Because, admit it, it's quite hard to get your head around
Your pension plan may seem like a while off, but it’s worth thinking about these things now. We’ve already told you how to save money, and everything you need to know about being freelance, and here, we give you a definitive and comprehensive guide from the obvious questions you’ve been worried to ask to the facts you might not have even known existed…
Alistair McQueen, Head of Savings and Retirement at Aviva, says: ‘Don’t worry if you find pensions confusing. Recent research from the Government found that one-in-two people felt they had little or no understanding of pensions, so you’re not alone. To add to the confusion, the word ‘pension’ can commonly have two meanings.
Firstly, it can mean the financial product you save into during your working life to provide money in retirement. At its simplest, this pension is like a big piggy-bank which is locked until you are at least aged 55, but it uniquely benefits from tax advantages which helps your money to grow. In this case, you’ll hear people say, ‘I am saving into my pension’.
Secondly, the word ‘pension’ can also be used to describe the flow of money you receive as income when you are retired. In this case, you’ll hear people say, ‘I am receiving my pension’.
What’s different between a state pension and a workplace pension?
‘The principles of the state pension and a workplace pension are the same because you save money into the pension and you then receive a pension income when you retire. The key difference is obviously who you are saving with. With a state pension you are saving with the state/government and with a workplace pension you are saving with your employer. Many people will have both.’
British state pension
‘The British state pension was first introduced in 1908 to provide a basic income in retirement and it’s one of the oldest state pensions in the world. Over the years it has also become one of the most complicated as different people will be entitled to different amounts of state pension from different ages, based on their date of birth and how much they have saved over the years. You save into the state pension via your national insurance contributions which are automatically deducted from your salary when you are employed. The best way to find out how much you are entitled to, and at what age, is to request a free state pension forecast from the Government. This can be done online. As a very rough indicator, it may be about £150 every week in retirement if you have a full saving history, but it could be more or it could be less.’
British workplace pension
‘To boost your retirement income beyond the state pension of around £150 each week you can choose to save more into a workplace pension. It is the law that, by 2018, every employer in the UK must offer their employees access to a workplace pension. If you choose to save into the workplace pension, your employer will deduct money every month from your salary. The employer will often contribute some additional money too and this money is then safely locked away until you are 55. You are then free to keep saving, or you can take some or all of that money. But don’t be tempted to spend it all at once. Remember, this money is intended to fund you in retirement when you are not working, and this could take you into your 90s or beyond. Every year, you should receive a pension statement which explains how much you have saved in your workplace pension so far, and how much income this could provide in retirement.’
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Why does work pay into it?
‘From 2018, it is the law that every employer must pay into your workplace pension, if you pay in (and if you are above the age of 22 and earning more than £10,000 each year). Even before this law came into force, many employers chose to pay into workplace pensions. This was done to recruit, reward and retain good people. Many employers see a good pension, with generous employer contributions, as a way of attracting the best people.’
How much must work pay in?
‘From 2018, it will be the law that every employer must pay into your workplace pension if you pay in (and if you are above the age of 22 and earning more than £10,000 each year). There are rules guiding the minimum levels that an employer must pay. Initially, the employer must pay at least 1% of the employee’s salary. In 2018 this minimum rises to 2% and in 2019 it rises to 3%.’
What does salary sacrifice mean?
‘Salary sacrifice is a process that allows your employer to manage employee-benefit payments, such as pension contributions, in a more cost-effective way. It is a fully legitimate process, but the decision to implement it lies with the employer, not with you as an employee. If your employer chooses to use it, they have a duty to explain this to you and you have the option to opt out if you wish.
The idea behind salary sacrifice (or sometimes called salary exchange) is quite simple. You give up part of your salary and, in return, your employer gives you a non-cash benefit, such as a pension contributions. Once you accept a salary sacrifice, your overall pay is lower, so you pay less tax and National Insurance. Paying less tax and national insurance is often beneficial to you. In addition, your employer will not have to pay their Employers’ National Insurance contributions on the part you give up, and some employers may pass on some or all of these savings to you.’
What happens if you move jobs?
‘The typical employee may now have up to eleven employers in their working life. This does not need to be detrimental to your retirement saving plans, though. When you leave an employer, any workplace pension savings you have amassed with that employer will be protected and the value of these savings will continue to grow as the underlying investments grow. It is unlikely, however, that you will continue to pay into that pension pot. It is more likely that you will open up a new pension with your new employer. You can leave the previous pension pot where it is, and it should be very safe until you reach your retirement. To keep you informed, you should also receive a statement each year from your previous employer explaining its value. You can also choose to transfer your old pension pot into your new pension. Many people are attracted to the option of transferring as it helps to keep all pension savings in one place.’
