Whether you’re approaching retirement age with unanswered questions or simply planning ahead, it’s always a good time to start learning about your pension options.
Finance Rate is your online resource to gain a better understanding of the UK pension system, understand the options available to you, improve your confidence and provide peace of mind for what’s to come.
In this guide, you’ll learn;
- What a pension scheme is, the schemes available and the pros and cons of each
- Ways to prepare for your future retirement
- Things to consider if you’re facing imminent retirement
First things first; what is a pension scheme?
What is a pension scheme?
A pension is a financial arrangement which provides individuals with income during their retirement years. It is a form of long-term savings, specifically intended to support individuals after they stop working.
Why is a pension scheme important?
A pension scheme is important because it;
- Provides you with a regular income after you retire from your active working life. It ensures you have a stable source of income to support your living expenses and maintain your standard of living during your retirement years.
- Helps give you some financial security by providing a reliable income stream that you can depend on, reducing the risk of poverty or financial hardship in your older years. Retirement can be financially challenging with many adjustments, especially if you haven’t saved enough, don’t have other sources of income or are hit with unexpected costs.
- Helps address the risk of outliving your savings with increasing life expectancy, by providing regular payments throughout your retirement, regardless of how long you live. This helps you manage your finances and maintain your quality of life even in old age.
- Prevents you from becoming dependent on your family or government assistance for financial support, and promotes confidence, independence and self-sufficiency throughout your retirement.
- Provides employee benefits – many pension schemes are sponsored or supported by employers as part of employee benefits packages, designed to attract and retain talented employees by providing them with valuable long-term benefits. Offering a pension scheme can enhance job satisfaction and employee loyalty.
- Improve the health of the national economy; as pension funds are often invested in financial assets, they promote long-term savings and investment, stimulate economic growth, provide capital for businesses, and support financial markets.
Types of pension
In plain terms, when you retire, you can get money from the government to help you live. This is called a state pension. To be eligible for a state pension, you’d need to have made National Insurance contributions over your working life. National Insurance contributions are made alongside taxes. The amount you are able to receive from a state pension depends on how much National Insurance you’ve paid and for how long. The amount of pension received can vary greatly between individuals.
If you’re employed, your employer should deduct National Insurance from your wages before you get paid and these contributions should be reflected on your payslip along with tax. If you’re a director of a limited company, you may be classed as your own employee, and pay Class 1 National Insurance through your PAYE payroll.
If you’re self-employed, you need to pay National Insurance contributions yourself at the same time as your income tax during a self assessment. These payments can be done online through the HMRC website.
State pension is usually not enough money to live on comfortably by itself – through a workplace pension or personal pension, you can supplement your pension income with extra money from other pots on top of a standard state pension.
Pros of the State Pension:
Guaranteed Income: A state pension provides a guaranteed income to you during your retirement years. It serves as a safety net, ensuring that everyone is entitled to a minimum level of income in old age.
Universal Coverage: The state pension is available to all eligible individuals, regardless of your employment status or whether you have access to a workplace pension. This promotes inclusivity and ensures that everyone has some form of retirement income.
Index-Linked Payments: Your state pension payments are usually adjusted annually based on inflation or average earnings, which helps to protect your retirement funds from the eroding effects of inflation.
Supplementary Benefits: In addition to the basic state pension, you may be eligible for supplementary benefits such as Pension Credit – this provides you with additional financial support to alleviate financial hardship if you have low income or limited savings.
Cons of the State Pension:
Limited Amount: The state pension might not be sufficient to meet all of your financial needs, especially if you have higher living expenses or specific healthcare requirements. Relying solely on the state pension might result in a lower standard of living into retirement.
Changing Retirement Age: The pensionable age is gradually increasing, which means you may have to wait longer before you become eligible to receive your state pension. This change may disrupt your financial plans.
Means-Testing: If you receive benefits which are subject to means-testing, such as housing benefit or council tax reduction, these may be affected by the receipt of the state pension. This can lead to issues with entitlements and potentially reduce your overall financial support.
Uncertain Future: The sustainability of the state pension system could be a concern due to demographic changes, such as an ageing population and declining birth rates. As the ratio of retirees to workers increases, there may be challenges in funding the state pension at its current level.
While the state pension provides a foundation of income in retirement, supplementing it with other forms of retirement savings, such as workplace or personal pensions, can help to provide a more comfortable and financially secure retirement.
Pension Credit Supplement
The UK government also provides an additional payment called Pension Credit which acts as a supplement to a standard state pension. It is provided to ensure that no matter your circumstances, your income will always reach an agreed minimum level. Not everyone is entitled to Pension Credit – to be eligible, you must fall below the income threshold and you cannot have capital which exceeds £10,000.
Types of Workplace Pensions
When you’re working, you get paid for the work you do, but a portion of your earnings are deducted from your wage and put into your workplace pension. This functions much like a savings account that you only gain access to once you retire.
Employers have a legal obligation to automatically enrol you into a workplace pension scheme, provided you are eligible. Auto enrolment is intended to make saving for retirement easier by allowing you to have a portion of your wages set aside each month without you needing to register or fill in additional paperwork.
If you feel like you’re able to (if you have extra savings at the end of the month for example) you can speak to your employer and opt to increase your personal contribution to your pension, allowing you to accrue savings faster.
Your employer is required to make their own contribution to your pension savings to help it grow even quicker. Employer and employee contributions need to be paid into the pension scheme regularly and these payments must adhere to a set minimum amount by law.
You will be contacted via letter or email by your employer’s pension scheme provider with full details about your account with them, as well as information about contributions and what payout may be available when you retire.
Defined contribution schemes
Also referred to as money purchase schemes, these are more common than defined benefit schemes and are used by many UK employers.
The employer determines your auto enrolment eligibility – you’ll be deemed eligible if you’re:
- at least 22 years old
- earning more than £10,000 a year
- below State Pension age
- working in the UK
Once you’re enrolled into the workplace pension scheme, you’ll pay a percentage of your salary. Both yourself and your employer will make regular contributions to this scheme, and these invested amounts add up over time to provide an amount of money to you upon retirement. If both employer and employee are opting into the scheme, the minimum required contribution is 8% of the employees salary.
The amount available in your pension at retirement will be based on the amount of money paid in and how the investments have performed.
