Personal Finance and Online Security

What is a pension?

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If you have recently become employed you would have been offered to join a pension scheme. In simple terms, a pension scheme is a type of savings plan to help you save money for later life. They are a tax-efficient way of saving for retirement. You save a small amount of your income during your working life and once you have retired and stopped working, your pension is likely to be your sole or main, form of income.

There are three main types of pension:

  1. Employer’s
  2. State
  3. Self Invested Personal Pension (SIPP)

Employer’s pension

Since 2012, automatic enrolment has been in place. This means that all workers aged between 22 and pension age, and earn over £10,000 a year, must be enrolled into a workplace pension by their employer. Of course, you can opt-out if you wish.

An employer’s or commonly known as a workplace pension comes in two forms:

Defined contribution

Here, your employer takes a percentage of your salary every payday and provides a percentage contribution themselves. This determines how much of an income you get when you retire.

The minimum contribution from your employer must be 3%. Your contribution must be at least 4%.

Defined benefit

This scheme ensures you are provided with a specified amount as a pension once you reach retirement age. The employer normally determines your pension amount based on the length of service and your final salary upon retiring.  

State Pension

As a UK resident, you will most likely contribute National Insurance tax each month, and throughout your life. However, not everyone gets the same amount. How much you get depends on your National Insurance record.

The state pension changed on 6 April 2016 for people who reach state pension age from then onwards. This is men born on or after 6 April 1951 and women born on or after 6 April 1953.

People with no National Insurance record before 6 April 2016 will need 35 qualifying years to get the full amount of new State Pension when they reach pension age. The full amount of the new state pension is £175.20 a week (2020 to 2021 rate).

For more information on what constitutes a qualifying year, visit the Gov.UK page here.

Self Invested Personal Pension (SIPP)

With an employer’s pension, you may not necessarily have much choice where your money is invested. Therefore, you can opt-out and set up a Self Invested Personal Pension (SIPP). A SIPP could provide a cheap, flexible way to save for your retirement. 

You will be taking on responsibility for building and managing your investments, therefore, it is critical you speak to a professional advisor before beginning. If you have a small amount of money to invest, say £1,000, then check out my best tips on how to invest this here!

There are two types of SIPPs:

Full SIPP

These provide the largest investment options but come with higher charges and are generally suitable for people with large pension funds. They are also aimed at experienced investors.

Lite SIPP

Otherwise known as a DIY SIPP. These offer a wide range of investments but do not include owning property directly, offshore funds or investing in unquoted shares.

As these SIPPS are generally execution-only the operational fees are lower as you are not taking advice from the investment platform.

When do I receive my pension?

Most commonly, pensions are set at a specified age before you can begin to withdraw funds. This is usually between 55 and 65.

Once you have reached this age, you can decide between either:

  • If you have a defined contribution or individual pension, you can take 25% of its value as a tax-free lump sum of money. You would then pay tax on the remaining value which you are free to use as you wish.
  • You could buy an insurance policy called an annuity that gives you a set guaranteed income for the rest of your life.
  • Some people reinvest their pension to provide a regular taxable income. This is sometimes called pension drawdown.
  • With defined benefits pensions, depending on the rules of the scheme, you could take a tax-free lump. Otherwise, the rest of the money will be paid to you as a guaranteed income for the rest of your life

Conclusion

Thank you for reading this short article defining pensions. I hope you now know what a pension is, the various types you can have and when you can receive your pension pot. 

As always, I’d love to hear your feedback and any comments.

-PocketPound

Featured image: Caroline Hernandez on unsplash

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