What is a pension scheme?
Essentially, a pension scheme is a long-term savings plan, one you can come to live off when the time comes to stop work and halt your usual monthly income. “It makes sense to put some money away for when you’re older and that’s what pension schemes help you do,” says a spokesperson for The Pensions Advisory Service (TPAS). “You save a little of your income regularly during your working life so you can have an income in later life, when you want to work less or retire.” It’s also worth remembering there are several types of pension schemes: some may be run by your employer, others you can set up by yourself, and saving into one scheme doesn’t mean you can’t save into another or use other tax-efficient savings plans like ISAs. “When the time comes for you to start enjoying your pension, there will be several options available to you,” adds the TPAS spokesperson. “These may include being able to take a tax-free cash sum and the added security of being able to receive a regular income.”
How does the state pension work?
The state pension is a pension paid by the government when you reach state pension age, which you get when you have paid or been credited with National Insurance contributions, with the current weekly amount being £115.95, explains Jackie Spencer from the Money Advice Service. “If you are not currently planning on making any additional provisions for your pension, it is important to consider very carefully if this is something you’d be able to live off,” she adds. If not, it’s worth investigating how else you could invest some of your income into a long-term pension product to ensure you have more of a nest egg when it comes to it.
What is auto-enrolment?
Every company in the UK should offer at least a basic pension scheme to their employees. “Currently an opt-out (rather than opt-in) system is in place,” says Jackie, “which essentially means you are auto-enrolled to have at least 1% of your salary going towards your pension – and with this, your employer matches the contribution or may choose to contribute more.” It also makes no difference whether you’re full-time or part-time: you have the same rights to join your employer’s workplace pension scheme or to be automatically enrolled, provided that you are eligible. Just bear in mind your employer will choose where and with whom to invest your pension (think third parties like Aviva). If you choose to invest your pension yourself, you get to choose the product and the manager. These are known as self-invested personal pensions or SIPPs.
How much should you put into your pension?
With auto-enrolment workplace pensions, there are minimum contribution levels. But if you can afford it, experts agree that you really should be contributing more – although personal circumstances also have a role to play. “Those in debt, especially at high rates of interest, should consider whether it'd be better to get rid of that before starting a pension,” says money expert Martin Lewis. “Plus, a pension's only one form of retirement planning. Combining it with other methods is often a good plan. The basic advice with pensions is to put in as much as possible, as early as possible.” According to Martin, there's also a rough rule of thumb for working out what you should contribute for a comfortable retirement. “Take the age you start your pension and halve it. Then put this percentage of your pre-tax salary into your pension each year until you retire. For example, someone starting aged 32 should contribute 16% of their salary for the rest of their working life. While 16% of your pay seems a huge commitment, this figure includes your employer's contribution – so you only need to fund the rest.”
What are the different kinds of workplace pensions?
Workplace pensions may also be known as company pensions and occupational pension schemes. There are different types of workplace pensions, all of which work in different ways, but they broadly fall under three main categories: defined benefit pension schemes (DB); defined contribution pension schemes (DC); and cash balance plans. “Defined contribution pensions build up a pension pot using your contributions (and if applicable, your employer’s input) plus investment returns and tax relief,” explains Jackie. “Defined benefit pensions are different, in that the amount paid to you at retirement is set by a formula based on how many years you’ve worked for your employer and the salary you’ve earned. If you currently work or have worked for a large employer or in the public sector, you may have a defined benefit pension.” It’s worth remembering however, that DB schemes are now incredibly rare given how many companies have found them to be financially unsustainable. So even if you join a company where some employees are on a DB pension scheme, you may find you do not qualify to join it.
Are there any tax implications?
According to Martin, one of the biggest advantages of paying money into a pension are the tax benefits. “A key plus of a pension plan is the tax relief, which comes in two forms depending on whether you're a basic-rate or higher-rate taxpayer,” he explains. “You get some tax back on the money you put into a pension, while gains from the investments you make with that cash are largely tax-free. You also get the tax back you've paid on all contributions, if you're under 75, subject to an annual allowance.” Limits can vary depending on your age, employment status and how long you live, but more information can be found here.
What happens when you leave your job?
You tend to leave your pension scheme when you leave your employer, or if you decide to opt out or stop making contributions. But even if you do, the benefits you’ve built up still belong to you. Therefore, you normally have the option to leave them where they are or to transfer them to another pension scheme. “Your scheme administrator or pension provider should tell you which options apply to you,” says the TPAS. “Most schemes will allow you to transfer your pension pot to another pension scheme, which could be a new employer’s workplace pension scheme, a personal pension scheme, a self-invested personal pension or a stakeholder pension scheme.” It’s important not to rush into a decision. “You can generally transfer at any time up to a year before the date that you are expected to start drawing retirement benefits,” adds the TPAS. “In some cases, it's also possible to transfer to a new pension provider after you have started to draw retirement benefits.” For more information, click here.
And what if you take an extended absence, like maternity leave?
As long as you are still being paid by your employer, your pension contributions should continue – although the terms might vary slightly depending whether you’re on a DC or DB pension scheme. “If you decide to take a period of unpaid leave after your paid parental leave, you don't need to continue contributing during the period of unpaid leave,” adds the TPAS. “Your employer may also cease contributing, unless your contract of employment states otherwise, but when you return to work, you (and your employer) may be able to pay extra contributions, depending on the scheme’s rules.”
Is there any way to protect the money in your pension?
With savings accounts, up to £85,000 per person per institution is fully protected should your bank go bust, with that protection provided by the UK's Financial Services Compensation Scheme (FSCS). The good news is this £85,000 limit has been extended to pensions and investments from 1st April 2019. “The FSCS safety applies if you lose money due to the pension or investment firm going bust,” explains Martin. “Usually with pensions, if you buy through a broker it doesn't hold any of the cash, it simply acts as a conduit for you to put the money into whatever funds or investments you want. Therefore, in the unlikely event the broker goes bust, your money should be okay, and still held by the fund manager or bank it resides with. The £85,000 protection applies should any of those go bust.” If protection kicks in, the FSCS will first try to transfer your funds from the failed company to another company. Bear in mind that if you've got a DB pension, there's a risk of your employer going bust, leaving you with no pension income at all. In this case, the Pension Protection Fund (PPF) is available and may pay compensation.
So, what happens when you retire?
Once money has been paid into a pension, it can't be withdrawn on a whim – it must stay there until you're at least 55. “At that point, you can take 25% of it as a tax-free lump sum, with the rest ideally providing an income for the rest of your life,” explains Martin. “If you get approached before you're 55, it's a scam known as pension liberation or unlocking. These scams are so damaging, the government banned cold calling about pensions in January 2019.” Think of it this way: when your regular work income stops, it's decision time, although ideally you should start preparing a few years beforehand. “Provided you're over 55, you'll be able to take as much of your pension pot as you like, when you like – though drawdowns above the tax-free 25% will be taxed at your marginal rate – so 20% if you're a basic-rate taxpayer, and 40% or 45% if you're a higher or additional-rate payer, or the amount you've taken from your pension pushes you into that rate,” adds Martin. Finally, it’s worth noting that in September 2020, the government announced that it was planning to raise the earliest age you could access your pension from 55 to 57 in 2028, so this may impact how you plan for your retirement.
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