If you’re offered a defined contribution scheme through the workplace and your employer makes contributions, taking the opportunity to join can increase the speed at which you accrue pension savings. It may be worth comparing benefits you can receive from personal pension schemes elsewhere if you aren’t eligible for automatic enrolment, or your employer reveals they do not make contributions.
Furthermore, while you can opt out of your workplace pension scheme, paying into your pension scheme if you can afford it means you’re contributing to your financial future upon retirement – so think carefully whether you are in the position to contribute now to secure a more comfortable income later.
Defined benefit schemes
A defined benefit pension scheme is less common these days than the direct contribution schemes. The number of years you’ve been a member of the employer’s scheme and the salary you’ve earned by the time you retire or leave the company determines the amount you’re paid at retirement. This amount paid out is a secure income for life, and adjusts to accommodate inflation each year.
You may have encountered defined benefit schemes if you’ve ever worked in the public sector for a large employer. Your employer (and you, depending on the terms of the pension scheme) contribute to the pot, to ensure there’s enough money at the time you retire for a pension income. Speak to your HR department for information about any workplace scheme you are entitled to.
Pros of Workplace Pensions:
Employer Contributions: One of the significant advantages of workplace pensions is that your employer contributes to the pension scheme on your behalf. These additional contributions from the employer can significantly boost the individual’s retirement savings.
Tax Advantages: Workplace pensions offer tax advantages. Contributions made by you as an employee are typically deducted from your salary before tax, reducing your taxable income. Additionally, your employer’s contributions are not subject to income tax or National Insurance contributions. This tax relief helps to increase the overall value of the pension fund.
Automatic Enrollment: In the UK, employers are required to automatically enrol eligible employees into a workplace pension scheme through the auto-enrollment program. This ensures that you as an employee are actively saving for retirement without the need for extensive paperwork or complex decision-making.
Professional Investment Management: Workplace pensions often provide access to professional investment management. Experienced investment professionals manage your pension fund and make investment decisions on your behalf. This expertise can potentially lead to better investment returns and improved growth of the pension fund.
Long-Term Savings Discipline: Workplace pensions encourage you to save for the long term. By deducting pension contributions directly from your salary, it helps foster a savings habit and a more disciplined approach to retirement planning.
Cons of Workplace Pensions:
Limited Investment Choices: Workplace pensions may have limited investment choices compared to personal pensions. As an employee you typically have a few investment options pre-selected by your pension provider or your employer. This may restrict you if you prefer a broader range of investment options or have specific investment preferences.
Lack of Portability: Workplace pensions are tied to employment, meaning that if you change jobs, you may need to transfer your pension to a new scheme or leave it behind. Transferring a pension can be a complex process, and there may be associated fees or charges. This lack of portability can create administrative burdens and potentially impact overall pension savings.
Minimum Contribution Levels: While workplace pensions have employer contributions, there are also minimum contribution levels set by the government. As an employee, you’re required to contribute a minimum percentage of your qualifying earnings, and employers must contribute a minimum percentage as well. This can be a financial commitment for you if you’re already on a lower income.
Retirement Age Restrictions: Workplace pensions typically have rules regarding when you can access your funds, which is usually linked to the state pension age. This means that you may not have flexibility in accessing your retirement savings before reaching a specific age no matter how much you need them..
It’s important you understand the specific terms and conditions of your workplace pension scheme, review investment options, and consider your individual financial circumstances and retirement goals when evaluating the pros and cons. Seeking professional financial advice can also provide valuable insights tailored to your specific situation.
Armed Forces Pension
The Armed forces pension schemes are available to provide you with an income after you leave or retire from the armed forces.
While state and work pension schemes require both employer and employee to make monthly contributions to the pension pot, for Armed Forces Pension Schemes the pension is free, paid entirely by the government, and you don’t make any contributions.
There are several armed forces pension schemes, which you would receive depending on which decade you served in, and whether you were in the army reserves.
The amount received for your armed forces pension can depend on your rank, your length of service and how old you were when you joined. The income received from Armed Forces pensions adjusts with inflation to make sure the amount you receive stays consistent regardless of the state of the economy.
For members of the Regular Armed Forces, the three Armed Forces Pension Schemes are as follows:
- Armed Forces Pension Scheme 75 (AFPS 75)
- Armed Forces Pension Scheme 05 (AFPS 05)
- Armed Forces Pension Scheme 15 (AFPS 15)
And for the Reserve Forces, there are four schemes:
- Full Time Reserve Service (FTRS) Pension Scheme 1997
- Reserve Forces Pension Scheme 05 (RFPS 05)
- Non-Regular Permanent Staff (NRPS) Pension Scheme
- Armed Forces Pension Scheme 15 (AFPS 15)
Which of the above schemes you belong to depends on which decade you served in, your role in the army and whether you were in the Army Reserves. Full literature on Armed Forces Pension Schemes provided by the government can be found here.
Pros of Armed Forces Pensions UK:
Generous Benefits: Armed forces pensions in the UK are generally considered to be quite generous compared to many other pension schemes. They provide a stable and secure income for retired military personnel, helping to ensure a comfortable retirement.
Defined Benefit Scheme: Armed forces pensions are typically defined benefit schemes, which means the pension amount is based on factors such as length of service, rank, and final salary. This provides a level of predictability and security, as you have a clear understanding of the pension benefits you can expect to receive.
Early Retirement Options: The armed forces often allow for early retirement options, which means you can retire and start receiving pension benefits at a younger age compared to many other professions. This can be an appealing feature if you desire to transition to civilian life or pursue other career opportunities earlier.
Index-Linked Payments: Like state pensions, armed forces pensions are generally linked to inflation, ensuring that the pension income keeps pace with rising living costs and helping towards protecting you against the eroding effects of inflation over time.
Cons of Armed Forces Pensions UK:
Time-Limited Service: A potential downside of armed forces pensions is that you have to have served a minimum period of service to be eligible. If you serve for a shorter period, or leave the armed forces before qualifying for a pension, you may not be eligible.
Limited Flexibility: Armed forces pensions may have limited flexibility compared to other pension schemes. The retirement age and access to pension benefits are often determined by military service rules and regulations, leaving less room for personal choice and flexibility in retirement planning.
Relocation Challenges: Military personnel often experience frequent relocations and deployments, which can create challenges in terms of continuity of pension contributions and maintaining a stable pension plan. It may require additional effort to ensure pension contributions are consistently made and to keep track of pension entitlements during various assignments.
