Resolver’s ultra-simple introduction to pensions!
02/02/17 A pension confession…
Let’s start this with an honest confession.
The vast majority of people don’t fully understand how pensions work. So you should never feel embarrassed about asking for help when it comes to your pension.
Pensions can seem complicated or intimidating. The terminology and terms and conditions often might as well be written in another language. At times, it can feel like you need to employ an expert just to make sense of them for you. And seeing as we’re doing confessions, many financial services experts find pensions hard work to understand too.
We won’t lie to you. Pensions can be all of those things. But it doesn’t have to be that way. A pension is the second biggest investment you’ll make in your life (after your mortgage) – so it’s really important that you understand enough to make an informed decision. And the fact is, even a little bit of knowledge can empower you to ask the questions you need to make sure you’re saving in the best way for your retirement.
Why don’t we understand pensions?
There are lots of reasons why people don’t ‘get’ pensions. Older people tell us they recognised the importance of paying into a pension but went along with what they were told by their pension provider because they didn’t feel they could question them. Younger people say that retirement seems a long way off – and they’re more focused on finding a decent job right now. And the rest of us worry about the plans we have (or lack of them) but don’t want to rock the boat or find out the truth of what we’re actually going to end up with at retirement.
It’s really important that you don’t go into pension denial. If you haven’t got enough money in your pension pot, it’s generally not too late to do something about it. For example:
- If you’re in a bad scheme that’s losing money you can move your pension.
- You can get good, clear advice that helps you cut down on the commission and fees you’re paying.
- If you’ve lost track of your old pension schemes you can find them simply and for free.
So what is a pension?
A pension is a way of saving up money to pay you an income after you retire. Pensions come with loads of tax benefits - and saving for your retirement is most definitely a good thing.
A big chunk of your pension plan will be invested in the stock market and as a result, its value can go up and down. A pension is a long-term investment, so the people who manage it will try to balance out some of this stock market risk, so over the years your pension increases in value (but this isn’t always guaranteed to happen).
Different types of pension
There are three main types of pension
Occupational pensions: These are schemes where a percentage of your pay is put into the pension scheme automatically every time you get paid. In most cases, your employer also adds money into the pension scheme for you. You may also get tax relief from the Government. Not all companies do this – but from 2018, under the Government’s ‘auto-enrolment’ rules, they have to offer you a pension by law.
State pension: This is the state (Government) pension scheme that you get when you hit the state retirement age – Right up until recently, there were two schemes, known as **jargon alert** the basic state pension and the State Second Pension or S2P (previously called the State Earnings Related Pension Scheme or SERPS). You build up your state pension through your National Insurance (NI) contributions throughout your working life. From April 2016, this all became one new state pension. Don’t get too excited. The maximum you’ll get is currently £155.65 a week. Our friends at MoneySavingExpert explain all of this in a handy guide.
Personal pension: This is a scheme that you buy and pay in to personally so you have a source (or another source) of income when you retire.
The rules surrounding these pensions have been tinkered with numerous times over the years which is why there are so many options and types of pensions doing the rounds. If you’re not sure what pension schemes you’ve got, just ask your employer or financial adviser (if you have one) what you’ve got.
When do I get my money then?
Once the money is in a pension, you can’t get your hands on it till you hit 55 years old (unless there are exceptional circumstances). Then you can take out 25% tax-free, with the rest until recently being used to buy an annuity (more on this shortly). However, last year the Government changed the rules, introducing ‘pension freedoms’ This meant you could take the lot – but you pay your top rate of tax on the remainder, so it makes sense to get financial advice before you do. So you could…
- Take it all out (with tax penalties).
- Leave it in for when you need it.
- Take your 25% tax-free and invest the rest.
- Take your 25% and buy an annuity.
What’s an annuity?
An annuity is an annual plan that you buy with your pension that pays you a regular income for the rest of your life, or sometimes over a set period of years.
Working out what you get is rather complicated, but basically, the insurance company that provides the annuity estimates how long it thinks you’ll live and spreads out the money over that period. It’s crucial that you get good financial advice because once you’ve signed up the deal is for life. A worrying large number of people buy their annuity from the same company they had their pension with. This is a sure-fire way to miss out on much better deals.
Annoyingly, because pensions are complicated it makes sense to speak to an expert before you make a potentially life-changing decision.
There are good pension and financial advisers out there and bad ones. So do a bit of research before you select one that works for you. Get a recommendation from a trusted friend or relative and do a few quick searches online. Financial advisers have to be regulated and are obliged to tell you about the commission they’re on, but make sure they’re not just giving you an option that’s expensive fees-wise. Ask for comparison tables and take time to think about things.
Finally, watch out for scams. You may get contacted by someone offering to help you ‘liberate’ your pension. These scams trick you into moving your pension pot to another, more costly scheme – and sometimes they are completely fraudulent.
One last thing…
As we said at the beginning, don’t be afraid to ask any business that’s helping you with a pension or investment to spell things out for you in plain English. It’s your money – so make them work for it!