A beginner's guide to pensions

We know pensions can be quite confusing so in this guide our guest blogger, Rachael Revesz, gives you all the information you need to know as a beginner...

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The word “pension” refers to an age that many people consider light years away. Why bother saving for a pension when it’s so far down the road? But the importance of a pension is really simple – it’s designed to provide you with an income once you’ve stopped working. (I’m personally dreaming about a luxury cruise.) Plus, pension money is protected and has great tax advantages. Read on…

How much pension do I need?

This answer varies for everyone and it depends how much you earn, how much you can afford to save, what age you want to retire, how much your employer contributes to your pension etc.

This online government tool does a fabulous job of estimating what age you can retire and how much you would need to save in the meantime.The general advice from experts is always the same, however: save as much as you possibly can, and it’s never too early to start.

Think you can survive on a state pension?

If you do not save, and instead rely on the government’s state pension, you will have to wait until you hit retirement age which is 66 as of October 2020 (and projected to rise). You will currently get a maximum of £185.15 a week – that’s if your national insurance record shows that you’ve worked for 35 years. The state pension amount is certainly not to be sniffed at, and we’re lucky in this country to have state support at all, but it may not be enough to maintain a lifestyle you’ve enjoyed during your working life.So the more we save beforehand, the better.

Free money from your boss!

Second, if you are fortunate enough to have a workplace pension, it’s a great idea to make the most of it. A scheme called auto-enrolment kicked in eight years ago, gradually requiring employers of all sizes to open a workplace pension and contribute to it on behalf of their employees. You, as an employee, are automatically opted in but you can opt out if you want to.

In 2020, your employer contributes a minimum of 3% of your salary, and you pay 5%. But that 3% from your employer does not come out of your salary, it’s equivalent to 3% of your salary. It’s essentially free money from your employer.

Tax-free savings

They say taxes are one of the very few certainties in life, but pension holders get a great deal. You can save up to £40,000 a year, tax-free, in a pension product – this is called your “pension annual allowance”. And that amount is double what you can save in one or more ISAs per year. (Granted, not that many people have £40,000 to put aside every year – but it’s good to know the option is there.)

What if I’m self-employed and don’t have a workplace pension?

You can open a pension yourself! You won’t get the contributions from an employer, but you will receive the tax benefits.

It’s important to do your research before opening a pension (Citizens Advice has useful information on that). How much does it charge? How easy is it to contact the provider? What kind of funds will your money be invested in? You may also want to contact a financial adviser.

As a freelancer, I also know the difficulty of knowing how much I can afford to put in my pension as I don’t always know my income in advance – I just save as much as I can throughout the year, pay my tax bill and put the rest into my pension and ISA.

Your money is protected

I’ve heard plenty people say, “Pensions are doomed. Look at the economy! I’m going to invest in property instead.”

Unlike owning a home, a pension is actually protected by the government, similar to your savings in a bank account, your ISA, or your money in Premium Bonds. This is because the Financial Services Compensation Scheme protects 100% of your pension money if your pension provider fails, and up to 85% protection if your Self-Invested Personal Pension operator fails.

Can I take my money before I retire?

Compared to a savings account or an ISA, it’s much more difficult to get your cash back early from your pension pot – without being landed with a massive tax bill.

The earliest you are able to take out money is age 55, if you have a company or private pension, where a quarter of the pot can be taken tax-free, and the rest used as an income on which you pay income tax.

But generally speaking, just like any money you invest, your pension is supposed to be invested over the long term.  

Tip: Don’t ignore your pension documents

Most pension providers will send you quite a hefty pack of documents once a year, including your annual statement. It will show your projected income at retirement age, which depends on you continuing to earn and save the same amount consistently until retirement age – it is not based on what you have contributed so far!

The documents should also tell you what you’re invested in, the annual costs and any changes in the investments – as well as how they’ve performed recently. (I would generally not get too tied up on the performance side of things, as it’s designed for the very, very long term.)

Thankfully, a lot more pensions now allow you to check up on your account online, and it may be easier to do that than plough through the paper.

Can I switch pensions?

If you’re in a workplace scheme you may be able to switch providers and keep your benefits from your employer – this will usually depend on the size of the company you work for and what alternatives are available.

It’s easier to change if you’re self-employed. You will need to a) choose a new pension product and b) tell your old provider where you’re switching to, so that the two companies can work together to do the transfer. Some providers take their sweet time, others are quicker. Just make sure before switching that you will not be charged any exit fees, and will not lose any benefits, especially if the pension is more than 10 years old.

In all scenarios, think carefully about why you want to switch, and get financial advice if you’re unsure.

Rachael Revesz is a freelance journalist and host of An Honest Account, a podcast about how money affects our lives. You can follow Rachael on Twitter, here.

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