8 Things You Need to Know About Pensions
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Clueless about your pension? Here are eight essential facts you should know.
#1 Is a pension worth it?
Forget your dream home. A pension trumps a lawned garden, four beds and two baths – trust us. It’s likely the best saving you’ll ever make.
#2 Even with walk-in closets and a pool?
Yep. You receive tax-relief on every pound you put into your pension. Let's spell it out: The government pays you back income tax. It’s a massive saving you won’t get from swimming laps (or extra shelving for that matter).
How much cash back are you talking?
For basic-rate tax payers you’ll get your 20% income tax back. Higher-rate tax payers get back 40% and additional-rate tax payers get 45%.
The image below illustrates how much tax-back you'll receive as top-up to your pension and as money paid back into your bank account. The higher your income tax band, the more you get back.
Side note: The government automatically tops up your pension by £25 for every £100 deposited, which covers basic rate tax payers. However, higher-rate and additional-rate tax payers may have to claim the extra tax owed to them. Read Tax Relief on Pensions to find out how to claim.
#3 Are all pensions the same?
There are two main types. Your employer may use either but if you’re going it alone, the first option is your only option.
Defined Contribution… This is where you or your employer, or both, pay a set amount of money into a pension each month. When you retire you have a pot of money and you can decide what to do with it.
Defined Benefit (aka Final Salary Pension)… This is an employee benefit scheme where your pension, when you retire, is a percentage of your yearly salary. A great perk but you usually have to wait until 65 to claim it. An added bonus? The longer you work at the company the higher the percentage you’ll get.
#4 If I’m paying money in, how much should I part with each month?
Try this simple formula for an estimate: Take the age you started your pension and halve it. Put this percentage of your pre-tax salary aside each year until you retire.
Example: Say you started at 30 and earn £50,000 a year (so you're a higher-rate tax payer) your total contributions should be 15% of £50K which is £7,500 a year or £625 a month.
OMG that's a lot of money!
Yeah it sure feels like it, but it's not as high as it seems because...
The government automatically tops up your pension by £25 for every £100 deposited, which covers 20% of your tax-back. Sticking with the example above, it means the pot is increasing by £9,375 a year (excluding any ups or downs in the investment fund); and...
Higher-rate and additional-rate tax payers can reclaim the extra tax they're owed (20% or 25%), which is paid into their bank account. For higher-rate payers the extra tax owed is £25 for every £100 deposited into a pension, making your outgoings easier to stomach. Sticking with the same example, a £625 a month contribution in effect costs £470.
So how much am I owed and how do I reclaim? Read Tax Relief on Pensions
#5 When can I access my pension?
For Defined Contribution pensions – which gives you a pot of money at retirement – 55 is the golden ticket. For Benefit (aka Final Salary) Pensions it’s usually older, around 65. But no one can force you to retire! You can leave your money in the pot until you’re ready or, if you want to work less hours, you can use it to top up your salary.
#6 Will it be worth a lot?
Well, it really depends on three things: The age you retire, how much you contribute each month and how well your pension investment performs. You can control the first two but the third is a toughie. We explain this in the How to Manage Your Pension guide.
For example, say you started your pension at 30 years old and deposit £600 a month (after the government top-up, this amounts to £750). You choose to retire at 65 and your pension fund investment on average rose 4.5% a year* and fees are 0.75% a year. At retirement your pot may be worth over £600,000.
*We choose 4.5% since this is regarded as medium growth in the current financial climate. It could be more or less depending on your pension fund. Explore your options in more detail with AVIVA's Investment Calculator.
#7 What can I do with it?
You’ve got loads of choices. Done with the 9 to 5 at 55? Not ready to say sayonara to your job until later? You can take a tax-free lump sum and leave the rest for a few more years of greying hair or you can knock down your working hours and use your pension to supplement this. There’s a lot of flexibility to choose what’s best, it all depends on what you want at the time. We can’t predict the future but we do have a guide so you know what you’re in for. Check out Your Retirement Options.
#8 Be honest, how much do I really need for retirement?
We don’t have a magic ball to know exactly what situation you’ll be in when you retire but it’s likely your outgoings will be lower. Why? You’ll probably own your home mortgage-free, you won’t have to support your children anymore (here’s hoping…) and you won’t have to spend a fortune on your commute to work. You may also have earnings from other investments and the state pension should kick-in around 68 (if you're retiring after 2030), which currently amounts to £8,296 a year.