A pension is a type of retirement fund and is key to retirement planning. Throughout your pre-retirement years, you put money into a pension fund. Once you turn 55, you can start taking money back.
The more money you put in your pension during your working years, the larger your retirement fund is likely to be. When you put your money into a pension, it is invested in assets that are expected to grow in value. So your final pension value should be greater than the total of what you put in.
It’s also important to know that savings in your pension pot are tax-free up to 100% of your annual salary or £40,000 each year.
Different types of pension
There are a few types of pension plans. You can enrol in a combination if you wish.
State pension. You will get a state pension starting at 65 (subject to an increase in the future). Every UK resident who pays national insurance contributions is entitled to a state pension, assuming you have a 10 to 35 year contribution record. When you reach the state pension age you will start to receive a weekly state pension income. It is not much – in the 2020-21 tax year it is £175.20 per week for a total of £9,110.40 per year. So you will not want to rely on this income alone.
Workplace pension. If you are over the age of 22 and employed at a job earning more than £10,000 per year, the employer is obliged to set up a workplace pension for you. You will be auto-enrolled, so you will have to choose to opt-out if you wish.
With a workplace pension, your employer will contribute between 3% and 10% of your annual salary each year. You can also sacrifice some of your pre-tax salary to increase the total amount going into the pension fund. According to financial experts, the total should be about 15% of your annual salary. Your workplace will usually choose which financial institution the pension fund is established with.
When and if you leave the company, the pension will not disappear. However, your employer will stop adding to the fund and unless you are adding money into it from your personal accounts, the value will only grow from interest and capital gains on the existing funds. If you start a new job and get a new workplace pension, it is fairly easy to transfer your old fund over and consolidate it with the new one.
Personal or private pension: You can also take matters into your own hands and create a personal or private pension. For those who are self-employed, this is the alternative to the workplace pension.
You will select which pension provider you want to use, and how much you want to contribute. You can contribute with regular or one-off payments, or both.
Because this is funded with your own money (rather than pre-tax salary like a workplace pension), you can get tax relief on contributions. To get that tax relief, you may need to mention the pension contributions in your self-assessment tax return.
There are two main types of personal pension
Self invested personal pension (SIPP) – A SIPP is a personal pension fund that gives you more control over what your money is invested in.
Stakeholder pension – these often have specific rules around minimum contributions and charges.
How do I get my pension money back in retirement?
You have many options on how to take out your money in retirement. Whatever option you choose, know that only the first 25% is tax-free – the rest will be taxed as income.
A big payout: You can receive a lump sum or partial payout in cash whenever you want after the age of 55. But this is not necessarily advisable for the long term, unless you are in poor health.
Income: Financial experts will encourage you to draw money from the pension fund as an income. You can get either an annuity, which is an insurance option that guarantees you a regular income for life or a set number of years. Or you can do a pension “drawdown”, where the majority of your money remains invested when you retire, but a little bit is removed at a time to provide you an income as and when you need it.
Ways to maximise retirement savings:
Don’t let your retirement be a surprise.
There are many pension calculators that can help you to set a realistic retirement income goal. This is based on how much you are willing and able to contribute each year, any lump sum contributions, how much money you need to retire, and when you want to retire.
The best advice is to start saving into a pension early and pay in regularly. If your employer is willing to match your contributions, go for the highest amount. Remember, the more you put in today, the more you can reward yourself in retirement.
And keep track of your pension so you can see how it is performing over time. If you are saving into a personal pension with PensionBee, you can track it on Money Dashboard along with your other financial accounts.
If you’re hoping to retire early, check out our guide here.