soon as it’s born!
We often don’t think about our pension until we’re in our 30s, 40s, or even 50s. However, the earlier you start paying into it, the harder your money works for you. Compound interest means small investments when you’re 20 grow significantly over time – with at least 35 years to develop, that’s a huge room for growth!
The older you are, the more you need to put away for your retirement. One way to do this is, when you get a pay rise, start paying the difference between your old and new salary into your pension. You won’t notice the difference, as you’re used to the old salary! But your retirement fund will quickly grow.
Employees often qualify for auto-enrolment into the workplace pension scheme. If you can afford it, try not to opt out. This is because there are so many benefits for ‘future you’ by paying into the workplace pension! In addition, if you move jobs, remember to find out if your new employer uses the same scheme or if you should transfer your pension into one pot.
Self-employed pensions work slightly differently for people who are their own boss. They still get tax relief from the Government, but won’t get employer contributions.
To make things a little more confusing than they already are, you can have different types of pension.
As mentioned above, this is paid once you’re 66 and is from the Government. You need to have a full National Insurance record to get the full amount. Check your State Pension forecast here.
All pensions that aren’t the State Pension are private. This means they’re operated by a company with business interest. So, you’ll pay fees to the company each year to hold onto and manage your pension funds. They profit from the fees – and you get your funds invested without needing to understand the stock market!
A pension offered by employer, these are dying out as they’re very expensive for businesses. You receive a set income based on your average salary during your time at the company. This is the gold dust of all pensions, and is mostly now found in public service jobs such as the NHS, local authorities, and police and fire services. If you have a final salary pension, as well as other pension pots, it could be worth keeping your final salary pension separate instead of moving it into one pot.
This is where you pay into your pension either through your employer or individually. Most pension schemes are defined contribution these days. It doesn’t guarantee you a final income when you retire. Instead, how much is in your retirement pot depends on the investment performance and the fees you pay.
This is the cheapest type of pension and it’s available to everyone. Most workplace pension schemes are now stakeholder pensions, too. Read more about stakeholder pensions here.
This is for confident investors. You get to pick and choose the funds you invest in for your retirement. Some low-cost SIPPs are very hands-on and DIY – you save in fees but need to know what you’re doing with investing. Higher-fee SIPPs have more guidance to help you decide how to invest.
Did you know that, if you have a pension, you’re an investor? It’s true! That’s because pensions use your money to buy stocks and shares.
Unless you want to be hands-on with a SIPP, you can leave your pension company to the investment stuff. The low-cost pensions operate mostly on automatic market trackers or robo-investments. Higher fee pensions have hands-on fund managers actively moving money when they anticipate a huge rise or drop in share prices, to try and get you better returns. Your returns get re-invested while your money sits in your pension, so the longer you can leave it the more it can grow.
Pension funds have different risk portfolios to choose from, so you can calculate the amount of risk you’re willing to take.
Generally, the longer you have until you can take the pension, the more risk you can take. Higher risk portfolios offer higher returns – but you could lose money, too. So, in your 20s and 30s, you can invest in a higher risk portfolio to take advantage of the overall higher returns. Then, as you start planning retirement in your 40s, move to a medium risk. In your 50s, it’s usually advisable to shift to a low-risk portfolio. This is usually mostly invested in Government bonds and things that are low-return but stable, which reduces the risk of your pension pot reducing.
If your life circumstances change, remember to take your pension into consideration, too. For example, if you’re in the middle of a divorce, check if you’re entitled to some of your spouse’s pension. This is most common if, for example, you’ve been the primary caregiver to children while your spouse worked. There are plenty of other situations in which you could get up to half of your spouse’s pension, so remember to include it even if you’re doing a DIY divorce.
At the moment, the earliest you can draw on your pension is age 55. In 2028, this goes up to age 57. Remember, the State Pension isn’t available until you’re at least 66 (and this will rise in future, too).
Leaving your pension as long as possible is the best way to grow your retirement pot. You may want to take early retirement at 55 – but if you keep working, your employer still contributes into your pension for longer! Once you start accessing your pension funds, you can take 25% tax-free and the rest is taxed at basic income rate. That’s why it’s a good idea to spread your retirement investments across more than just your pension.
For example, invest in antiquities, artwork, or other non-stock market assets that you could sell. Or, use savings in a Lifetime ISA or other ISA wrapper to take a tax-free income when you need, before using your pension. Or, if you’re in a position to do so, consider investing in a buy-to-let property for additional retirement income. Diversifying your long-term investments like this also helps protect against market fluctuations.
You have a few different options to access your pension.
Deciding what to do depends on a whole range of circumstances. It can even affect inheritance – so make sure you speak to an independent pensions adviser before you do anything. Pension freedoms mean you don’t have to buy an annuity with your current pension provider, for example – so it’s important to make sure you’re getting the best deal.
However you may feel about pensions, it’s something we should all think about sooner rather than later. It’s never too early to plan for retirement. But are pensions worth it?
Personally I’m still putting money into a couple of pensions.
Firstly, I choose a stakeholder and a SIPP (click here for more on SIPPs). Secondly, as I’ve always said, it’s important to spread your bets. I also put money into stocks and shares ISAs, property and alternative investments. If you’re not sure about investing, read our guide for beginners.
I do think spreading your money out is the best way forward. You never know what will come down the line. That’s particularly true with pensions since new future governments might set out new rules. That way, at least a portion of your money is protected.
We have worked with PensionBee on this handy guide that you can download here.
You can also find more information in these articles:
*This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.