A pension is a tax-free method of saving for retirement. Money is paid into the fund free of tax, so a basic rate tax payer gets £22 topped up to £100 by tax relief while higher rate tax payer gets £40 added to every £60 they pay into a pension. The money then grows free of tax. At retirement most of the money built up is then used to buy an income.
Since few of us can afford to live on such a basic state pension, the only way to ensure a financially secure old age is to save for it ourselves. As part of a job offer an employer may give you the chance to join the company pension scheme. You are not obliged, but you are almost certainly better off joining it rather than going it alone. In addition to the money you pay in, your employer will usually pay money in on top. There will probably be other extra benefits such as free life insurance cover.
More and more employers are opting out of offering employees final salary schemes, which are more expensive to the employer, but give a guaranteed pension level based on a percentage of your final salary. You are more likely to be offered a money purchase scheme, which is an individual fund (rather than into the collective final salary pension), and your fund grows within the company’s overall scheme. When you retire your pension will be based on the value of that fund.
If a company has five or more employees then it must provide access to a pension scheme. At the very least it will have to introduce you to one of the new low-cost and flexible stakeholder pension schemes. It must tell you about the scheme and arrange for money to be deducted from your pay if you decide to join it.
You can pay up to 15 per cent of earnings a year into a company pension scheme. In addition to this, if you earn less than £30k per year, you can pay £3,600 a year into a stakeholder pension at the same time. You can do this for the next five years. Personal pension payments depend on age, starting at 17.5 per cent of earnings, rising to 40 per cent for people aged between 61 and 74 years old.
What happens to your pension if you change jobs depends on the sort of pension you have, and how long you have held it. In general, if you have had an occupational pension for less than two years, you will be refunded the contributions. If you have lost track of old pensions, you can trace them through the Occupational Pensions Regulatory Authority.
You cannot get at your money until you retire. In normal circumstances the earliest you can do this is age 50. At that point you have to use most of your pension fund to buy an income, although you can take 25 per cent as a tax-free lump sum. Most people take their income from an annuity which they buy using their accumulated pension fund. This will pay an income for life, no matter how long you live. Annuities are not very good value at the moment and you can take income direct from the fund. This is called income draw-down and is really only for people who can afford to take a risk with their retirement money. Everyone has to take an annuity by 75 years of age.
Alternatives to a pension
There is increasing evidence that pensions will not be as good an investment for your retirement as they used to be. Today’s 25 year olds, on an average salary of £23.5k, will have to save a staggering half a million pounds to retire comfortably at 65, according to investment company Bestinvest. Equally alarming is the news for people over 40 who haven’t been paying into a pension scheme – they will need to contribute nearly a third of their gross salaries to retire at 65.
Alternatives include Individual savings accounts (ISAs). These offer good tax breaks and do not lock up your money in the way pensions do. You can pay into up to £7k into an ISA after tax. You can take the money when you want and it is tax-free. If you take an ISA instead of a pension you will have to be very disciplined and ensure you don’t touch the money until you retire.
Property is also seen as a good investment, as in a buoyant housing market, property prices tend to rise faster that interest rates. Buying one or more properties could make you more money than more traditional methods of investment.
For more information, see
For more information, see http://www.moneymadeclear.fsa.gov.uk/pensions.