What is a pension?
In its simplest form, a pension is a set amount of money paid out on a regular basis to a person on retirement from work. The age at which someone is eligible to receive a pension is dependent on the type of pension it is.
People opt for a pension over the other various forms of saving due to the tax relief that you get on the money put in, which should mean you’re left with a bigger pot for your retirement.
What are the different types of pension?
UK State Pension
In the UK, a basic State pension (‘State’ meaning that it’s paid out by the government) is provided to any person who is eligible and over the State pension age.
The state pension age is currently 65 for men and nearly 62 for all women. However, this state pension age is set to increase in coming years and will rise to 65 for both men and women in 2018, before reaching 66 by 2020. You can check the age at which you can expect a state pension with the Government’s State Pension Calculator Tool
To be eligible to receive a State pension you must have been paying National Insurance, receiving National Insurance credits or been covered by a carer’s or partner’s contributions. To get the maximum amount, you’ll need to have been making these payments or receiving the credits for a minimum period of 30 years. Full eligibility criteria can be found at the Gov.uk website
The current maximum State Pension is just over £110 per week, which means it’s essential to look at other types of pensions to ensure you have sufficient finances for your retirement.
Workplace pensions are the primary additional pension taken out by people across the UK. They can be arranged directly through your employer and are often the best option, as many employers will also make a contribution to your pension fund based on the amount you put in. By 2017 it will also be a requirement for employers to pay a minimum level of contributions.
With a workplace pension, you’re able to set the amount you’d like to put in and then each month this will automatically be deducted from your salary payments, which means it’s also a simple option as the paperwork is done by your employer.
You can set up a personal pension directly with your bank or building society, who will invest your savings on your behalf to try to get the maximum return possible. Like workplace pensions, you’ll get tax relief on the money you put in (up to the annual allowance) and there’s also the flexibility to change the contributions you make.
There is more admin associated with personal pensions compared to workplace pensions and you won’t benefit from the contribution that any employer would have to make with a workplace scheme.
What happens when you retire?
Unlike having to wait to over the age of 60 to receive your state pension, you can usually decide to take a retirement income from a workplace or personal pension from the age of 55. This can sometimes also be done even if you’re still working, helping you to get some extra income each month.
At the date set with your pension provider, you’ll have a variety of options to choose from and so it’s often best to take some independent advice at this point from a financial adviser. The main decision you will have to make is on annuities.
So what’s an annuity? Essentially it’s a payment plan to provide you with regular installments for the rest of your life, rather than having your full pension pot in one go. Annuities are provided by insurance companies, who will buy your total pot and then provide you with regular payments. It’s a big decision because once you’ve chosen an annuity you’re not able to change or cancel it – this is why it’s imperative to get independent financial advice, even if you do think it is expensive at the time.
The alternative to annuities is known as income drawdown, which involves withdrawing from your pension pot directly, which means you aren’t guaranteed payments for the remainder of your life if there aren’t sufficient funds.
Are there any risks with pensions?
The money you put into your pension is invested by pension companies in the stock market, which means your pension pot can go down as well as up. Therefore it’s vital to research the company you plan to use, whether it’s for a workplace pension or personal pension.
Unlike other savings, your money isn’t protected in full by the Financial Services Compensation Scheme (FSCS). However, most brokers don’t hold the cash themselves as it’s held by the banks and fund managers. Therefore if the broker goes bust, you should still be OK and the FSCS will attempt to transfer your pension fund from the failed company to a new one.
If you’ve got a private pension, make sure your money is spread between a variety of different banks as the FSCS will only cover up to £85,000 per financial institution - ask your Self Investment Personal Pension (SIPP) provider to confirm which bank is used if you aren’t sure yourself.