Potential for Physical Demands: Serving in the armed forces can involve physically and mentally demanding roles, and life threatening situations. While pensions may provide financial security in retirement, there may be health considerations and potential long-term impacts from the physical and mental demands of military service.
If you’re serving in the armed forces, it’s important to fully understand your specific pension scheme, eligibility requirements, and retirement options. Seeking guidance from military pension experts and financial advisors can help you make informed decisions regarding your armed forces pension and retirement planning.
Aside from state and work pensions, private pensions (also known as a personal pension) are a potential third option and provide another stream of income at retirement.
Personal pensions give those who don’t qualify for a workplace pension another way to save for their retirement.
The money you pay into a private pension is put into investments (such as shares) by the pension provider. The money you’ll get from your personal pension usually depends on:
- how much money has been contributed
- how and when you decide to take your money
- how the fund’s investments have performed
Because there are so many providers of personal pensions on the market, choosing one can be confusing.
- Compare! Compare the packages from different providers. They must provide you with the key facts document for each private pension plan you are considering – this summary can make comparisons easier.
- How risky? Determine where the funds will be invested and the risk involved.
- Can you afford the contributions? If you have a low or irregular income you could put yourself under strain. Check if you have to commit to regular payments or if there is flexibility in how much and how often you make contributions.
- Additional fees? Check for additional charges like administration fees, transfer charges, penalties for missed payments or taking your pension early.
Remember – if you are struggling with your finances because of a low or irregular income, if you’re facing unexpected fees and considering a loan, need help with budgeting or have any other finance related questions, Finance Rate is here to help fill in any knowledge gaps and give you the answers you’re searching for.
How do you get a Private Pension?
Unlike state pension and workplace pensions which are arranged by someone else, a private (or personal) pension is one which you arrange yourself.
Providers include banks, building societies and insurance companies – and unlike workplace pension schemes, you can choose your provider.
Pros of Personal Pensions UK:
Flexibility: Personal pensions offer you greater flexibility in terms of contribution amounts and investment choices. You can contribute as much as you want (up to certain limits) and adjust your contributions based on your financial circumstances. They also have a wider range of investment options, allowing you to choose investments that align with your risk tolerance and investment goals.
Portability: Personal pensions are portable, meaning they are not tied to a specific employer. This allows you to continue contributing to the same pension scheme even if you change jobs or become self-employed. Portability provides continuity in pension savings and eliminates the need for transferring funds between different schemes.
Additional Tax Relief: Private pensions offer additional tax relief on contributions. You receive tax relief on your contributions at your marginal income tax rate, which can result in significant tax savings. Higher-rate and additional-rate taxpayers receive even more tax relief, making personal pensions an attractive option for tax-efficient long-term savings.
Access to Pension Funds: Personal pensions provide you with more flexibility in accessing your pension funds. While there are rules and regulations in place, you generally have more options when it comes to accessing your pension savings, such as taking a tax-free lump sum, purchasing an annuity, or opting for flexible drawdown.
Cons of Personal Pensions UK:
Lack of Employer Contributions: Unlike workplace pensions, private pensions do not benefit from employer contributions. You are solely responsible for funding your pension and may miss out on the additional contributions that can significantly boost your retirement savings.
Investment Risk: Personal pensions require you to make investment decisions or choose a pension provider who manages the investments on your behalf. This introduces investment risk, as the value of the pension fund can fluctuate based on market conditions. You need to be comfortable with taking on investment risk and may require financial expertise or advice to make informed investment decisions.
Administrative Responsibility: Private pensions require you to manage and monitor your pension funds, which can be time-consuming and complex. You need to review your investments regularly, stay informed about changes in legislation or regulations, and ensure compliance with reporting requirements.
Retirement Income Uncertainty: The responsibility of generating retirement income rests with you. The personal pension income is based on the performance of the investments and the decisions made at retirement, such as whether to purchase an annuity or opt for drawdown. This introduces uncertainty in terms of the actual retirement income you will receive.
If you’re considering personal pensions, it’s crucial to carefully evaluate your retirement goals, investment knowledge, and risk tolerance. Seeking advice from a financial advisor can help in choosing the right personal pension scheme and making informed decisions about contributions, investments, and retirement income options.
A stakeholder pension is a money purchase pension (aka direct contribution pension – the kind commonly available in employment) which is provided by a bank, building society or insurance company instead of by an employer.
The options for investment are broader, there’s more control, but also more complexity, which may mean you’d need a financial adviser to help with decision making. Trade unions may also offer stakeholder pensions to their members.
The government has enforced a limit on how much the pension company can charge you each year for managing your money, to make sure these pensions are fair and easy to use for everyone. These pensions also offer flexibility to decide how much money you want to put in.
That means that even if you can only save a little bit, that’s fine. You’re also able to start and stop saving money whenever you want.
You might want to consider a stakeholder pension if:
- Your employer offers it as a type of workplace pension
- You don’t have a workplace pension in place
- You aren’t working but can afford to pay for a pension
- You are self-employed
- You want to save money for retirement alongside your workplace pension
You can set up a stakeholder pension yourself, or your employer might contribute to the scheme. Your contributions are usually invested in stocks and shares. The aim is to increase the fund over the years before you retire, accruing money over time as the stocks grow more profitable.
You can usually choose from a range of funds to invest in, but due to the unpredictable nature of the market, the value of investments can go up or down over time.
As you near retirement, investments can be moved from higher risk investments to lower risk to prevent you from losing the money you’ve accrued over the years as the market fluctuates.
Pros of Stakeholder Pensions UK:
Accessibility: Stakeholder pensions are designed to be accessible to a wide range of individuals. They have low minimum payment requirements, making them affordable for those who may have limited income or savings. This helps promote a habit of saving for retirement.
Flexibility: Stakeholder pensions offer flexibility in terms of payment amounts and contributions. You can contribute as much or as little as you want (within certain limits) and have the freedom to stop and restart payments according to your financial circumstances. This flexibility allows for customisation of savings based on your needs.
Government Standards: Stakeholder pensions must meet specific government standards. These standards aim to ensure transparency, fair treatment, and low costs for you. Stakeholder pensions have capped annual management charges, preventing excessive fees and protecting your savings.
