If you want to take control of your retirement, it’s important to understand how pensions work. Here’s a guide to help you get familiar with the world of pensions.
What is a pension?
Put very simply, a pension is a sum of money that you receive when you retire – it can either be a large lump sum or smaller amounts paid to you on a regular basis. Now, ask anyone around you and you’ll certainly hear that pensions are too complicated and a bit confusing, and trust us, we can’t blame them! After all, there are many types of pensions which come with their own rules and benefits. And yet, when it comes to preparing for retirement, it’s a usually a good idea to learn a fair bit about your pensions. Luckily, this guide explains in a very simple way how pensions work
What are the different types of pension?
In the UK, there are three types of pension: the state pension, workplace pensions, and personal pensions, also known as SIPPs (Self-Invested Personal Pensions). So, what are they?
The state pension is simply a regular payment paid to you by the government as soon as you retire. How much you receive depends on you having paid a certain amount of national insurance contributions during your working life. If you’re employed and earn over £166 a week, the process should be automated and your company should pay your national insurance contributions out of your salary. If you’re self-employed however, you’ll need to arrange the payments by yourself.
To get any pension at all, you’ll need at least 10 years’ worth of contributions – if you don’t have enough, then you may not receive any state pension. As things currently stand, the maximum you can get is £9,100 a year and you’ll need at least 35 qualifying years’ worth of contributions to be able to claim the full amount – a ‘qualifying year’ is a tax year (April to April) during which you’ve paid, have been treated as having paid, or have been credited with enough National Insurance Contributions to make that year qualify towards a Basic State Pension1. If you’ve got any gaps, it could be worth contacting HMRC to check how many years you need to catch up and whether you’re eligible to pay voluntary contributions. If you want to check your contributions, you can simply do it online on the HMRC website: https://www.gov.uk/check-national-insurance-record
A workplace pension is a scheme that lets you put money aside for retirement, and it’s generally arranged by your employer. If you’re employed, this means, you could be automatically enrolled in your workplace pension, depending on your personal circumstances. Once you’re in the scheme, you and your employer will add money to your pot and this money will be invested in funds – think of them as hampers full of different investments, such as shares, bonds, and property. Currently, you must contribute at least 5% of your salary and your employer should pay a minimum of 3% of your pay – again the process is fully automated and you don’t need to arrange any payments, the money will go to your pot every month before tax. If you can afford to pay more, then it could be a good idea to review your contributions, and if you were to increase your contributions, your pension could potentially grow a little faster.
A personal pension is a type of pension that gives you more control and flexibility over your retirement savings. Not only can you choose how much you want to pay into your pot, you’ll also receive 20% tax relief on each contribution you make. So, say you’re a basic rate taxpayer and you decide to put £800 in a personal pension. As a thank you, the government will add an extra £200 to your pension and you’ll have £1,000 in your pot. Now if you do the maths, you’ll realise that £200 is 25% of £800, which means that you’ll effectively get a 25% uplift on each contribution you make. If you’re a higher or an additional rate taxpayer, the top-up you get should increase, but you’ll need to get in touch with HMRC to claim the extra money.
Why open a personal pension?
Many people assume that they’ll be just fine with a state pension and the savings from their workplace pensions, but as they retire, they could be in for a nasty shock. With the ever-increasing cost of living, relying solely on your state and workplace pensions could not be enough to reach your retirement goals. Having a personal pension and getting tax relief on your contributions could help boost your future income.
Obviously, opening a personal pension isn’t a small decision and before you take the plunge, it’s important to consider your financial situation and personal circumstances, especially as tax rules will depend on those. In other words, can you afford to have a personal pension? Generally speaking, it’s a good idea to have your finances in order before you start a personal pension.
What is your personal allowance?
Each year, you can put as much as you want into your personal pension, however, the amount you’ll receive tax relief on is limited – this is your pension annual allowance and it’s currently set at £40,000 per tax year, or 100% of your income (whichever is lower) – this includes all your contributions across all pensions plus tax relief.
If you put more than the allowance in your pension, then you won’t receive tax relief on the excess. One thing to note is that an annual allowance charge will be added to your taxable income for the year.
When can you start taking money out of your pension?
Everything you put in a pension is locked away, generally for a long time. For instance, you can’t claim your state pension before you reach your retirement age, which is determined based on a number of factors, including your date of birth and gender. If you’re enrolled in a workplace pension and/or pay into a personal pension, then you should be able to access your money after your 55th birthday (subject to change – the minimum age at which you can tap your personal pension is set to increase to 57 in 2028), but make sure you check with your provider as it can vary. And although it’s tempting to take your money as soon as you turn 55, you could also wait a bit longer before moving your pension into drawdown, that way your money could have more time to grow and benefit from the power of compounding – where your reinvested returns could generate further returns.
