Recent media coverage has highlighted how important it is for everyone to contribute towards their pension pots as soon as possible. It’s never too early to put money aside – after working all your life, you want to live a comfortable lifestyle during retirement.
Following this coverage, we have witnessed a shift in attitudes. For example, personal pension provider True Potential’s Investors Saving Gap report shows that in Q3 2016, 35% of Brits contributed nothing towards their pension. Illustrating a 4% decrease on Q2, it shows that overall pension awareness is on the up.
As interest in pensions grows, it’s important that everyone is educated on the options available to them for putting money towards their pensions. With that in mind, we have created this guide to the different types of pensions available and the benefits they offer:
Personal Pensions
A personal pension is a popular way of preparing financially for your retirement. With a personal pension, you can contribute as much and as often as you like. The money you set aside is invested with the aim of increasing the pot’s total size by the time you retire. You have control over how and where your money is invested.
There is no limit on how much you can contribute to your pension each year. However, there is a limit to how much can be claimed as tax relief in a tax year. The maximum gross contribution allowable is currently £40,000 or 100% of your income, whichever is lower. However, this does depend on your earnings. Once you reach 55 years old, you’ll be able to access the funds — 25% of which is typically tax-free. You can use your funds to purchase an annuity which is a monthly taxable amount that’s paid until death, take an income via Drawdown or take your funds as a lump sum.
There are a number of benefits of personal pensions, many of which apply to other pension types. This includes:
- Tax relief on the money you contribute up to £40,000 this tax year or 100% of your earnings (whichever is lower).
- Potential to increase the fund through investment.
- Suitable for those who may not have access to a workplace pension.
Auto-Enrolment
Auto-enrolment is a compulsory method used by employers of placing you into a pension scheme Under this scheme, your pension will receive contributions on a weekly or monthly basis (however you are paid) from three parties: you, your employer and the government.
There is a legal minimum amount that must be contributed – currently this is 2%, made up of 0.8% from you, 1% from your employer and 0.2% as tax relief. However, as of April 2018, this will rise to 5% of your total earnings (2.4% from you, 2% from your employer and 0.6% as tax relief). By April 2019, the minimum contribution will be 8% (4% from you, 3% from your employer and 1% as tax relief). You can choose to opt down and contribute less, although this would remove you from the auto-enrolment scheme all together.
In order to be automatically enrolled within a workplace pension, you must meet certain criteria. You’ll need to be:
- Over 22.
- Under the State Pension age.
- Not currently in a qualifying scheme.
- Earning over £10,000 per year. However, if you do earn less than this or work part-time, you do have the option to opt into a workplace pension scheme.
Some of the key benefits of a workplace pension are:
- The pension is set up for you.
- Receive contributions from your employer and tax relief.
Defined Contribution vs Defined Benefit Pensions
What about defined contribution and a defined benefit pensions? These pension options differ in that the final amount you receive from a defined contribution pension is dependent on the amount you pay in and the investment’s performance. In contrast, defined benefit pensions guarantee a set amount in retirement, although this is dependent on a number of factors, such as your salary and the rules of the pension scheme. Defined benefit schemes are usually linked to employers and are relatively uncommon.
A defined benefit pension is always a workplace pension; however, a defined contribution pension can be either personal or workplace.
With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Tax rules can also change at any time.
