Everything you wanted to know about pensions, but were afraid to ask!
WHAT ARE PENSIONS AND WHY SHOULD YOU HAVE ONE?
Many people have their hands over their ears (figuratively speaking) when it comes to the subject of saving in a pension. It’s seen as a very complex area and hard to understand. My job when I work with my clients is to break things down to make them as simple as possible to grasp, so I will try to do this here too.
There are fundamentally two types of pensions:
- The defined benefit pension (also known as the final salary or career average pension) and
- The defined contribution pension (also known as the money purchase pension – or money pot pension as I like to call it).
For this blog, I will refer to the first type as the defined benefit pension and the second as the “money pot” pension.
- Defined benefit pensions are offered only by employers and are relatively uncommon now.
- Money pot pensions are available for employees, business owners and individuals to invest in.
Pensions are a tax efficient savings scheme that you (and your employer if it’s a workplace scheme) can pay into to help save for your retirement. There is also tax relief on contributions, dependent on how you pay into your pension – more about that later.
The defined benefit pension pays out a % of your final salary, or an average salary over a period of time, as an income for the rest of your life.
The money pot pension payout depends on how much you put into it, and how well your investments grow, as well as when and how you take your money out in retirement.
WHAT’S YOUR PENSION WORTH IN RETIREMENT?
Do you know how much your pension pot needs to be worth to give you a particular standard of living in retirement?
If the answer is no, you are not alone.
The pension pot you require is probably larger than you think for quite a modest annual income.
It is important to start saving for retirement as soon as possible, because:
1) You have more years to save
2) There is a compounding effect – (compounding makes your money grow faster because income from investments are directly invested straight away)
So, if you haven’t yet started a pension fund, it would be a good idea to consider doing so sooner rather than later. The older you are when you start, the more you need to save per month or in lump sums. And with life expectancies increasing, the amount that needs to be saved is also increasing.
Many Financial Planners, such as me, have cashflow planning software that can help take a lot of the guesswork out of any calculations on what you should be targeting to save.
Remember, everyone is different with very different needs, so one size will not fit all.
There are lots of sources of information1 if you want to find out more, or you could ask me if you would like.
PENSIONS GIVE YOU TAX ADVANTAGES
If you are in a workplace scheme, your employer will likely contribute into your pension pot – and many employers may even match your contributions - which means that you are getting extra contributions into your pot.
In addition, you receive tax relief on your pension contributions subject to certain limits.
If you pay into a personal pension, the tax relief will boost your contributions by 25% immediately – for example, if you contribute £80 into your pension, it will be topped up by £20 to a total of £100.
Higher and additional rate taxpayers can claim even more tax relief through their tax returns.
In addition to this, your pension pot is separated from your assets in the case of bankruptcy, so your investment is safe if your business were to go into liquidation.
IT’S NEVER TOO EARLY TO GET A PENSION
Did you know that you can set up a pension for your child? – from the first day of life (although to be fair, you’re probably distracted with other things on your child’s birthday…. Perhaps the day after instead 😊).
Currently you can invest in a Children’s Pension up to a maximum of £2,880 per year, which is topped up by £720 to £3,600 by the Government.
In fact, what would you think if by putting aside £5 each day from the date of your child’s birth until their 10th birthday, their pension pot could be worth £1 million by their 65th birthday? This may be possible thanks to the effects of compounding (when your money grows faster because income from investments are directly invested straight away) and a long-term investment horizon. It also assumes 7.2% annual growth rate and without allowing for inflation.
In addition to the actual pension pot, your child will get the benefit of a better understanding of savings and pensions as part of their financial education. A great gift for their future wellbeing.2
EXPOSING THE GENDER PENSION GAP
The average woman has less retirement savings than the average man 3. The difference between these two amounts is called the GENDER PENSION GAP.
There are a number of reasons for this gender pension gap, including:
1. Despite the law, there are still gender pay disparities
2. Part-time roles tend to attract lower rates of pay than full time roles
3. Women take career breaks to have children and fulfilling caring roles which affects their lifetime earning capacity
All in all, women’s lower pay, fewer pay raises and possible breaks in pension contributions leads them to save substantially less in their pension funds than men.
There are things you can do about this discrepancy, and you can read my blog on the Gender Pension Gap for more information.
Have you considered the size of your pension pot and your likely needs in retirement?
As you can see, pensions can be a complex topic and that is why people speak to professionals, like myself, to see what support we can give, helping them prepare for their well-earned retirement.
The value of a Pension with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
1 Sources of information:
https://www.gov.uk/browse/working/state-pension
https://www.moneyadviceservice.org.uk/en/articles/pension-information-guide-to-the-basic-facts
2 This figure is an example only and is not guaranteed - they are not minimum or maximum amounts. What you will get back depends on how your investment grows and on the tax treatment of the investment. You could get back more or less than this.
3 Royal London’s “Tackling the gender pension and wealth gap” published in January 2024, including a survey of 3,000 adults across the UK in October 2023 and coupled with latest available official statistics (such as Office for National Statistics releases).
Clicking a link will open a new window. Any external sites are not endorsed by St. James's Place.
