Pensions might seem complicated, but the basic idea is a simple one. It’s worth understanding the benefits of saving into a pension scheme, because your State Pension – while providing a foundation – may not be enough to live on.
The importance of retirement savings
Did you know?
The maximum State Pension is a lot less than the amount most people say they hope to retire on – for 2020-21 it’s £175.20 a week, or £9,110.40 a year.
Millions of people aren’t saving nearly enough to give them the standard of living they hope for when they retire.
If you fall into this category, you have three choices.
- retire later
- start saving more
- adjust downwards your expectations of what you’ll be able to afford in retirement.
Don’t rely on the State Pension to keep you going in retirement.
Even if you’re eligible for the full State Pension of £175.20 a week for the tax year 2020-21, this is far below what most people say they hope to retire on.
The advantages of saving into a pension
Once you’ve decided to start saving for retirement, you need to choose how you’re going to do it.
Pensions have a number of important advantages that will make your savings grow more rapidly than might otherwise be the case.
A pension is basically a long-term savings plan with tax relief. Getting tax relief on pensions means some of your money that would have gone to the government as tax goes into your pension instead.
If you save through a scheme known as a defined contribution’ pension scheme your regular contributions are invested so that they grow throughout your career and then provide you with an income in retirement.
Generally, you can access the money in your pension pot from the age of 55.
How tax relief tops up your pension pot
Once your income is over a certain level, the government takes tax from your earnings.
You can see this on your payslip. If you put money into a pension scheme, it qualifies for tax relief.
This means that as well as the money you’re putting in, some of your money that would have gone to the government as tax now goes into your pension pot instead.
With personal or stakeholder pension schemes that you take out yourself, and with some types of workplace pension schemes, you can still get tax relief on your pension contributions, even if your income is too low to pay tax.
However, with other workplace pension schemes this doesn’t apply.
Top-ups from employers
To help people save more for their retirement, employers are now required to enrol their workers into a workplace pension scheme.
This is called ‘automatic enrolment’.
If your work gives you access to a pension that your employer will pay into, then unless you really can’t afford to contribute or your priority is dealing with unmanageable debt, staying out is like turning down the offer of a pay rise.
Of course, if your employer will contribute to your pension regardless of whether you pay into it, then you should join the scheme whatever your financial circumstances.
A tax-free lump sum when you retire
You can usually take up to a quarter of your pension savings as a tax-free lump sum.
If you’ve built up your own pension pot in a defined contribution scheme (as opposed to a salary-related pension scheme) you can then use the rest of your pot as you choose once you reach the age of 55.
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