Saving for life after work
What is a pension?
A pension is the most popular way to save up money to support yourself when you retire. The main benefit of a pension is that your contributions receive tax relief from the government. Essentially, this adds a large chunk of extra money on top of everything you pay in. A workplace pension may also receive contributions from your employer too. These special features give pensions a huge advantage over ordinary investments.
How do pensions work?
There are two main types of pension, which work in different ways. The most common kind is called defined contribution (DC). This is essentially a big savings pot that you pay into regularly. You can then access this money at any age from 55 onwards. Most workplace pensions and all personal pensions are this type.
The other type is a defined benefit (DB) pension, offered by some workplaces. You pay in contributions each month, and when you reach a certain age the pension pays you a guaranteed income for the rest of your life. This type is also known as a final salary scheme.
Please assume we’re talking about defined contribution pensions unless we say otherwise.
Why you should start saving early
Your retirement may last for 25 years or more, so you’ll need to be able to support yourself for that length of time. So even for a no-frills retirement, you’ll have to build up substantial savings.
Fortunately you have a powerful friend on your side: compound interest. The longer your money is invested, the more interest it can earn, and the interest will itself earn interest, and so on. This means that even someone on modest earnings can save up an impressive amount, just by starting early enough and paying in every month.
Ideally you should start a pension as soon as you start your first job – but late is still better than never.
The State Pension
The State Pension is a guaranteed income paid to you by the government, provided you’ve made sufficient National Insurance contributions. But be warned: the amount is small, and is only paid to you from the State Pension age, which rises regularly. So you will probably need your own pension savings to support you both before and after you reach State Pension age.
Getting a pension if you're self-employed
If you work for yourself, you’ll need to get your own personal pension. This will still give you tax relief on all your contributions, but of course there won’t be any employer contributions. You may be able to use the government’s own pension scheme (NEST), or you can choose one of your own.
There are different types of personal pension, including stakeholder pensions and self-invested personal pensions (SIPPs). Ask your financial adviser to tell you more about these. Your adviser can also help you select the best pension funds for your circumstances.
Saving into a pension
You should contribute a portion of your earnings into your pension every month if you can. If your earnings are unpredictable, be sure to make up for any missed contributions by paying in more later.
If your employer also contributes, try to make the most of this. Some employers make contributions in proportion to what you pay in (e.g. matching or doubling up), so this can be a real incentive to save more.
Also make best use of your tax relief. If you’re a basic rate taxpayer, you’ll get 20 per cent tax relief (so every pound you pay in becomes £1.25). But if you’re a higher-rate taxpayer, you’ll get 40 per cent (so every pound becomes around £1.66). Additional rate taxpayers get 45 per cent tax relief.
Pensions aren’t the only way to save for retirement. Another way is with a Lifetime ISA (LISA).
You can open a LISA if you’re between 18 and 40, and can save up to £4,000 into it each year. The interest is tax-free, and everything you pay in before the age of 50 is topped up by a 25 per cent bonus from the government. So if you save the maximum every year, your total bonus will be £32,000.
There are restrictions on accessing the money in a LISA. You can draw it out at any time to use as the deposit on a first home, or after the age of 60 for any reason. But if you withdraw money in any other circumstances, you will pay a 25 per cent penalty – which will more than cancel out the 25 per cent bonus.
Money withdrawn from a LISA is tax free (unlike money taken from a pension, which counts as income). However, because of the savings limits, a LISA is not a substitute for a pension.
Other ways to save
There are other ways to put money aside to help fund your retirement. Property can be good long-term investment, as can investments such as equities (preferably held in ISAs to be more tax-efficient). If you want to explore other options in addition to your pension, talk to a financial adviser.
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