A comprehensive guide to pensions
A step-by-step guide to making the most of your cash
No matter how old you are, retirement can seem like a lifetime away. But as those in their 60s know, time can quickly creep up on you while you’re busy doing more important things.
And, before you know it, you need to think about how you’re going to get by when you eventually stop working.
Don’t presume that you’ll simply be able to rely on the state pension. Anyone who does that is likely to have a big financial shock in store.
Instead you have to make your own plans or face the prospect of drastic cut backs when you stop earning. But don’t worry, by even thinking about it, you’ve taken an important step towards securing a better financial future.
- Section One: The state pension
- Section Two: What are you saving for?
- Section Three: How much will you need to save?
- Section Four: Cashback? No, it’s a tax benefit
- Section Five: What will your company do for you?
- Section Six: Isn’t my pension based on my earnings
- Section Seven: Why fund performance is important
- Section Eight: Check the charges
- Section Nine: What if I have an old pension?
- Section Ten: If I’m 55, should I cash in my pension?
- Section Eleven: Be wary of pension fraud
- Section Twelve: Getting the benefit
1. The state pension
Have you any idea what the current weekly state pension payout is? As at July 2016 it’s just £155.65. And out of that pensioners have to cover all their outgoings, not just food and heating or essentials.
You can find out what your expected state pension is likely to be here. Depending on when you were born or how long you’ve made National Insurance contributions, it will be different. Knowing how much you’re likely to get will indicate how little you may have to survive on.
And if you’re smart enough to think about making the most of your money now, you should be smart enough to think about making the most of your financial opportunities. And that means making a few plans.
Don’t think about it as planning for retirement. Instead think about it as planning for your life. Or, to put it another way, you probably plan for a holiday, so why not plan for the longest holiday you’re ever likely to have?
2. What are you saving for?
Retirement planning simply means saving up some money for your future self. How much do you need to save? That depends. It depends on what you’re hoping to do when you give up work and therefore, how much you might need to spend.
If your dream is to doze every day in a hammock then you may only need enough money to buy a couple of strong trees, a decent hammock, and the weather environment that will make dozing pleasant.
If you hope to do a lot more travelling, or take up an activity such as sailing or golf, then you’ll need more money. The question is, how much? Only you can work that out.
3. How much will you need to save?
The truth is that retirement planning is all about choices. If you choose to spend all your money now and worry about the future when it arrives, then you should make the most of today and prepare to face more frugal times and a cutback in your lifestyle when you stop earning.
If you’d like to maintain a decent standard of living when you retire, then you have to choose to save some of your money now to give you a decent life later.
If you’re starting a pension now with the aim of maintaining your current standard of living when you retire, experts reckon you need to save half your age as a percentage of your income. So if you’re 24 now, you’d need to be stashing the equivalent of 12% of your income into a retirement pot.
Don’t be put off by that amount. Bear in mind that many companies will match or better workers’ pension contributions. That will effectively cut down the amount you need to put in to just 6% of your salary.
To put it another way, if you earn £2,000 a month, you should be thinking about putting £120 into your pension to be on the right track.
4. Cashback? No, it's a tax benefit
While a pension is effectively simply a savings scheme, it’s one that comes with huge tax benefits. In simple terms, the government tops up your pension contributions by giving you tax relief on them. It’s almost like getting cashback, although to get it your pensions savings are stashed away before any tax is taken.
That immediately gives any pension savings a 20% boost if you’re a basic rate taxpayer, while higher-rate taxpayers get a 40% boost.
To put it another way, for every £1 that goes into your pension pot you only need to put in 80p if you’re a basic rate taxpayer because of the government top up. If you’re a higher rate taxpayer, you only need to put in 60p to get £1 in your pension.
That’s an attractive proposition, especially when you consider how poor the interest rates offered on savings accounts are at the moment.
5. What will your company do for you?
Employers have to offer their staff a pension scheme. In general they will match your contributions so for every £1 you stash away, your company will probably do the same.
In effect it means that for every 80p you put into your pension, with tax relief and your company contributions, that translates to £2 added to your retirement pot. If you’re a higher rate taxpayer, for every 60p you add to a company scheme, the pot will be £2 better off.
And the more you put into a pension, the more your company will add, up to certain limits.
Sound attractive? It is. Some companies have even more generous schemes with the most generous ones having non-contributory schemes. That means your firm will make all your pension contributions – you won’t need to add a penny.
To find out about your company pension scheme you will normally need to talk to your human resources department or ask your line manager. They will be able to tell you how much you can put in, how much your company will add, and, crucially, how your money is invested.
The latter is important and, once you find it out, it may be worth getting a professional opinion on the investment alternatives.
6. Isn’t my pension based on my earnings?
It used the be the case that most company pensions were paid out according to how long you had worked for a firm and how much you earned when you retired. They are known as final salary or defined benefit schemes.
There were very popular with workers as they offered an element of certainty about how much you would be paid when you retired.
