Retirement – it all seems so far away when you're young. You might be forgiven for thinking you'll start saving for it when you've landed that dream job with the bumper salary that the future is just waiting to unveil for you.
However, at current interest rate levels, it's estimated that you'll need to save somewhere in the region of £400,000 over your working lifetime in order to get a payout of £20,000 per year when you retire. Bearing in mind that's a whole lot of money to rack up, it's best to get on the wagon as soon as you can. If you don't, you could come to regret it in later life.
The State Pension
But the Government provides pensions, doesn't it? And they are paid for out of the taxes we all contribute. So what's the problem?
It's true, every UK national is entitled to a basic state pension. But it won't fund your round-the-world cruise, nor your membership for the country club – in fact, you'll struggle to get a day out at the good old English seaside out of it. Currently, it pays around £100 per week, at its maximum level, for single people, and £155 for married couples. This will rise, roughly in-line with inflation, but whatever it is by the time you reach retirement age, don't expect it to look much more attractive. The age at which you will be eligible to receive your state pension is also rising. It used to be 65 for men and 60 women; it's going up to 66 for both by 2020 and there are consultations to raise this further still to 68. The national average age in the UK is growing and the government simply can't afford to keep such a large percentage of society in retirement and lose the revenues that people generate, both in contribution to GDP and income taxes, while they are in work.
What's more, you need to have paid National Insurance for at least 90 per cent of your working life in order to qualify the maximum state pension allowance. If you have been out of work and haven't made voluntary National Insurance payments for more than 10 per cent of your working life, excluding periods when you were in full time education, the amount you get through your state pension will be pro rata with the amount of time you're short. Should you so choose, you can continue to work, passed the normal state retirement age, until you reach the threshold, or you can make additional top up payments.
If the state pension is your only source of income in retirement and you don't have any savings you will qualify for a top up. However, this currently only brings you up to around £130 per week for singles and £200 for married couples.
It's vital then, that you take further action, while you are able to, to support yourself in later life. You don't lose the state pension benefit by having additional self-funded schemes in place; you are entitled to it regardless.
The Company Pension
If your employer offers a company pension scheme you should almost certainly snap their hands off (metaphorically speaking, of course – the physical assault of HR directors is likely to lead to disciplinary action). Company pensions schemes used to be even more lucrative than they tend to be now, but they remain a very savvy way to save for your retirement. Many companies used to offer Defined Benefit schemes, also known as Final Salary Schemes, whereby they would commit to paying you a portion of your total salary when you retire, with you contributing along the way and the company making up the shortfall.
Today, there are very few of these schemes left in place. Now, more often than not, companies will offer Defined Contribution schemes instead. With these, you and the company add fixed amounts to the pension pot as agreed and the payments you receive at the end are directly dependent on the total saved.
The reason for the change has been largely influenced by two main factors: firstly, when the recession kicked in, many of the investments that pension funds were set against fell heavily in value, meaning there is less money in place to pay out on policies with. Secondly, life expectancy is creeping up steadily and the pension funds are having to be stretched out further than was first planned for.
However, Defined Contribution schemes, while not usually as lucrative as Final Salary Schemes, can still pay out very handsomely, with companies paying much more into their workers' funds that they could get with interest rates on savings accounts, as a perk of the employment. You'll need to work out whether you could stand to gain more with this option or with a private pension.
When it comes to the time that you retire, the pension will pay you a yearly salary for the rest if your life. You have the option on retirement of taking a tax-free lump sum up to the value of 25 per cent of your pension. If you do, your regular payments will be reduced accordingly with what's left in the pot.
The Private Pension
Private pension schemes are also available, either as well as, or instead of, a company scheme. They may be your best option if you are self employed or there isn't a scheme available through your company. It may be that your company does in fact offer a scheme but you think you can get better returns by taking your money to a private one. You can have both a company and a private pension scheme in place at the same time, if you want to hedge your bets.
Available through high street banks, building societies, insurance companies and specialist investment services, there are many different types of private pensions schemes available. Most work by exactly the same premise as company pension schemes – offering a yearly income against the total amount of monies that are in the fund and sometimes operating in conjunction with an annuity (explained further down). Where they differ is in the way that you fund them and the way that they earn you money.
With a standard personal pension product, you pay the company that you choose either a lump sum of money or a regular payment and they invest it in the stock market. You then get a return on your money on retirement at a set date, with the amount dependent on the performance of the investments.
With Self Invested Personal Pension Plans (SIPPs), you can choose the investments that your pension will earn against. This might be buying company shares, investing into an insurance scheme, putting your cash into property developments or a whole world of other types of investment.
There are set up fees available on personal pensions which usually sit at around five per cent of your investment as well as yearly management fees of 1.5 per cent of the fund.
Introduced by government to make taking out a pension as easy as possible, Stakeholder Pensions offer you the chance to invest anything from £20 per month into a market-driven private pension fund supplied by one of the accredited providers. You can select a level of risk that you prepared to take with the money and it will be spread among dozens of investments accordingly, in order to limit the chances of losing all of cash. You can make payments whenever you like and are not obliged to stick to any regular amount of routine. You will also face no penalties for moving your money from provider to provider, although you will face management charges which are capped at 1.5 per cent of the fund. You can access the money at any time between the ages of 55 and 75.
Annuities
With an annuity scheme, you invest a lump sum with a company – usually an insurance firm. In return, they will give you a guaranteed fixed sum income for life from the agreed date that the fund starts to pay out. Currently, annuity schemes annually pay out somewhere in the region of 5 to 7 per cent of the total amount of money invested.
With many private and company schemes, you are obliged to transfer your fund to an annuity when it matures. In fact, it used to be that you were forced to take out an annuity with any money in your pension pot when your reached the age of 75. This is no longer obligatory; you are fully within your rights to leave your money in a private scheme attached to market investments. Annuity schemes remain, though, one of the safest ways to invest for your retirement, if potentially not the most lucrative, because the payments are guaranteed. And the only way you'll lose your money completely is if the company you place it with goes bust.
For more information on pension annuities read our in-depth guide here.
How does tax work with pensions?
You are entitled to tax relief on up to £50,000 worth of payments into a private or company pension scheme each year. This means that the income tax you pay on the portion of your wages that you pay into the pension will be refunded by being added to the total pot. You are able to carry over your allowance from the previous three years if you haven't used it, so somebody that is in their fourth year of working but hasn't saved anything in a pension scheme up until then is entitled to put up to £200,000 tax free into a pension scheme during that year.
However, when you come to receive your allowance upon retirement, the payments are taxable, whether still within a scheme held by your company, an investment service or through an annuity.
Who regulates the pensions industry?
The pension industry is fully regulated by the Financial Services Authority and practitioners need at least The Chartered Insurance Institute Certificate in Financial Planning (1 – 5) in order to advise you. Ensure that anybody you seek advice from has not only the necessary credentials but an excellent and proven track record in dealing with pensions before you employ their services.
If you need further advice, you can call The Pensions Advisory Service (TPAS) – an independent non-profit organisation backed by grants from the Department for Work and Pensions – on 0845 601 2923.
Click here to compare the pensions from the UK's leading providers on Know Your Money.
Author: KYM Editor
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