Portability: As a form of personal pension, stakeholder pensions are portable, tied to you instead of an employer. You can maintain the same pension scheme even if you change jobs or become self-employed. This portability allows for continuous contributions to the pension and eliminates the need for transferring funds between different schemes.
Cons of Stakeholder Pensions UK:
Limited Investment Options: Stakeholder pensions typically offer a limited range of investment options compared to other types of personal pensions. The options are often pre-selected by the pension provider, which may feel restrictive if you prefer a broader range of investment choices or have specific investment preferences.
Retirement Income Uncertainty: The income from a stakeholder pension is uncertain and depends on various factors, including the performance of the investments made within the pension fund. You bear the investment risk and need to carefully monitor and manage your pension investments to achieve your desired retirement income.
Lower Contribution Limits: While stakeholder pensions offer flexibility in payment amounts, there are lower contribution limits compared to other personal pensions. This may limit the overall growth potential of the pension fund, particularly if you have a higher income and wish to save more for retirement.
Limited Advice and Support: Stakeholder pensions are often seen as more basic pension arrangements and may not provide extensive advice and support compared to other pension options. You may need to seek additional financial advice or education to make informed decisions about your stakeholder pension and retirement planning.
If you’re considering a stakeholder pension, it’s important to evaluate your retirement goals, risk tolerance, and investment preferences. Seeking advice from a financial advisor can provide insights tailored to your circumstances and help make informed decisions about stakeholder pension contributions, investments, and retirement planning strategies.
Self-invested Pension Plan
Self-invested personal pensions (SIPPs) are a type of private pension similar to standard personal pensions, except with more flexibility with the investments you can choose. Some schemes give you a much wider choice of investments, which you can manage yourself, or with the assistance of a professional financial adviser. Examples of this wider array of investment options include:
- Company shares (UK and overseas)
- Collective investments – such as open-ended investment companies (OEICs) and unit trusts
- Investment trusts
- Commercial property such as office builds and land – but not residential property
As there’s lots of moving parts and investment know-how involved, it’s wise to use a regulated financial adviser to help you select and manage your SIPP investments (unless you’re experienced in investment management and completely confident you’d be making the right decisions for you).
Pros of SIPP Pensions UK:
Investment Control: One of the significant advantages of SIPPs is the level of investment control they offer. You have a wide range of investment options and can choose from various asset classes such as stocks, bonds, funds, and commercial property. This flexibility allows you to tailor your investments to your risk tolerance, financial goals, and investment preferences.
Tax Advantages: SIPPs offer tax advantages similar to other pension schemes. Contributions made to a SIPP receive tax relief at your marginal income tax rate, which can lead to significant tax savings. Additionally, any investment growth within the SIPP is generally tax-free, providing potential long-term benefits.
Consolidation of Pensions: SIPPs allow you to consolidate multiple pension pots into a single plan. This simplifies pension administration and can provide you with a clearer overview of retirement savings. Consolidating pensions into a SIPP can also make it easier to manage investments and potentially reduce administrative fees.
Flexibility in Contributions: SIPPs provide flexibility in terms of contribution amounts. You can contribute as much or as little as you want (within certain limits) and adjust your contributions based on your financial circumstances. This flexibility allows for customisation of savings based on your needs and affordability.
Cons of SIPP Pensions UK:
Investment Risk: With greater investment control comes greater investment risk. SIPPs require you to make your own investment decisions or choose a pension provider who offers a range of investment options. This introduces the risk of poor investment performance or making uninformed investment decisions, which can result in a reduction in the value of the pension fund.
Complexity: SIPPs can be more complex than other pension options. They require you to have a good understanding of investment principles and financial markets to make informed investment choices. The complexity of managing a SIPP may be overwhelming for you if you aren’t experienced with investments.
Higher Fees: Compared to other pension schemes, SIPPs may have higher fees and charges. This is mainly due to the increased investment options and administrative complexities associated with managing a SIPP. You should carefully consider the fees and charges associated with your SIPP provider and the potential impact on your overall pension returns.
Responsibility for Investment Performance: With a SIPP, you bear the responsibility for your investment performance. The value of the pension fund is dependent on the performance of the chosen investments, and you need to actively monitor and manage your investments to ensure they align with your retirement goals.
If you’re considering SIPPs, it’s crucial that you evaluate your investment knowledge and personal goals. Seeking advice from a financial advisor with expertise in pensions and investments can help in making informed decisions about contributions, investment choices, and retirement planning strategies within a SIPP.
Planning Ahead of Retirement
How much pension do I need?
If you’re planning for retirement, it’s not uncommon to be uncertain about how much pension you’ll need saved up to be able to retire and support a comfortable, happy lifestyle.
While it is true that your individual circumstances can have an influence on the amount of pension you’d require (lifestyle, medical conditions etc), tools such as the pension calculator on the Which website can help you put your spending and lifestyle habits into perspective. It may also help by inspiring you to ask yourself certain questions you might not have considered when it comes to planning your retirement.
Making regular contributions to different pension pots is making progress towards having financial security in the future – but if you don’t know how much you need to save at a minimum, it might feel like you’re chasing a constantly moving goalpost, unsure whether you need to increase your contributions and speed up your saving.
Alternatively, you won’t know if you’ve already met your savings criteria, and be able to relax a little and reduce your contributions, preventing yourself from feeling that peace of mind.
Alongside other tools and sources of information like financial advisors, FinanceRate is here to be your font of knowledge about all things finance.
To help you on your way, below is a non-exhaustive list of questions you could ask yourself when planning for retirement. Feel free to add to the list with whatever questions you feel are appropriate for you; the more questions you consider, the more informed your retirement plan.
The more comprehensive your plans are and the more contingencies you have in place, the more confidence you’ll have when it comes to building your pots, understanding the amount of contributions you’d need to make and for how long.
Lifestyle habits checklist
Several factors come into play when estimating the pension amount required for a comfortable retirement. Here’s a list of questions you could consider when planning for a comfortable retirement;
- What activities might you pursue for entertainment and what would be the costs associated with them? For example, tickets and travel to and from venues, or clothing and equipment that may be required.
- Would you be taking regular trips or holidays?
- What would be the cost for flights, food and activities while on holiday?
- What supplies would you need for hobbies?
- What would be the costs for memberships for clubs, gyms etc?
- Will you own a vehicle during retirement?
- Will you have a new or old vehicle?
- Buying outright or paying over time?