It’s important to know when you’ll be able to take your money out, but it’s as important to understand how withdrawals work with pensions. For your state pension, you won’t need to do anything and once you reach your retirement age, you’ll receive regular payments from HMRC. Now, with a workplace pension and a personal pension, there are many drawdown options depending on the type of pension you’ve got. If you have a defined benefit scheme, you can expect to receive a guaranteed income for life from day one of retirement. And that’s not all, the amount you’ll get could also increase every year – make sure to check with your provider or employer. If you have a defined contribution scheme, then the pension you’ll receive will depend on how much you’ve paid in (including tax relief from the government and contributions from your employer), how long you’ve held onto your pension, and how well your investments have performed. The good thing about it is that you can choose how you want to take your money out. You can either take your whole pension in one go as a lump sum, withdraw money when you need it, or get paid a regular income based on your pot size. Whatever pension you’ve got and option you go for, you’ll be able to take up to 25% of your money as a tax-free lump sum based on current rules.
Should you consolidate your pensions?
Well, it’s completely up to you. If you’ve moved jobs several times and have number of pensions floating around, but don’t mind having different providers to manage your retirement savings, then it’s absolutely fine – you do you! But if you’re afraid to lose track of your money or pension fees, it could be worth transferring all your pensions in one place – remember you can only transfer your workplace and personal pensions, not your state pension and not all providers accept a workplace pension transfer. Getting everything in one single scheme could make things easier as you’ll only have to manage one pot of money. Also, if you happen to find a provider offering cheaper fees, then you could be keeping more of your returns.
Things to consider when transferring a pension?
Pension transfers come with many different rules and it’s important to be aware of them if you want to move your pot(s) somewhere else.
- If you hold a defined benefit scheme as they can be quite complex, you are required to take financial advice before doing anything.
- If you transfer a defined benefit scheme to another provider, you may lose some of the valuable benefits attached to it, such as final salary promise, where you’re guaranteed to receive your salary when you retire and not all providers are able to accept these types of pension schemes
- You may not be able to transfer your pension if you’re already taking an income from it.
- Transferring a pension often requires your investments to be sold, so they can be converted into cash, transferred over, and then invested by your new provider. In other words, you could find yourself with less money after the transfer is completed if the value of your investments is down during the sale.
- You can’t transfer an ISA into your personal pension because both account types are subject to different tax treatment.
If you’ve decided to transfer a pension, remember to check the different rules and it’s always a good idea to seek financial advice to determine what’s right for you.
Transferring your pension can feel like a big job, but it doesn’t need to be. Before moving anything, you’ll need to know where your pension pots are. If you’ve lost some of your pensions, don’t worry, you’ll be able to locate them. All you need to do is visit the HMRC website and fill in a quick online form and you’ll be given the contact detail of your pension provider: https://www.gov.uk/find-pension-contact-details. Once you’ve located your pensions, you’ll need to collect all your pension documents and contact your new provider to let them know you want to transfer your pension. You’ll be asked to provide them with some information, including who your old provider is, a reference number, and an estimated value of your pot – these details can easily be found on your latest pension statement. Then your new provider will contact your old provider to get the transfer process started. In some cases you may need to contact your old pension provider, for example, if they object to the transfer or need further confirmation. Throughout the entire process, your new pension provider should be in touch with you if anything is needed from you.
How to find a pension provider
Whether you want to open a personal pension or move your pots to a new place, you certainly want to find the right provider. So, what do you need to do to find ‘The One’? Well, first, you’ve got to know what you’re looking for. What’s most important to you when it comes to a pension? Then, you’ll need to do your research and shop around. Depending on your priorities, it could be a good idea to look at the fees taken by each provider. Ultimately, fees and charges will eat into your returns, so if you want to make the most of your later life and boost your pension savings, it could be wise to try and keep them to a minimum. But don’t just focus on fees and make sure to look at the services being offered too. What kind of policies are they offering? Where will your money be invested? How easy is it to check the performance of your pension? And how good is their customer service?
With online pension providers multiplying, it could be a good idea to look at robo-investment platforms – these are online platforms that are designed to make investing as effortless as possible. But if you’re comfortable doing the work on your own, then you could also use DIY platforms. Robo-investors are particularly well designed for people who are too busy and not confident enough to do the investing themselves. With Wealthify, for instance, you don’t need to know much about stock markets to get started. Our team of experts will do the investing for you, from picking the right mix of investments to managing your personal pension on an ongoing basis. All you need to do is choose your investment style and how much you want to put in your pension – you can start with just £50! And once your pension is all set up, you’ll be able to check how your pension is doing at anytime, anywhere.
Whether you’re at the beginning, middle, or end of your pension journey, our pension calculator can help you understand what your finances could be like in retirement.
Past performance is not a reliable indicator of future results.
The tax treatment depends on your individual circumstances and may be subject to change in the future.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.