Beginner’s Guide to Pensions

Introduction to pensions
- Pensions are tax efficient in 3 ways
- Investment choice – how much risk do you want to take?
- Flexibility
Why you should consider an occupational pension
Personal pensions
- What to look out for
- Should you get a SIPP?

Introduction to pensions

When planning how to provide for your retirement, there are several ways to put money aside:

• State Pension (which you contribute to through National Insurance contributions)
• Savings
• Investments
• Personal pension
• Occupational pension

Back to top

Pensions are tax efficient in 3 ways

1. Personal and stakeholder pensions benefit from an Income Tax rebate on contributions you make (up to certain limits). That means every time you contribute to your pension pot, the taxman pays some tax in as well! Here’s how it works:
   
   

   Basic Rate Taxpayers

   Your pension provider claims basic rate tax relief back from HM Revenue and Customs. You don’t need to do anything. So, for every £100 contribution you make, £125 will be added to your pension pot.

   Higher/Additional Rate Taxpayers

   Your pension provider claims basic rate tax relief back from HM Revenue and Customs (HMRC). However, the additional 25% that you pay is not claimed back automatically. If you’re a Higher Rate Taxpayer you just need to contact HMRC to claim the remaining tax relief (which may involve completing a tax return). If you’re an Additional Rate Taxpayer you will need to declare your pension contributions on your tax return and HMRC will reimburse you. In both instances this reimbursement comes to you directly, not your pension provider. So you’d need to either make an additional contribution to your pension as a one-off payment, or if you can afford to, make higher contributions throughout the year.



2. Gains made by your pension are also tax efficient because they are exempt from Capital Gains Tax and Income Tax. (other than a non-reclaimable 10% tax credit which is paid on equity dividends).
   


3. When you come to take your pension, at the age of 55 or later, you have the option to take up to 25% of your pension pot as a tax-free lump sum. While pension contributions and growth aren’t taxed, when you come to take an income from your pension, this will be subject to Income Tax.

Back to top

How much risk do you want to take?

The best pensions allow you to hold a range of different investments. You can choose a pension fund based on how much risk you want to take with your money, and hold a number of different funds to spread your risk further.

Risk is an important part of deciding which funds to invest in within your pension. Generally-speaking, there are two main factors that will affect how much risk you wish to take:

• Your age in relation to when you want to retire
• Your attitude towards riskier investments

Younger pension investors can usually take on more risk as their investments have longer to come good if a loss is made early on. It’s also the case that investments tend to perform better over longer periods of time. However, that said, past performance is no guide to the future.

The closer you are to retirement, the more you’ll want to consolidate your pension pot and want to protect it from making a loss.

You could also consider splitting your contributions among several different funds with varying levels of risk, to minimise the chance of one badly-performing fund wiping a sizeable chunk off your pension.

As with any investment decision, it’s important to take independent financial advice if you are in any way sure of which pension or fund is best for you.

Back to top

Pensions aren’t flexible - but that can be a good thing

You can’t access the money held in your pension pot until you reach your 55th birthday. That’s under current rules – it’s probable that future governments will increase this age as life expectancies continue to rise.

However, it depends on your situation and character as to whether such a lack of flexibility is a good or bad thing…

If you’re worried about lack of flexibility in a pension it might be wise to look at keeping a pot of other savings, possibly in a cash ISA or equity ISA that you can call upon if you have to.  

Beware of companies that offer to let you release you pension pot tax free. Read why you should be wary in this guide.

Back to top

Why you should consider an occupational pension

An occupational pension simply means a pension plan that’s offered through your employer. There are two types of occupation pension:

• Final salary (or defined benefit) scheme
  This is where you contribute to a pension scheme that will pay you a defined monthly income in retirement, based on how long you’ve been a member of the scheme and your earnings (not on investment performance). With a final salary scheme there is no need to purchase an annuity at retirement.
• Money purchase (or defined contribution) scheme
  This is where you contribute to a pension scheme that will pay you an income in retirement, based on the amount you’ve paid into the scheme and investment performance over the life of the pension. With a money purchase scheme you can purchase an annuity or drawdown income to convert your pension into income.

In both instances your employer helps by making contributions to your pension – meaning you can build up a larger pot than if you were contributing alone. However, the downside is that you are restricted to the pension scheme that your employer has chosen (although you may have a choice of funds if you are part of a money purchase scheme).

From 1 October 2012 employers have to automatically enrol you in a pension scheme if you’re not already a member and you earn more than £8,105 per year.

Final salary pensions have historically offered very generous pensions in comparison to money purchase schemes. Because of this they have been dwindling in popularity over the last few years as they have become very expensive to honour for many employers.

Occupational pensions don’t have to stop if you leave an employer - you can still contribute to a money purchase scheme after you leave an employer. Although your previous employer’s contributions will stop, your pension will continue to grow (depending on investment performance and charges), even if you are no longer contributing. You can transfer your pension too, but remember that there will be fees for moving your pot to a new provider.

Transferring occupational scheme benefits is a complex decision and you should get advice from a specialist pensions adviser.

There’s no such thing as a ‘frozen pension’. Even a pension you are no longer contributing to remains invested, and is still subject to charges from the fund and pension provider.

Find out how to track lost pensions in our guide.

Back to top

Personal pensions

You may want or have to consider a personal pension instead. It doesn’t matter if you’re self-employed, a stay-at-home mum or dad, or even a child – anyone can start their own personal pension.

If you are employed, you might like to have a personal pension outside of work (you can have more than one pension), so that they you can decide which company your pension is with.

Back to top

What should you look out for with a personal pension?

When choosing a personal pension it’s important to shop around for the best deal. But what should you look out for when making a comparison?

• Fund choice
  The pension that offers the most choice isn’t necessarily the best. Look for the pension that will offer the funds that you want to invest in. Most providers now offer ethical funds, so make sure this option is offered if this is where you wish to invest your pension.
• Minimum monthly contribution
  Some providers will require you to make minimum monthly or annual investment to your pension. If you don’t meet the pension’s minimum contribution requirements, you may be charged a penalty fee.
• Fees and charges
  Many pension plans will charge an annual management fee. If you invest in certain funds, there could be management fees to pay here as well. There will also be a fee if you wish to transfer your pension to another provider. It’s worth finding out what these fees are before making an application, and comparing them between providers.
• Past performance
  Although past performance is no indication of the future, you might find it helpful to decide between providers. However, if you’re comparing past performance, make sure it’s over a longer period (at least 5 or 10 years) as investments can fluctuate quite a lot in the short term.

If you are in any way unsure which pension, or fund to invest in, you should seek independent financial advice.

Back to top

Should you get a SIPP?

SIPP is short for Self Invested Personal Pension. It’s a type of pension saving that allows you to take more hands on control of your financial destiny by allowing you to invest directly in shares, collective investments and other types of investment.

Recently low cost SIPPs have allowed more and more amateur investors to take the reins of their pension – to find out more read our guide “Is a SIPP right for you?”.

SIPPs are only for you if you are confident and experienced in making and managing your own investments.

Back to top