- What would be the costs of insurance and vehicle maintenance?
- Do you intend to work a part-time job during your retirement?
- Are you expecting an inheritance?
- Any other supplementary sources of income?
- Will you be a homeowner or renting?
- Single, married, widowed, divorced or in the process of divorcing? How will this impact your finances?
- Are you currently paying a mortgage?
- How long until the mortgage is paid?
- Would you be looking to move to a larger, more expensive home, or downsize?
- Do you have a location you intend to settle down in for retirement, or would you prefer to be on the move frequently?
- What about the moving costs for moving frequently, or could you manage moving yourself?
- Would you be moving somewhere with a higher or lower cost of living?
- Healthcare, existing medical conditions, terminal illnesses, life expectancy, reduced quality of life, mobility apparatus or adapted living needs?
When setting out a retirement plan, it’s important to keep in mind that circumstances can change drastically and quickly. Leave some flexibility in your plans to allow for such changes, as these may influence how much you need from a pension pot.
Building your pension pot
After answering the above questions and adding your own to get a clearer picture of what your retirement outgoings may look like, you can start to build your pension pot with better clarity on your personal time-frames and better confidence in your decisions.
Now it’s just a matter of building your pot. Below is a concise round-up of methods alongside the usual state pension which you can use to build your retirement fund.
One of the most accessible and advantageous ways to build your pension pot is through workplace pensions. Many employers in the UK offer automatic enrollment schemes, where both you and your employer contribute to your pension fund.
These contributions benefit from tax relief and can significantly boost your retirement savings over time.
It’s essential to understand your employer’s contribution levels, take advantage of any matching contributions, and review your pension regularly to ensure it aligns with your saving goals. If you feel like you could contribute more to your pension with the disposable income you have left at the end of each month, you can choose to contribute more to your pension and speed up the saving process.
Personal pensions are another avenue to build your pension pot, where you contribute directly to a private pension plan of your choice. Personal pensions offer flexibility in terms of contributions, investment options, and provider selection. You can contribute regular payments or make lump-sum deposits, and the contributions benefit from tax relief.
Personal pensions enable you to take control of your retirement savings, tailoring them to your specific needs and investment preferences.
Self-Invested Personal Pensions (SIPPs)
For individuals seeking greater investment flexibility, self-invested personal pensions (SIPPs) are an attractive option because of the wide range of investment assets available.
The broad selection of investment comes at an extra cost compared to standard personal or stakeholder pensions – you could be paying more for something you might not use to its fullest, so take time to consider if you will be able to take full advantage of SIPPs.
SIPPs allow you to choose from a wider range of investment assets, including stocks, bonds, funds, and commercial property. This greater control over investment decisions can potentially generate higher returns, but it also carries higher risks – it’s important to carefully consider your risk tolerance, investment knowledge, and seek professional advice before venturing into SIPPs.
Individual Savings Accounts (ISAs)
While not a pension product, individual savings accounts (ISAs) are a popular and tax-efficient way to build your retirement savings. ISAs provide the flexibility to save and invest without incurring tax on the income generated. Contributions to ISAs are subject to annual limits, but any growth or withdrawals are tax-free.
Utilising cash ISAs and shares ISAs allow you to take advantage of potential investment growth and enjoy tax advantages while contributing to retirement savings.
A long-term strategy to build your pension pot, owning property can provide rental income during your working years and contribute to your retirement savings. Additionally, property values may appreciate over time, potentially resulting in a significant capital sum when you sell the property.
However, property investments require careful consideration, as they involve upfront costs, ongoing maintenance, and potential risks associated with rental income and property market fluctuations.
[An annuity converts your savings into another type of annual pension](https://www.ageuk.org.uk/information-advice/money-legal/pensions/annuities/#:~:text=An annuity converts your savings,or for a specified period.), paid in addition to other pensions, savings or investments. This provides guaranteed income over time and supplements your other streams of income into your retirement years.
What is an Annuity?
There are seven main types of annuities:
- Level Annuity: provides a fixed income throughout retirement but does not adjust for inflation.
- Escalating annuity: offers an increasing income over time, usually linked to a fixed percentage.
- Inflation-Linked annuity: an inflation-linked annuity rises each year alongside the retail price index. It starts at a lower rate but is designed to protect your annuity against inflation.
- Impaired / enhanced annuity: if you have health or lifestyle conditions which may shorten your life expectancy. This annuity provides higher income payments.
- Short/fixed term annuities: if you don’t want to commit your pension fund to a lifetime annuity You can use part of your pension pot to buy an annuity that provides a short-term income instead. The rest of your pot is left invested, and you can still get a lifetime annuity when your short-term one expires.
- Lifetime annuity: this annuity will pay you an income for the rest of your life, unlike a short-term or fixed-term annuity.
- Joint-life annuity: this will pay a lower rate income to your spouse or partner after your death
Each type of annuity has its own features and considerations and picking the correct annuity for you can be difficult. Seek professional advice from a financial adviser or speak to your pension provider to explore your options and ensure the choice you make aligns with your needs.
Tax Relief on Pension Contributions
What is tax relief?
Tax relief is an incentive available to you when saving for retirement. It allows you to put money into a pension plan and reduce your tax payments each year, while still receiving the same amount of take-home pay.
Tax relief is available on private pension contributions worth up to 100% of an individual’s annual earnings and is applied automatically if your employer takes workplace pension contributions out of your pay before deducting Income Tax.
Relief at source (discussed below) means that your pension provider will claim it as tax relief and add it to your pension pot.
Taking advantage of tax relief can help you achieve financial security in your retirement by allowing you to save more without having to pay extra out of pocket.
It ensures that you receive the same amount of take-home pay each month while putting away additional sums for your future.
Relief at source
Relief at source is a concept used in personal pensions, workplace pensions, and stakeholder pensions, where money is taken directly from the pension provider to pay an appropriate level of tax, also known as relief, before it reaches you. This process simplifies the management of taxes for you, since you don’t have to handle the administration associated with filing taxes on your own or updating government records.
Overall, relief at source is beneficial for both you and employees; you’re able to manage tax efficiently and conveniently, while employees receive immediate tax relief rather than having to wait until a later settlement date.
When you have to claim tax relief
Claiming tax relief on pension contributions is an important part of retirement planning. If you pay income tax at a rate of 20% or more, generally the pension provider will automatically claim the first 20% for you as relief at source, meaning that no additional paperwork needs to be done by you.
