Why save into a pension?
Pensions might seem complicated but the basic idea is a simple one. It’s worth understanding their benefits, because your State Pension – while providing a foundation – may not be enough to live on. You need to save more.
The importance of retirement savings
Did you know?
The maximum basic State Pension is far below what most people say they hope to retire on.
More than half of people in the UK either aren’t saving at all for their retirement or they 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. You can:
- adjust downwards your expectations of what you’ll be able to afford in retirement
- start saving more
- retire later
Don’t rely on the State Pension to keep you going in retirement. The maximum basic State Pension of £155.65 per week (effective from 6 April 2016), and 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 to do so. 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 - 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 personal 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. The government will still put tax relief into your pension pot, even if your income is too low to pay tax.
Top-ups from employers
To help people save more for their retirement, employers are gradually being required to enrol their workers into a workplace pension scheme if they are not already in one. This is called ‘automatic enrolment’ and is gradually being made compulsory for all employers.
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 have 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 from age 55 onwards.