Blog » A beginner’s guide to UK pensions: understanding your options

A beginner’s guide to UK pensions: understanding your options

January 22, 2024
The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article.

Looking ahead and keeping safe

For many younger individuals, retirement is a distant thought. For these reasons, more immediate financial issues tend to take precedence, and it is easy to delay saving for post-work years. But the fact is, the earlier you start saving for your retirement, the more comfortable you are likely to be. Knowing where to start with understanding your pension options can be dauting, but once you understand the basics, you can be well on your way to a comfortable retirement.

This article covers how pensions actually work and the different pensions you can put your money into.

What is a pension?

The pension world can seem pretty daunting and complex to most of us. To put it simply, opening a pension is a way of putting money aside and investing it so that you will have an income when you finish work. There are many different ways of saving your money, but a pension will fence off some of your savings specifically for when you retire.

It is important to remember that pensions, like any investments, are liable to swings in value depending on how well the investments perform. For this reason, your capital is at risk.

Pensions and employment

A great way to start saving is through a workplace pension. If you work in the UK, have no current workplace pension, are aged at least 22, and earn over £10,000 a year, then it is mandatory for your employer to offer you a pension. If you meet this criteria, you will be automatically enrolled for your workplace pension. If you are aged between 16 and 22, you can voluntarily opt in to your workplace pension. Your contribution is taken out of your monthly wage packet at source and your employer will also contribute a percentage each month.

An occupational pension has many benefits:

(1) It gets you into saving for your retirement years without any real hassle.

(2) Your employer will arrange the contract with a pension provider.

(3) You will receive extra contributions from your employer, increasing your final payout.

(4) The main benefit to saving into a pension is the tax relief. Any tax you have paid on the amount contributed to your pension from your wages is paid back into your pension pot.

Two types of employment pension

Typically, there are two types of retirement pension you can receive through your employer:

  1. Defined benefit pension scheme

Often called a final salary scheme, this type of pension pays you a guaranteed amount for the rest of your life once you retire. The final payout is dependent upon your salary when you retire and the number of years you worked for your employer. It is not dependent upon the growth of investments like a defined contribution pension. In the 21st century, this type of pension is now rare as many employers cannot afford to use it. These types of pensions are most common with the NHS, civil service, and teachers, for example.

  • Defined contribution pension scheme

Also known as a money purchase scheme, this is where you (and your employer) contribute to a pension pot through your salary and your money is put into investments. You will also receive tax relief on the contributions you make into the scheme. You can change the size of contributions you are making and check the performance of your fund by directly contacting the pension provider.

Unlike defined benefit schemes, the amount you end up with after you retire is not guaranteed. As with all investments, pensions are liable to swings in value depending on how well they perform – capital is at risk.

If you should be away from work for a long period of time (such as sickness), it is important to know whether your employer will continue to pay contributions while you are away.

Your State Pension

As long as you are eligible, you will receive a State Pension on your official retirement date, which is set by the government. This date is regularly changing due to social and environmental pressures – you can find your official retirement age by clicking here. The weekly amount you receive will depend on the total National Insurance contributions you have made. National Insurance contributions are taken out of your salary at source when you are working. They are also taken at source if you claim benefits when you are away from work.

You can check how much you will receive by clicking here.

If you are concerned you will not receive the maximum State Pension, you can make voluntary National Insurance contributions.

Private pensions

It is wise to have a private pension running alongside your State Pension as it can make your retirement much more comfortable – rather than relying on only the basic income you would receive from your State Pension. As stated above, many individuals have occupational pensions, but you can also check out the current market to find out the most appropriate private pension scheme for your needs.

Choosing a pension scheme or pension provider is not easy as they can all offer different benefits and pitfalls, such as provider fees and investment portfolios. It is wise to seek out the guidance of a regulated financial adviser. Here are some factors to bear in mind:

  • When you choose a pension provider you will have the option to allow them to invest your contributions for you. Or, if you are financially savvy yourself, you can determine where you want to invest your money.
  • You will need to decide what level of risk you are willing to take with your investments. Determining the appropriate level of risk depends on how comfortable you are with risk in investments, how long you have until you need the money, and other factors such as your health and financial circumstances. As you approach retirement you are more likely to be looking for low risk investments. This is something a regulated financial adviser can help you to determine.
  • Your pension provider charges different types of fees, like management fees, and it is a good idea to compare between different schemes to make sure you have the best deal.
  • You will receive tax relief on your contributions.
  • As a private pension is not linked to your employment, it is much more flexible and is not dependent upon any career changes.

If you have the assistance of a regulated financial adviser, they will be able to tell you the pros and cons for each scheme.

Accessing your pension

In the UK, you can access your pension when you reach the age of 55*. Some individuals may retire or part retire at this time but others continue working and just access money from their pension when they need it. There are several different ways you can access your pension pot, for example, the money from your pension fund can be taken as an income, it can be used to buy an annuity or you can take out a lump sum or series of lump sums.

*from 2028 the age you can access your pension will rise to 57.

The important point is to be aware your pension pot is not just a savings account and is meant for when you retire. Withdrawing money early from your pension will leave you worse off in retirement. It is therefore recommended that you seek the advice of a regulated financial adviser to ensure (1) any resources taken from your pension scheme does not impinge on your retirement security and (2) your actions are tax efficient.

Keep your pension front of mind

Your pension is a strategy and resource for a secure and comfortable lifestyle when your work income has ceased. The earlier you organise your pension, the more time it will have to grow. So, even though retirement may be many years ahead, always think about how your income now can keep you safe in the future.

Regularly check on the performance of your pension (your pension provider will forward a report once a year) and make any necessary changes. Changes may include finding a new provider or fund, or transferring monies into different pots or changing the contribution amount. This can be made a little easier with the help of a regulated financial adviser.

Also, remember when you change your employer you may well have to start a new pension. It is important therefore to keep a record of all pensions you have started before. All this money is valid for when you retire – don’t lose it!

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