However, if your pension is not set up this way or if someone else is contributing to your pension, then you may need to make a separate claim for tax relief in order to get the full benefit that’s owed to you.
When making a manual claim for tax relief, you’ll need to provide two documents: Proof of PAYE (Pay as You Earn) and proof of personal payment such as a bank statement or salary slip.
The relevant form needs to be filled out and sent back with these evidence documents in order to process the claim.
Taking advantage of these types of tax relief can help you save money and improve your financial situation in retirement, making it all the more important that those eligible take full advantage whenever possible.
If you don’t pay Income Tax
If you do not pay Income Tax, you are still eligible to receive tax relief of up to 20% on the first £2,880 you invest in a pension. This tax relief can be obtained by registering with your pension provider and they will then claim tax relief for you at a rate of 20%. This allows those on lower incomes or those who don’t pay any income tax to still enjoy the benefits of investing in a pension.
This form of tax relief works by reducing the amount of money that an individual has to pay their pension provider each year. The money saved is retained by the individual and can be put towards financially preparing for retirement. Furthermore, this form of tax relief encourages individuals who would otherwise not be able to participate in pension investments due to their low incomes or lack of paying taxes, to begin setting something aside for their retirement.
What are relevant UK earnings?
Relevant UK earnings are those types of income that are liable for taxation, either via relevant legislation or through payments made into recognised pension schemes.
Relevant earnings include;
- income from an employment such as salaries, wages, bonuses, overtime and commission
- redundancy payment above the £30,000 tax-exempt threshold
- benefits in kind which are taxable
- profit related pay (including the part which is not taxable)
- income from a trade, profession or vocation conducted individually or as a partner acting in a partnership
These are all forms of income where tax relief can be obtained and must be declared to HMRC for legal compliance.
What are salary sacrifice arrangements?
Salary sacrifice arrangements are agreements between an employee and their employer, where the employee gives up part of their salary in exchange for their employer making a contribution to their pension.
This means that all of the contribution is treated as coming from the employer rather than the employee, meaning they don’t receive any tax relief as such.
Whilst reducing their overall salary might seem counter-intuitive, this strategy can be beneficial as it leads to less Income Tax and National Insurance being paid than if they had not taken part in the arrangement.
What if another person wants to contribute to my pension or I want to contribute to theirs?
If someone else wishes to contribute to your pension or vice versa, it is important to check with your employer and the pension provider in order to confirm if it’s possible. Depending on the type of pension you have, this might not be an option.
It is important to ask if you are in a personal pension that has been either set up by yourself or your employer.
If someone else (other than your employer) does decide to pay into your pension (provided that this is accepted) then the contribution would be seen as coming from you.
What are the tax relief limits in the UK?
Tax relief on pension contributions in the UK is available based on a person’s annual earnings. Individuals can receive relief on contributions up to 100% of their annual income. For those earning less than £3,600 per year, they are eligible to receive relief on contributions up to £3,600.
The annual allowance sets a cap on the maximum amount an individual can contribute to their pension pot each year, currently set at £40,000, before incurring tax liabilities. However, for individuals earning over £240,000 including pension contributions, the allowance is tapered or reduced. The minimum annual allowance for those subject to tapering is £4,000.
The lifetime allowance is the maximum cumulative value that an individual can accumulate in their pension pots without being subject to tax. At the time of writing, this value is £1,073,100.
After an individual withdraws savings from a defined contribution pension, their ability to contribute to other defined contribution schemes and receive tax relief on those contributions is limited. This limit is known as the money purchase annual allowance, which is set at £4,000.
Find my lost pension: tracing lost pensions
Keeping track of a pension can be hard if you have been part of multiple schemes or have switched employers during your career. As time passes, pension providers may undergo closures, mergers, or name changes. Therefore, even if you recall the original name of your scheme, it might now go by a different title.
It is crucial to ensure you claim your pension, making it advantageous to promptly trace any lost pensions.
Remember – whether you have an old pension waiting to be reclaimed or not may depend on the period during which you were employed. Below is some general guidance to give you an idea, but the retention of your pension can depend on individual providers.
- If you left your employer before April 1975, it is probable that your contributions were refunded. Some schemes did not require members to make contributions, and in such cases, you are unlikely to be entitled to any pension benefits from the scheme.
- If you left your employer between April 1975 and April 1988, and you were over the age of 26 with at least five years of service, there is a possibility that a pension was retained for you. If you left with less than five years of service, it is possible that your contributions were refunded.
- If you left your employer after April 1988, there is a chance that you may be eligible for a pension, provided you had completed a minimum of two years of service. If you left with less than two years of service, it is possible that your contributions were refunded.
Here are some ways in which you can be reunited with your savings if you’re looking to consolidate.
Contact your former employer
If you’re trying to trace a workplace pension scheme arranged by an ex-employer and don’t know the provider’s details, your first point of contact should be the employer directly.
Ask what type of plan the scheme is (such as defined benefit or defined contribution) and which pension provider your pension is with. To access this information, you may be required to provide some details, so have the following information to hand:
- Your national insurance number
- Employment start and end date
- Pension scheme start and end date
Contact the pension provider
If you know which provider your pension was with, feel free to skip contacting your old employer and contact the provider directly. To help them assist with your query, be sure to provide as many of the following details as possible:
- Your plan number
- Your date of birth
- Your national insurance number
- The date your pension was set up
When trying to get a careful overview of your pension pot, be sure to ask;
- What is the current value of the pension pot?
- Is there a nominated recipient for any death benefits?
- How much has been paid into the pension pot?
- What charges are you paying for management of the pension pot?
- How much income is the pension pot likely to pay out at your chosen retirement date?
- How is the pension pot being invested and what options are there for making changes?
- Would there be any charges if you wanted to transfer the pension pot to another provider?
- Are there any special features, such as guarantees like a guaranteed annuity rate or a guaranteed minimum pension?
- What are the death benefits – in other words, how much money would be paid from the pension if you died?
Contact the Pension Tracing Service
If you can’t find the contact details of an old employer, or you don’t know the provider of a personal pension, you can contact the Pension Tracing Service instead.
The Pension Tracing Service is a free government service which searches a database of workplace and personal pension schemes to try to find the contact details you need. You can also phone the Pension Tracing Service for free on 08007310193.
