Pensions are an essential part of life, and yet many people don’t have a great understanding of them. Knowing what you’ll need in retirement and what options you have will help you make smarter choices for your future self. Unfortunately, the UK’s current state pension is not enough to live on. This stark reality has many people concerned about and looking for ways they can secure their future. If you want to retire comfortably, there is no avoiding a discussion of pensions.
Pensions are an essential part of life, and yet many people don’t have a great understanding of them. Knowing what you’ll need in retirement and what options you have will help you make smarter choices for your future self.
Unfortunately, the UK’s current state pension is not enough to live on. This stark reality has many people concerned about and looking for ways they can secure their future. If you want to retire comfortably, there is no avoiding a discussion of pensions.
What are pensions?
A pension is money you put aside for your future and provides an income when you retire. Generally, most pensions don’t allow you access until you reach 55.
Economic uncertainty is bound to hit at some point. We can’t control the wider economic climate, but we can control how able we are to deal with difficult times. A pension is just one way to prepare yourself for economic uncertainty in the long run.
Unlike a savings account, the government provides tax relief. Your tax-free pension contributions limit is £1,073,100 in a lifetime or 100% of your earnings in a year or £40,000 annually.
For a UK workplace pension, employers also pay in. The minimum contribution for a workplace pension is 8% overall, with 5% from you, the employee, and 3% from your employer. These contributions may be more for you or your employer, especially if you are enrolled in a defined benefit pension scheme.
What types of pensions are there?
There are several types of pensions and schemes.
First, UK citizens have a state pension. This is provided by the government and is given to everyone, even if they have other incomes from personal or workplace pensions. How much you get from the state pension depends on your national insurance record, but the full amount is £185.15 per week, which makes £9,627.80.
You may be eligible for a higher amount if you have over a certain additional state pension or delay taking your state pension.
Aside from the state pension, there are also workplace pensions arranged by your employer or personal pensions, which you organise yourself.
Workplace pensions usually schedule payments automatically every time you get paid. With these schemes, your employer will also usually contribute, and the government often provides tax relief.
If you worked in the public sector or for a large business, you might be enrolled in a defined benefit scheme. These pensions pay a secure income for the rest of an employee’s life and rise in line with inflation.
Alternatively, you may pay into a defined contribution pension with your private or workplace pension. This type of pension may also be called a private or stakeholder pension. Defined contribution pension pots are invested and can go up or down depending on how the investments do. You can take money out in lump sums or as regular payments. Usually, 25% of this pot is tax-free.
A defined contribution pension can run out, while a defined benefit pension will not. Therefore, you must check your fund at least once a year so you know how much you have left and can manage your withdrawals and investments accordingly.
How are pension pools invested to generate income?
A pension pool, usually controlled by investment managers, is usually invested in stocks and bonds.
If retirement savings are to maintain or increase their value, then simply saving money is not enough. Inflation, especially over a long period, means that a given amount is not worth as much in the future as it is now.
Traditionally, pension pools were invested in low risk ‘blue chip’ stocks. Blue chip stocks are stocks in large companies with excellent reputations and years of success. Today, pensions are more often invested in private equities, including real estate, infrastructure, and gold, as a better hedge against inflation.
Most pension funds are strategically invested, so pay-outs occur at regular intervals, supplementing state pension payments.
It is also common practice for investment managers to invest in increasingly lower-risk investments closer to retirement age. This is done to protect your pension fund since higher-risk investments are more likely to grow faster but also more likely to fall in value fast.
What’s a good pension?
So, you know you need a pension, but how much do you need?
There are two main recommendations when it comes to pensions. The first is to save 10 times your current salary. So, if you earn £25,000 a year, you should aim to have £250,000 in your pension by retirement.
The second theory suggests 70% of your current income times the number of years you will be retired. Of course, this may involve some estimation. For example, say you earn £25,000 and plan to retire at 65, expecting to live another 20 years (based on factors like your lifestyle and family). In this case, you would want to save £17,500 a year for 20 years, equalling a total of £350,000.
The average pension fund in the UK is just £50,000. Typically, men have more, and women have less. For most people, a £50,000 pension fund is not enough.
Ultimately, how much you need depends on factors like whether you own your own home and what type of life you want to live in your retirement.
Ideally, you want to start contributing to your pension early. The sooner you start, the more time you have to save. It can be challenging to balance everything you need to do and pay for but understanding the key factors of your personal finance will help.
Not everyone starts their pension as early as they might want. Whether you start on time or a little later than planned, it’s good to know which schemes can help you get more from your pension pot.
Schemes that can help you maximise your pension
Some workplace pensions involve a salary sacrifice, or SMART, scheme. With this scheme, you give up part of your salary, which your employer pays directly into your pension. By paying into your pension through this scheme, you and your employer may have to pay a lower tax and National Insurance contribution.
There is also the additional voluntary contribution (AVC) scheme. This allows you to make further contributions to a workplace pension, typically tax-free up to your annual allowance and can come with additional perks like a lifetime income.
If you delay getting your pension, you can also maximise the amount you get. For example, under current rules, you would get an extra 5.8% or £10.70 weekly if you deferred your state pension for a year.
Pension scams to avoid
Scams have increased as people have gained greater control and access to their pension pots. A general rule of thumb is that if something sounds too good, it probably is.
Aside from this, there are several indicators that something might be a scam:
- Unsolicited contact – You’ll rarely receive pension offers via phone, email, or in person without some prior contact.
- Free pension reviews or no-obligation consultations.
- Pressure to decide quickly.
- No contact names or too many people involved.
- Pension liberation before you turn 55.
You should treat any such pension offers or discussions with extreme scepticism.
What are some alternatives to pensions?
You may have heard of a 401K as a pension alternative. This is a saving system for retirement but is only available in the US. A 401K is like a defined contribution pension and, generally, is controlled by you rather than an employer.
In the UK, you can invest money privately instead of or as well as your pension. Private investments give you greater control over what you invest in and when. They also allow you to withdraw money before the age of 55. However, with private investments, you miss out on employer contributions and tax savings.
Pensions and retirement planning can feel overwhelming. However, knowing your options can help you make the right choice for your current situation and future self. If you’re still uncertain, consider seeking advice from a finance or pension professional. They will help you understand your options and guide you in the right direction.