For the average person in the UK, the world of pensions can be very confusing. In this article we’ll cover the basics and give you a solid grasp of the options available to you today. No matter how they’re structured, all pensions have the same objective – to help you save your income and provide you with a comfortable income during your retirement.
What Is A Pension Scheme?
A pension scheme is nothing more than a savings plan to help you build up a nest-egg for later life. What differentiates it from a normal savings plan are the tax benefits you can enjoy. In other words you pay less tax!
The UK Government provides a basic pension to almost every adult in the UK – its just not very much to live on – which is why we strongly recommend augmenting the state pension with your own. Saving a little money during your working life can have a major impact on the quality of life and flexibility you enjoy during your retirement or semi-retirement.
There are quite a few different types of pension schemes other than the State Pension. Many people take part in a Workplace Pension Scheme (run by your employer) while others set a pension up themselves. You can even save into more than one pension as well as tax-efficient savings plans like ISAs.
When you decide to retire you’ll have a number of options including taking a tax-free cash sum or receiving a regular monthly income. Or a bit of both!
All About The State Pension
From the 6th April 2016, the state pension system will change to a flat-rate, single tier state pension with a full level of £155.65. Whether you qualify for the full new state mention will be determined by the number of years you’ve paid tax via National Insurance Contributions (i.e. via your salary).
Amongst existing pensioners, there will be winners and losers when the new pensions rules come into force. Those who will generally be better off under the new system include the self employed, women, carers and low paid workers. Those who may be worse off include workers with less than 10 years of NI Contributions, workers with more than 35 years of NI Contributions, high earners and your “other half” (wife, civil partner, widows and widowers) who will no longer be able to claim/inherit a pension based on your NI contributions.
How Does A Pension Scheme Work?
There are different types of pension scheme available but they are usually either classified as being “defined benefit” or “defined contribution”. Here we will explain the differences and the rules applied to each.
A defined benefit pension scheme will give you a specified monthly income when you reach retirement age. The formula used to calculate your income is based on your salary over the years and the number of years you have worked. Your employer will pay contributions on your behalf but it is common for you to be asked to top up the scheme by paying in your own contributions on top. The exact details of your scheme can be provided by your employer.
A defined contribution pension scheme allows you to build up your own pot of money throughout your working life. The income you will receive after retirement is not guaranteed in advance. Instead the money is invested on your behalf and the value of your pension will depend on the amount of money paid in and the performance of these investments over time.
Automatic enrolment is a reasonably new Government initiative (being phased in since 2012) that forces employers to enrol all eligible workers in a formal workplace pension. Employers are required to pay a small contribution on behalf of the worker while employees can add to it as they wish. The aim is to ensure every worker in the UK has a private pension to top up their state pension during retirement.