It will attempt to trace your pensions every 14 days using basic information like your name, current address and date of birth. You do not need to know the names of the pension providers or your policy numbers.
Consolidating your pensions
Pension consolidation involves merging your pension pots into a single pot.
Throughout your career, you may accumulate various pension schemes or pots from different employers. Additionally, if you have been self-employed, you might have private pensions too.
As you approach retirement, you may find yourself considering if you’d prefer to consolidate them or keep them separate.
Approaching retirement? Here’s what you need to know
If you are slowly reaching retirement age or at a stage of life when you want to slow down, you may decide that now is the time to start taking some money from your pension savings.
Even though we all pay into some sort of pension scheme throughout our life, does anyone actually know how you go about withdrawing from your pension savings?
Taking money from your pension pot
Usually, there are multiple options as to how you can access your pension savings.
Note: Each of these options will come with its own tax rules, so it is best to find this out before you make any decisions that could impact your financial future.
Annuity is an annual series of payments that you will receive for the rest of your life. With this option, you can also take a lump sum of your pension tax-free and buy your annuity with the remaining amount in your pension pot.
There are various levels of annuity available, so make sure to shop around before deciding on the best one for you. Especially as you usually cannot stop this process once you have bought your annuity.
Take a lump sum of cash
If you really want to live large once you reach retirement age, you can take all of your money out of your pension savings. However, if you don’t want to live life quite as large, you can always just remove smaller amounts throughout your retirement years.
Note: Just 25% of your entire pension savings will be tax-free. The rest you pay tax on as if it was a regular stream of income.
Another option for withdrawing pension funds is to take an income in retirement, whilst keeping the rest of your pension pot safe in investments. This is also known as income drawdown.
Note: Some types of pension providers do not offer income drawdown, so be sure to check the terms and conditions of your provider to see if you are eligible.
When using income drawdown, there is no limit on the amount of money you can take, meaning you can still take your 25% tax-free funds without any implications on the rest of your money!
Combine your pension options
If none of these options take your fancy, you can use all of these options throughout your retirement. That way, you can do what is best for you at that time.
What to consider before you withdraw from your pension
Before you withdraw any money from your retirement pot, there are a couple of things to consider – especially when you consider this money is supposed to last you for the rest of your life!
What happens to my partner if I die?
If for some unfortunate reason you die first between you and your significant other, the less money in your pension pot, the less there is for your partner to live on.
It is worth sitting down with your partner and discussing how much it would cost you both to live independently and then you can figure out how much you can afford to take out of your pension savings.
Have you considered all of your options?
More often than not, pensions gain compound interest; meaning the money in your account earns interest, and then this interest earns interest on itself! In simple terms, the sooner you start putting money away, the more money you will have once you reach your retirement age.
However, if you ever remove any money from your account, you will not earn as much interest as there is less money to build on.
Therefore, before you remove any amount of money from your pension funds, think about how this could impact your savings at retirement.
Will you have enough for the future?
As we just mentioned, any money you remove from your pension fund will impact your future retirement situation and the amount of money you have during these years.
It may seem like a great idea to use £10,000 of your lifelong savings to go on your dream holiday, but will you then be spending the rest of your days eating beans on toast and scrambling for every penny you find?
You’ve put money away for your retirement savings throughout your entire working life, make sure you spend it wisely!
Have you asked for any help or guidance?
There are people whose job it is to give advice on pensions. These pension professionals are the ones to go to if you have an enquiry about pensions – especially if you believe that you might be a victim of a scam.
They can give you advice on what would be best to do in your position, how to plan for your retirement wisely, and answer any questions – no matter how silly you think they are, they are usually worth asking!
Unfortunately, pension scams are not unusual. For obvious reasons, scammers tend to target the 25% tax-free money of a pension and it isn’t necessarily the easiest money to get back.
You can use the Financial Conduct Authority (FCA) Register to double check that the provider you want to go with is legitimate. Plus, it has a warning list of individuals and firms that are operating without official approval, so you can be sure to avoid any potential scam artists.
Note: If a ‘company’ says it can withdraw your pension funds early for you – usually before you are 55 – it is more than likely it will be a scam. Always double check before making any decisions regarding your pension.
Early pension withdrawal – what do you need to know?
Although you can cash your pension at the age of 55, this is not usually advised as it comes with some implications.
For example, you will be charged 55% in tax from HMRC for withdrawing your money before the normal minimum pension age (NMPA). This is true for workplace pensions, private pensions, or state pensions.
Note: In 2028, the NMPA is increasing to 57 – currently it is 55.
More often than not, most reputable providers in the pensions industry will not let you take any money out of your pension fund before your NMPA due to the significant repercussions, such as running out of money during your retirement years!
Although, if you would still like to withdraw your money early in spite of this potential outcome, you will likely need to use a third party to access your funds who can charge up to 30%. Therefore, you could be left with just 15% of your overall pension!
However, there are some circumstances where accessing your pension early is allowed:
- If you have been given less than a year to live and are younger than 55, you could qualify to access your entire pension in one lump sum – all tax free!
- A serious medical condition or have poor health in general
- If your pension includes a protected retirement age (PRA), for example, in a professional sport where retirement at an early age is expected
Death and pensions
When you pass away, your pension will be able to be accessed by your partner, spouse, or any beneficiaries.
Note: A beneficiary is someone you nominate to receive your money.
The rules and regulations regarding your pension once you die will depend on the age you are when you pass away and the type of pension you own.
New pension rules were introduced in 2015 which changed what happens to your pension savings after you die, as well as how your pension can be accessed.
Within this new set of guidelines, pensions are now thought to be outside of your estate. This means that after you pass away, any beneficiaries – including your civil partner or spouse – will have access to your pension without having to pay any inheritance tax.
After you have passed away, it is recommended that whoever is in charge of your affairs should get in touch with your specific pension provider to find out what the correct next steps are.
Pension benefits for passing away
When you pass away, you could get access to death benefits on your pension. However, this is dependent on what kind of pension you own. If the person who dies is younger than 75, it is likely that this amount of money will be tax free, but it is dependent on the pension provider, so it is best to check with them what your beneficiaries, civil partner, or spouse is entitled to.
Usually, your state pension will stop being paid after you pass away. However, your spouse or civil partner might be entitled to inherit some of your state pension.