But they are very expensive for companies to maintain. As a result very few firms still offer them. In fact you are only likely to have a final salary scheme if you work in the public sector, such as for the civil service.
Most pension payouts now are worked out according to how much is put into them and how much the cash has grown over the years in the investment market. They are known as defined contribution schemes as they are based on your contributions, not your salary.
They offer no certainty and if stock markets tank immediately before you retire, you are likely to end up with a lower pay out. Therefore it’s important to know where your pension cash is invested and how it is doing.
7. Why fund performance is important
Your pensions savings are normally invested in stocks and shares in the anticipation that they will grow over time to build up a decent retirement pot for you.
But if you are in the wrong funds or investment opportunities your savings may not be growing as well as you’d hope. That’s why it’s important to check the performance of your funds regularly so that you don’t end up with less at retirement than you had planned for.
In simple terms the more risk you take with your cash, the higher the potential returns available. With that in mind, when you’re younger you may be able to afford to look at quite high-risk investments on the basis that if things go wrong you’ll have plenty of time to put things right. That would be decades if you’re still in your 20s.
But when you’re getting close to retirement you’ll normally want to lock in any gains you’ve made. That means reducing the risks. It could mean, for instance, switching out of speculative overseas funds into bonds that can offer a more reliable, albeit lower, return.
It’s a complicated decision to make which means finding out as much as you can about investments, what affects them, and what your view is about risks and potential rewards. There is a lot of help online or you could track down an expert to help you make the right decision.
8. Check the charges
Whatever pension scheme you have, you’ll have to pay charges on it. That’s because pension managers are paid for managing your savings.
But if you started a scheme some time ago you may be paying more than you need to. That’s because management charges have become more competitive and dropped substantially in recent years.
Older schemes may charge as much as 2% a year while newer ones typically charge nearer 0.65%. That may not seem much but over time the charges will eat into your savings.
The annual charge should be listed on the statement sent by your pension manager. If it’s more than 1% you could be paying too much.
It’s worth talking to an expert such as an independent financial adviser who may be able to help you find a lower-charging scheme. You can find details of independent financial advisers at www.unbiased.co.uk
9. What if I have an old pension?
If you’ve paid into a pension scheme before but have lost track of it, it should be relatively easy to track it down.
You can contact the pension firm, if you can remember which it was. Or you could get in touch with your former employer if it was a company pension.
Failing those two, there’s an organisation called the Pension Tracing Service which should be able to help you.
You can phone the Pension Tracing Service on 0845 6002 537 or visit the website. You’ll need to have some crucial details such as your National Insurance number and the name of the company you used to work at.
10. If I’m 55, should I cash in my pension?
New rules were introduced in 2015 that allow people aged 55 or over to take the cash out of their pension pot if it’s a defined contribution scheme. The idea of getting at your cash now may be tempting, but there are a lot of things to consider and you shouldn’t take cash out of your pension without understanding the full implications.
Bear in mind that your scheme would have been set up to give you some cash in retirement. Spend the money before that and you won’t have it later, when you may need it more. There are also tax implications to consider that could mean losing a fair chunk of your cash if you don’t withdraw it carefully from your pension pot.
In short, you are allowed to take up to a quarter of your pension pot as a tax-free lump sum. Take any more than that and you would be hit with a tax bill at your standard rate.
You should certainly take advice before making any move but many don’t bother doing so, either because they’re put off by the cost of paying an expert, or think they know what they’re doing.
But the fact is you can get free guidance online through the government-backed Pension Wise service, and a consultation over the phone or face-to-face by calling 0800 138 3944. It makes sense to get as much help as you can to avoid making a costly mistake – especially when it’s free.
11. Be wary of pension fraud
Since pension freedoms that allow you to start taking the cash out of your pension at age 55, an army of fraudsters have targeted people with dodgy schemes.
Unusually high investment returns, cold calling and offers of free financial advice classic signs of a sting. Pension scammers typically offer great returns in schemes that may invest in such things as wine, diamonds or land or some ‘clever’ offshore fund that they say will help you avoid paying too much tax in the UK.
Sometimes they will even claim to have some loophole which will allow you to get at your cash without having to pay any tax on it at all.
But their claims are almost always bogus and the schemes often non-existent. They simply want to trick you out of your hard-earned savings.
If you agree to transfer your cash you may never see it again and you may even end up with a huge tax demand on top.
You should check the website of the City Watchdog – the Financial Conduct Authority’s – to make sure any firm offering a pension deal is legitimate. Or you can call Pension Wise on 0800 138 3944 or the Pensions Advisory Service on 0300 123 1047.
12. Getting the benefit
Almost two-thirds of older people don’t claim government benefits they may be entitled to. There are a lot of reasons for this, sometimes because people simply don’t know about the extra cash they could have.
On average pensioners could be losing out on hundreds of pounds by not claiming all their state benefits, but in some instances it could be thousands.
The charity Turn2Us has details of benefits and grants that older people may be entitled to and a useful Benefits Calculator.