Following on from Pension Awareness Week, we wanted to provide you with the answers to some of the most frequently asked questions that arise when it comes to pensions. We hope that you find them useful!
A pension is a long-term investment that aims to provide you with an income when you retire and in later life. There are three main types of pensions to consider – the State Pension, a company or workplace pension, and a personal pension (also known as a private pension).
When you stop working, you’ll no longer have your salary, yet you will still have bills to pay. There’s no obligation to take out a pension but if you still want to maintain a comfortable lifestyle when you stop working, then you’ll then need to save the money to do so.
The State Pension is a regular payment that you receive from the government when you reach a certain age (the State Pension age). You will continue to receive this payment for the rest of your life. The State Pension is funded by National Insurance Contributions (NICs) and to receive it will depend on how much you’ve accumulated during your working life. In certain circumstances, you may also have been given National Insurance credits, for example, if you have been a parent or a carer, or have been in receipt of certain benefits.
To understand when you’ll reach the State Pension age or Pension Credit qualifying age and how much you may get, you can visit: https://www.gov.uk/calculate-state-pension
A company or workplace pension scheme is a pension that is set up by your employer. Usually, you will be required to make regular pension contributions based on a percentage of your salary. Your employer will also pay into it and the government will pay into it in the form of tax relief. New ‘automatic-enrolment’ rules mean that employers now have an obligation to enrol their eligible workers into a workplace pension scheme.
A personal or private pension is a type of defined contribution pension scheme. This is usually something that you arrange yourself and pay regular monthly amounts or a lump sum to a pension provider which then invests the funds on your behalf. These pension contributions attract tax relief. You can still take out a personal pension even if you are paying into a workplace pension scheme.
A Self Invested Personal Pension (SIPP) is a type of personal pension that provides a great deal of freedom and control over the investment decisions that are made.
Stakeholder pensions are personal pensions. These types of pensions must meet certain government standards designed to make sure they are of good value.
There are two main types of workplace pension schemes – defined contribution and defined benefit. Defined contribution (or money purchase) is the more common one and this is where your pension pot is put into various types of investment, such as stocks and shares. Defined benefit schemes (sometimes called a final salary pension scheme) is a scheme that promises to pay out an income in retirement based on your salary and the number of years of service with the employer.
The money that you pay into your pension goes to a pension provider and they, in turn, use it to buy investments, such as stocks and shares, with the aim of growing it over the years before you retire. If you are a member of a workplace pension, then your employer will select the provider on your behalf.
The main advantage of saving into a pension is the tax relief – your pension grows largely tax-free, which can help to boost the amount you will receive. When you are enrolled in a workplace pension, your employer will also make contributions, so this increases the funding of your pension. When you reach pension age, you can take up to 25% of your pension pot as a tax-free lump sum (depending on your pension scheme rules), the rest of the pension pot is used to provide a taxable income.
The earliest that you can take your pension benefits are currently age 55, however, this is due to increase to 57 by 2028. You don’t have to retire or stop working to take your pension.
As with any type of savings, nothing is entirely risk-free and the value of your pension pot can go up as well as down. However, there are controls in place to minimise the risks to pensions. For example, if your employer goes bust then your pension is usually protected, and if your pension provider goes bust and cannot pay your pension then you should be able to obtain compensation. How your pension is protected depends on the type of scheme.