Note: It is only spouses or civil partners that can inherit your state pension, not beneficiaries.
There are some caveats to this, such as the number of National Insurance (NI) contributions you both made, as well as how far you are from reaching the state pension age.
Note: The state pension age is currently 66, but this is set to rise to 67 for those who were born after 1960.
Private and workplace pensions
What happens to your private or workplace pension after you pass away is completely dependent on the style of pension you own.
For example, your beneficiaries could receive money from these types of pensions. However, different providers have different rules for this, so be sure to speak to them to discover what options you have for your specific pension.
Pensions – Frequently Asked Questions
- What is the average pension?
The question of the average pension often arises when planning for retirement. But it’s important to remember that the average pension amount can vary significantly based on several factors, so don’t expect to compare your pension with someone you know and see similar pension pots.
One crucial factor is the individual’s work history and earnings. Variables include salary increases, employer contributions, increased employee contributions, the performance of investments, the number of years of employment and the salary earned during that time, among other things.
Therefore, individuals who have worked for a longer duration and earned higher salaries tend to receive higher pension amounts.
Another factor which influences the size of your pension pot is the type of plan. Pensions for armed forces personnel can have more generous pension plans with additional benefits. Whereas someone only in receipt of a state pension may have a smaller pension pot to draw from.
The age at which an individual starts receiving a pension can affect the average amount too – early retirement may result in reduced benefits, while delaying retirement can increase the pension payout.
While understanding the average pension can provide a useful benchmark, it is important to remember that everyone’s retirement needs and goals and lifestyles differ.
Factors such as recreational pursuits, travelling, healthcare costs, and personal savings can greatly impact the amount of income required during retirement.
- What is an Occupational Pension?
An occupational pension is another term for a workplace pension. They can also be called ‘company’ or ‘work-based’ pensions.
Workplace pensions are set up by employers to let you save money for retirement. The employer normally has to make you part of the pension scheme, and pays into it for you.
This type of pension usually falls into two categories; defined benefit pensions and defined contribution pensions.
- Do I have to join my workplace pension scheme?
Workplace/occupational pension schemes play a large role in helping to secure financial stability when you retire.
But participation in a pension scheme, especially with lower income jobs and the cost of living crisis, might not be something you’re comfortable with.
You may wonder if you have to join your workplace pension scheme. So let’s explore the essentials of workplace pension schemes and clarify the obligations and benefits associated with your participation.
Understanding your options will help you make an informed decision about whether joining your workplace pension scheme is the right choice for your financial future.
Workplace Pension Scheme Basics
Workplace pension schemes are a significant component of the UK’s retirement savings framework. Under current legislation, employers are obligated to offer eligible employees access to a workplace pension scheme.
These schemes, commonly known as automatic enrollment schemes, aim to encourage individuals to save for retirement. While employers must provide access, employees have the option to choose whether or not to participate.
Automatic Enrollment and Opting Out
Automatic enrollment is a key feature of workplace pension schemes in the UK. It means that eligible employees are automatically enrolled in their employer’s pension scheme, typically between the ages of 22 and state pension age, and they also must be earning above a certain threshold.
However, employees have the right to opt out of the scheme within a specific time frame after enrollment.
Opting out means you will not contribute to the pension scheme, but it also means you will lose out on the employer’s contributions and potential tax advantages.
Benefits of Joining a Workplace Pension Scheme
Joining a workplace pension scheme offers several advantages.
The primary benefit is the opportunity to save for retirement with contributions from both yourself and your employer. Your employer’s contributions are essentially “free money” that boosts your retirement savings. Moreover, pension contributions receive tax relief from the government, meaning you get additional savings in the form of tax benefits. By participating in a workplace pension scheme, you are taking proactive steps towards building a secure financial future.
While you have the option to opt out of your workplace pension scheme, opting out means missing out on the employer’s contributions and the potential for tax relief, significantly reducing your retirement savings potential and the speed at which you can accrue savings.
Assess your personal financial situation and long-term retirement goals – consider the value of employer contributions and the potential for investment growth over time. It’s worth noting that the earlier you start contributing, the longer your investments have to grow.
Joining your workplace pension scheme in the UK offers significant advantages for your retirement savings, and while automatic enrollment ensures you have access to the scheme, the decision to participate ultimately rests with you.
- What is the current state pension age?
The state pension age can vary over time and increases in the pension age can be attributed to longer life expectancies. At the time of writing in 2023, the state pension age is 66, but is set to rise to 67 by the year 2028.
You can use an online state pension calculator to determine when you’ll hit pension age based on the year you were born.
- How much should I put in my pension?
While making adequate contributions to your pension is important for securing a comfortable retirement, your concern may lie in whether or not you’re contributing enough to provide you with the right sized saving pot to support your lifestyle, by the time you’re due to retire.
There is no one-size-fits-all answer to how much you should put in your pension, but gaining more clarity on;
- What you’d be spending your retirement money on
- How much you’d need to support your retirement spending
- How long you have to save the absolute minimum
- Can you reduce spending in one area to reduce the stress on other more important areas (e.g. downsizing your home to support more regular holidays)
- Can you supplement your income to facilitate a comfier retirement (taking a part time job)
By making these considerations, you can begin to build a picture of what you’d like your retirement to look like and form a plan as to the measures you’d like to take to make it happen.
- How much of my pension is tax free?
In the UK, if you’ve taken out a personal pension plan or have a defined contribution pension scheme through your employer, you are typically entitled to a tax-free cash lump sum upon retirement.
This lump sum is known as the Pension Commencement Lump Sum (PCLS) or tax-free cash. The tax-free portion of your pension depends on the specific rules and limits outlined in the Pensions Tax Manual by HM Revenue and Customs (HMRC). Currently, the standard allowance allows for 25% of your total pension value to be received as a tax-free lump sum.
For example, if your pension pot is worth £200,000, you can withdraw £50,000 as a tax-free cash lump sum.
Taxation of Pension Income
While a portion of your pension can be received tax-free, it’s important to understand that the remaining portion is subject to tax.
The taxable portion of your pension income is treated as regular income and is subject to income tax. The amount of tax you will pay on your pension income depends on your total income from all sources, including any state pension or other earnings. It is worth noting that taking a tax-free cash lump sum may reduce the overall size of your pension pot, which can subsequently impact the income you receive from the remaining pension fund.
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