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Pensions: Everything you need to know

• Written by Josh

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By law, all UK employers must offer a pension scheme. This is in addition to the State Pension which the government provides. Therefore, pensions are a very important part of life and you'll most likely be relying on one or more pensions once you retire. For younger people, it might seem silly to start thinking about their pension at all. However, as many older people can attest, thinking about your pension throughout your working life can be very wise. After all, the earlier you start putting in, the more money you'll have when you retire.

Today's post will take an in-depth look at pensions and how they work in the UK. For more financial advice, read our Top 10 Finance Tips for Older People.

What is a Pension?

As we have already mentioned, pensions are important throughout your working life, not just once you've retired. The Money Saving Expert website defines a pension as:

"a tax-free pot of cash that you, your employer (and sometimes the Government) pays into, as a way of saving up for your retirement."

The main types of pension are:

  • State Pension: paid to you by the government once you reach State Pension age. The amount you receive will be based on the National Insurance contributions you have made over your lifetime.
  • Workplace Pension: your employer will contribute to this pension pot. You will also make contributions which will be taken from your wages throughout your working life.

If you are unsure about what each type of pension means for you, don't worry. We'll discuss both workplace pensions and the State Pension.

Workplace Pensions

As of the Pensions Act 2008, all employers are legally obliged to offer a pension scheme. Furthermore, since 2019, all workplace pensions are available on an opt-out basis. This means that all workers over 22 who earn more than £10,000 per year will be enrolled automatically into their workplace pension scheme. Previously, workers had to opt-in to enjoy a workplace pension.

With a workplace pension, contributions are taken directly from your pay and added to your employer's contributions. There are two main types of workplace pension schemes:

Occupational Pensions

This is a pension set up by your employer. Occupational pensions fit into one of two categories:

  1. Final Salary Schemes - Your pension is linked to your salary whilst you're working, which means that your pension will increase if you get a pay rise. The amount of money in your final pension pot will depend on your salary at the point of retirement and the length of time you have been enrolled in the scheme. With this kind of scheme, you will usually pay a set percentage of your wages towards your pension and your employer will pay the rest.
  2. Money Purchase Schemes - The money you pay into this scheme is invested, with the aim of giving you more money than you initially paid in when you retire. Your pension will be based on the amount of money you paid in, and the success of the investments that were made with the money. You'll usually pay a percentage of your wages into the scheme and your employer may also contribute a regular amount, but this isn't always the case. Bear in mind that the money you receive in retirement will depend on how well the investments perform.

Occupational pensions can also offer other benefits such: as life insurance, which pays a lump sum to your dependants if you die whilst still employed; access to your pension if you have to retire early due to a long-term medical condition; and a pension for your spouse or other dependant(s) when you die.

Group Personal Pensions

These are a good option for those who might not be eligible for auto-enrolment into a workplace pension. This could be because they are under the age of 22 or earn below the £10,000 threshold. The employer will choose the pension provider, but the employee will have an individual contract with that provider. You will pay contributions into your pension fund directly from your wages, with the money being used to grow your pension pot. However, your employer does not have to make contributions.

Just like with a money purchase scheme, your contributions will be invested. This means that the amount of money you receive in retirement will depend on the success of those investments.

Changing Jobs

Should you leave your current job, there are a few options available to you:

  • Leave the funds in your old employer's scheme and access them once you reach that scheme's pension age.
  • Transfer any funds in the previous pension pot across to your new employer's scheme. This isn't always possible, so contact your pension provider to discuss your options.

If you leave funds in a former employer's pension scheme and then change your home address later on, don't forget to inform your old pension provider of your new address so they can reach you.

How much will I put in?

The law regarding minimum pension contributions changed in April 2019. Now, your employer must contribute a minimum of 3% of your annual earnings, while you will need to pay 5%. These figures apply to all occupational pensions.

On the other hand, the maximum that you can pay in over one tax year depends on your earnings. It will either be:

  • A gross contribution of £3600, or
  • 100% of your earnings, subject to the annual allowance - commonly £40,000.