What happens if the pension companies crash, where does the money go?
‘Savers should save with confidence as there are strong protections in place to ensure your money is safe. In simple terms, pension providers pay a levy to a central agency that is there to step in should the provider face difficulties. There are two main central agencies and each looks after a different type of pension. One is the Pension Protection Fund (PPF) and the other is the Financial Services Compensation Scheme (FSCS).’
What’s the benefit of increasing your contributions?
‘In simple terms, the more you contribute (or save) to your pension, the more money you will have to live on when you reach retirement. When considering how much you should save, the answer is different for different people as it is influenced by your age, your salary, your other financial commitments and you desired lifestyle in retirement. Fortunately, there are many free online tools to help you work out how much you might want to save. For example, spend five minutes on this tool from the pension provider Aviva and you will have a better idea if your savings are on track, or not.’
Can you increase contributions ad hoc?
‘Most modern pensions allow you to stop, start, increase or decrease your contributions as you wish, without any charge. Whether you do this yourself or via your company will depend upon the kind of pension you have.’
How do freelance workers pay into a pension?
‘Whether you are an employee or freelancer, there will likely come a day when you want to retire. Helpfully, a pension can work for both groups. The one big difference however is that, if you are an employee your employer will have probably chosen a pension for you, and the employer will likely contribute some of its own money. If you are freelance you obviously have no employer to do this choosing, nor the paying in. Finding a pension on your own however need not be that tricky. Google can be your friend, or if you are unsure you can speak with a financial adviser who can choose one for you. (They will likely charge you a fee, however). If you don’t have a financial adviser and you are interested in using one, you can find a helpful directory here.’
What happens if you have pensions across different companies?
‘Having different pension pots with different pension companies is very common, and it should not be a cause for concern. Each pot will continue to be protected and each pot will grow as the underlying investments grow. When you reach retirement you can withdraw money from each pot as you see fit. Many people, however, choose to consolidate their various pension pots in one place. Each pension will carry a charge, so it could be cost-effective to move your pension savings from a high-charging pension to a low charging pension. Also, having all your pensions in one place will make your pensions administration easier.’
So, what should we do?
‘Start saving today! We’re living longer. In 1917, the British King sent 24 telegrams to people on their 100th birthday. Last year, the Queen sent over 10,000. This is great news but a longer life will hopefully mean a longer retirement so we’ll need more money to pay for it. The sooner you begin saving, the more you will benefit in later life. You can then hopefully look forward to thriving, not just surviving, in later life.’
Saving for your pension
Minister for Pensions, Richard Harrington explains, ‘When you’re in your 20s and 30s retirement can seem like a long way off. But it’s exactly the time to be putting money away so you can have the lifestyle you want when you finish work. I know it can be tempting to have as much of your cash at your fingertips to spend on the things you love, but if you stay in your workplace pension from early on in your career, by the time you reach retirement you could be sitting on a nice pot of savings.
‘Of course, everyone can expect the State Pension when they retire but that’s just a safety net to cover the very basic costs of living. For most of us, if we want to continue to do the things we enjoy in retirement, a workplace or personal pension on top of that is something we’ll need.’
Pension saving tips
‘Auto enrolment means that if you are over the age of 22, and earn over £10,000, your employer will automatically set you off paying a small amount in. It’ll come out of your pay packet before it hits your bank account so you probably won’t notice the difference.
From then on you’ll probably get a statement every year telling you how much you’ve saved and what you would get in retirement. You’ll see this go up for every year you pay in.
Many employers are willing to increase their contribution into your workplace pension if you decide to pay more yourself. Why not check if they’d match your contributions if you can afford to put a little more away? It’s an easy way to get more from the money you put in.
Saving after a pay rise is the perfect time: If you’re lucky enough to get an increase in your pay, you could consider putting a percentage of this straight into your pension – this will mean that you can build up extra savings without denting your take-home pay. Also, as in most cases pension contributions get tax relief from the government so you would also pay less tax on this money when you save it rather than spend it. Speak to your employer about how you might be able to do this.
Good things come in threes. By 2019, for every £40 you put in, your employer will pay £30 and there may be an additional £10 from tax relief. This combination is a very good deal and something you don’t get with any other form of long-term saving!
Starting early on can significantly boost your savings – money put into a pension before you’re 40 could benefit from decades of interest before you’ll need it. Saving into a pension as early as possible means you will gain the most from compound interest. This is where you earn interest on your original amount, but also on your interest, even if you’re only paying in the same regular amount. Over the years, this adds up and your savings will grow faster – quite considerably in many cases. Let the money do all the work!
Think about the lifestyle you want when you’re older.’