Many of us pay into at least one, but very few of us would choose “what is a pension?” to be our specialist topic on Mastermind. Here are five things you need to know about pensions.
1. A pension could be the biggest financial commitment you will ever make
When we come to begin our working lives, most of us start paying into a pension through our employer. Initially, it barely registers, beyond noticing it as a deduction on our wage slips; but in time you will begin to build up a reasonable pot of money, which in retirement you will come to use.
What this means is you could be paying into a pension for more than four decades – there will be few instances in life, if any, where you save up for that length of time.
In retirement, your pension savings will typically replace that regular employee wage, and be used to fund the rest of your life. It is a really important investment, which could go a long way to shaping your future.
2. Having a pension means you are an investor
Your pension savings aren’t simply locked away until you need it, but invested on your behalf, with the aim of increasing its value.
Many people don’t pay too much attention to this, trusting their pension provider to manage this for them. Others take more control, by selecting their own pension funds to invest into – often with the help of financial advice.
3. There are many different types of pensions, and some require more maintenance than others
If you’re in a defined benefit scheme, your pension is managed for you – including how it is invested. When it comes to your retirement income, the amount you receive is linked to how many years you have worked for the company, and your earnings.
Most other people have a defined contribution pension, where its value is largely dependent on how much you save into it over the years. From the age of 55, you can access your full pot and use it however you like.
4. There could be two major, additional incentives for paying into a pension
Firstly, with workplace pensions, your employer will match your contributions by paying in too. If you could afford to pay in more, you should look to do so as your employer may also pay in more.
Another significant benefit is tax relief that starts at 20%, and could be even higher depending on your income tax status. For every £80 you pay in, you will receive £100 in your pension pot. If you’re a higher rate or additional rate taxpayer, the cost is effectively £60 or £55 respectively for every £100 paid in (providing you claim for it via your self assessment tax return).
5. Don’t forget the basic state pension
For the 2017/18 tax year, the basic state pension will be worth a maximum of £159.55 per week, or £8,296.60 per year. However, not everyone will qualify for the full amount – it depends on several factors, such as your level of National Insurance contributions.
You can find out how much you are on track to receive by asking for a state pension forecast. If there is a shortfall, you can decide your options.
Your capital is at risk so you may get back less than you originally invested. The value of your investments and any income from them may fall as well as rise. The tax relief available on pension contributions depends on your tax status and prevailing legislation, both of which may change in the future.