Your employer may give you the option of 'salary sacrifice' as part of their pension scheme. In this case, your pension contributions will be taken directly from your salary and paid straight into your pension pot. In some cases, this will mean that you pay less tax and National Insurance each month.

When can I withdraw my Pension?

Usually, pension schemes will specify an age at which you can start to withdraw money. Generally, this is between 55 and 65. If your health deteriorates or you suffer from a disability and have to retire early, you may be able to withdraw your pension sooner.

Once you can withdraw your funds, you have the freedom to choose how you use each of your pension pots, based on what best suits your needs. You should think carefully about how and when to withdraw your pension money. You should consider your:

  • Long-term health and life expectancy.
  • Age.
  • Family.
  • Lifestyle.
  • Current sources of income.

Different providers give you different options when it comes to withdrawing your money. Options commonly include:

  • Withdrawing some or all of your pension pot as a lump sum. Please note that there may be high fees or charges each time you withdraw funds. Furthermore, only 25% of each withdrawal (or of your lump sum) is tax-free.
  • Investing part or all of your pot on the stock market. Remember that this means your income will not be a guaranteed amount. Without a maximum limit on how much you can withdraw annually, you could run out of money.
  • Buying an annuity. You can normally withdraw 25% of your overall pension pot as a tax-free lump sum. Then, you have the option to use the remaining money to buy an annuity. An annuity pays you a regular income in retirement, either for a set number of years or for life.

If you have any further questions about workplace pensions, the Money Advice Service has a fantastic Pensions and Retirement section on their website, with free one-to-one support from expert advisors.

Next, we'll discuss the State Pension.

State Pension

The State Pension is the regular payment that you'll receive from the Government once you reach State Pension age. This age will vary depending on when you were born. You can use the State Pension calculator to find out the exact date when you can start claiming your pension. The State Pension age is constantly under review by the government, which means it could change multiple times in the future.

The government made some changes to the State Pension back in 2016. The previous 'basic State Pension' is available to men born before 6 April 1951 and women born before 6 April 1953. If you were born on or after these dates, you will eligible for the new State Pension instead.

How To Claim Your State Pension

It might surprise you to learn that you will not receive your State Pension automatically; you will need to claim it. Four months before you reach  State Pension age, you should receive a letter from the government's Pension Service which will tell you what to do.

If you haven't received a letter three months before you reach State Pension age, you'll need to call the telephone claim line on 0800 731 7898. Alternatively, you can claim your State Pension through the online service, or by downloading a form and sending it to your local pension centre.

How much will you get?

The amount of money that you receive will depend on how many "qualifying years" of National Insurance contributions you have made. These will build up throughout your working life, so the number you have will depend on how many years you have been in work.

Under the rules which came into affect in April 2016, you will need to have made a minimum of 10 years National Insurance contributions before you'll get any payout at all. If you reach this minimum threshold, you'll be paid around £46 per week. On the other hand, if you have 35 or more years of NI contributions, you will receive the full State Pension of £175.20 per week. This total figure will rise each year according to inflation, average wage growth, or by 2.5%, whichever is highest.

Some people may receive more than this, if they were formerly entitled to the Additional State Pension. This was a top-up to the former basic State Pension. Although this top-up no longer exists in the new rules, the Government has allowed many workers in their 40s, 50s and early 60s to keep any extra cash they have already amassed.

As a general guide to what you might get, multiply the number of years of NI contributions you've made by £4.55 – this figure will be a rough estimate of the amount you could receive each week.

Can I keep working while claiming my State Pension?

There is nothing stopping you from carrying on working while collecting your State Pension. Any money that you earn will not affect your State Pension, although it may affect your entitlement to other benefits such as Pension Credit and Housing Benefit.

You should also bear in mind that income from State Pension is taxable. This means that, if you keep working while claiming your State Pension, the extra money could tip you into a higher tax bracket for the year.

Personal Alarm Information

For anyone approaching pension age, a Lifeline alarm could be a very wise investment. For more information about our service, please get in touch with our friendly team on 0800 999 0400. Alternatively, complete our Contact Us form and we will get back to you as soon as possible.

Read our top 10 financial tips for older people.

Editor's Note: this article was updated on 15 July 2020 to reflect current information.

Originally published March 2018.

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