A Beginners Guide to...Pensions

May 4, 2022
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Staying in control of your finances is difficult, especially when you’ve got pensions scattered across different providers. Find out everything you need to keep your retirement savings on track.

A pension is something that aims to grow your money over time so that you have enough to support yourself in later life. It’s a type of savings product that works by investing your money into things like the stock market, and if the value of those investments increase then so does the value of your pension pot.

You may have received a pension from your employer (or past employers) and you can also set one up yourself to get saving. There are three different types of pensions in the UK: the State Pension, workplace pensions and personal pensions.

Key types of pensions:

State Pension

The State Pension is a regular payment people can claim when they reach State Pension age. How much you get depends upon your National Insurance Contributions, with the government determining your pension payments through the credits you’ve accrued throughout your working life.

How do I qualify for the State Pension?

You’ll need to have at least 10 years of National Insurance Contributions to receive the bare minimum. To receive the maximum State Pension amount, you’ll need to have 35 ‘qualifying’ years. The full State Pension is currently £185.15 per week (2022/23) totalling £9,627.80 per year.

Workplace pension

A workplace pension is a pension that’s arranged by your employer. It’s a legal requirement under Auto-Enrolment rules for employers to enrol all eligible employees into a suitable workplace pension scheme. Auto-Enrolment was established in 2008 and since 2018 affects all companies. Contributions are taken directly from your wages and paid into your pension.

Your employer will contribute at least 3% and you’ll contribute at least 5% of your qualifying salary - unless you opt out of your workplace pension. Contributions you make are eligible for tax relief from the government. There are two types of workplace pension: defined benefit and defined contribution.

What is a defined benefit pension?

A defined benefit pension, or ‘final salary’ pension, is a type of workplace pension that pays you a retirement income based on your salary and the number of years you’ve worked for the employer. These pensions usually benefit from rising in line with inflation, with the aim of gradually increasing your retirement income to adjust to the cost of living. Defined benefit pensions are considered valuable and are increasingly rare, but you may have one if you’ve worked for a large company or a public sector organisation.

What is a defined contribution pension?

A defined contribution pension is the most common type of pension, its value is based on contributions that are invested and the performance of those investments. These pensions usually offer the freedom to move and manage your money, meaning you can consolidate previous defined contribution pensions as you change jobs. As this type of pension is dependent on an investment portfolio, your balance may go up and down over time. Most modern workplace and personal pensions are defined contribution pensions.

Personal pension

A personal pension, or ‘private pension’, is a type of defined contribution pension. You can set up a personal pension alongside any workplace pensions you may have. The money you put into your personal pension will usually be invested in a range of assets like company shares, bonds, property or cash. When you start your pension, you’ll usually get a choice of pension funds to select from, based on how much risk you’re willing to take. You may also find options geared towards socially responsible investing, which will give you the ability to exclude certain sectors such as oil, tobacco or gambling.

What is a Self Invested Personal Pension (SIPP)?

A Self-Invested Personal Pension (SIPP) is a pension plan which allows you to choose what your savings are invested in. A SIPP is a type of defined contribution personal pension, which means the value of your pension pot at retirement depends on the amount you pay in and the performance of your investments. SIPPs can offer more flexibility than other pensions, as you choose each investment yourself. However, you’ll need a good understanding of investments to manage it effectively.

What is a self-employed pension?

Self-employed pensions are personal pensions. You can add regular contributions or make ad hoc payments into your self-employed pension, and your pension provider will usually claim basic rate tax relief for you and add it to your pension pot. If you’re the Director of a limited company, company contributions may be considered an allowable business expense and could be offset against your company’s corporation tax. You can start a new self-employed pension from scratch by contacting a pension provider who offers this flexibility.

Tax relief on pension contributions

Most UK taxpayers get tax relief on their pension contributions, which means that the government effectively adds money to your pension pot. Basic rate taxpayers get a 25% tax top up; HMRC adds £25 for every £100 you pay into your pension. Higher and additional rate taxpayers can claim a further 25% and 31% respectively through their Self-Assessment tax returns.

For the 2022/23 tax year you can get tax relief on pension contributions up to £40,000 or 100% of your salary (whichever is lower). Any pension contributions that you make over this limit are taxed at the highest rate of tax you pay. If you earn less than £3,600 annually or don’t earn anything, the maximum amount you can contribute to your pension within the tax threshold is £2,880, bringing your total annual contribution to £3,600 once tax relief is added.

Risk warning

As always with investments, with a pension your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

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