Lucy O’Boyle • Pensions • 2 min read
Pensions... we all have them, but they are wrapped in so much jargon that most of us don't fully understand them. So, we've gone back to basics for you.
A pension is a tax-friendly (a financial arrangement that allows you to legally pay lower taxes) way to save and grow your money for retirement. It allows you to put money aside so that you can withdraw money from your pension pot later in life.
If you are employed, your employer must legally pay into your pension pot (a minimum of 3% as of 6th April 2019). Under auto-enrolment, a minimum of 3% of your monthly salary will be contributed to your pension.
The government also adds 25% to any additional payments you make into your pension (up to a limit).
Current government rules, allow access to your state pension pot from age 55. But the Government has said this age will rise to 57 by 2028.
Access to a workplace or private pension is usually granted around the age of 55, but it depends on the rules of your pension provider. You may also be charged a fee for withdrawing early.
It's not always easy navigating the world of pensions when you might have more than one type of pension. So let's outline the three different types of pensions available in the UK.
1. State pension - Once the state pension age is reached, which is 66 right now, a state pension can be claimed. Contributions, typically made during working years to National Insurance will determine the amount of state pension received.
2. Workplace pension(s) - If you are employed, your employer is required by law to enrol you into a workplace pension that both of you pay into each month. A workplace pension will either be what is a called a ‘defined benefit’ (DB) or a ‘defined contribution’ (DC) pension.
3. Personal pension(s) (sometimes called a ‘private pension’) - A pension that you can pay into outside of your existing workplace pensions. You may open a personal pension to combine your old workplace pensions, add additional contributions to your pension outside of your current workplace scheme, or if you are self-employed or not working for an employer.
These are a form of defined contribution plan, just directed by you, the individual rather than your employer.
When you put money into your pension, you are putting away a small amount of money now that will grow over time to give you a pension income later in life. The earlier you start putting money into your pension, the more time your pension has to work hard for you and grow.
Each year, the amount your pension grows is reinvested back into your pension, which makes a huge difference to the sum you end up with when you retire. Some
As an example, £5 left in a pension would be worth £38 after 30 years. But £5 left in a pension for just 5 years at the same average return, would only be worth £7.* Time in the game matters!
A common way to calculate how much to put into a pension each year is the ‘half your age rule’. Divide your current age by 2, and that number as a percentage is how much you could pay into your pension each month.
For example, if you’re 30, 15% is a reasonable amount for your contributions combined with your employer’s. Or, £300 a month.
*Calculated using a 7% average return each year.
The easiest way to see the total amount your pensions are worth is by combining your pensions into one pension pot. 40% of people in the UK have multiple pension pots. This is because, if you have had multiple jobs, then you likely have a different pension provider for each employer you have worked for.
Combining all of your old pensions used to mean digging out the policy numbers for each pension. CIRCA5000 runs a service where we trace your old workplace pensions for you, for free, no strings attached. Once your old pensions have been traced, you can combine your pensions with CIRCA5000 and see one sum, representing the worth of your pension pot.
Besides providing a gradual way to save and grow your wealth for retirement, pensions offer three other benefits:
Investment gains - In a defined contribution plan, your savings are typically invested on your behalf by the pension administrator. For that reason, the amount eventually received could be higher than the actual savings you put into the account.
Employers’ contributions - Employers must contribute extra to pensions on top of your base salary, which adds to the savings pot.
Tax benefits - Tax relief is provided automatically for pension contributions by employees and added to the pension pot. Once retired, people are often on a lower income so benefit from paying a lower tax rate in the future when they claim their pension income. These benefits are available to pension contributions made by self-employed individuals as well.
When investing your capital is at risk. You should carefully consider whether opening a CIRCA5000 pension or transferring your old pensions to CIRCA5000 is right for you. Please note that tax rules and reliefs depend on your personal circumstances and might change. CIRCA5000 does not provide financial or tax advice and you are responsible for your own tax reliefs/payments.