Pensions – we've all heard of them but it can sometimes be confusing to understand what they are, what they do for us and why we need one. With so many changes over the last couple of years, we give you an overview of what they are, what they do, and the choices and options that might be right for you.
What types of pensions are there?
There are several types of pension, and they all work in different ways. What's most important is that you understand that a pension is there to help you save money for retirement. Let's look at the types of pension available - they fall into three main categories.
What is the State Pension?
The State Pension is a regular income that’s paid to you by the Government when you reach State Retirement Age. The income you receive is dependent on having paid a certain level of National Insurance over your working life. Rules around the State Pension – and how much you receive – have changed following the introduction of the new State Pension in April 2016.
These rules are likely to continue to change, so it’s always best to look at the Gov.uk website to find out exactly what you are entitled to, and when.
What is a workplace pension?
A workplace pension is a way of saving for your retirement that's arranged by your employer, it's likely that you'll be offered one of the following:
- Defined benefit schemes or final salary pensions – these pay you a guaranteed income each year when you retire. The amount you get depends on your pensionable service, pensionable earnings and an accrual rate.
- Defined contribution schemes – these are also known as a money purchase scheme. The money that you pay into them is invested by a pension provider chosen by your employer. The amount you get when you retire usually depends on how much has been paid in, how long you've been paying in and how well the investment has done.
Since October 2012, employers in the UK have been obliged to operate a new system of automatic enrolment for workplace pensions. So by 2018 most employees will automatically be members of a workplace pension scheme. In many cases, employers will use a multi-employer scheme, such as NEST, NOW or The People’s Pension.
There are also group personal pensions, which are a type of defined contribution pension. Group personal pensions are a collection of pensions where members of these schemes build up a personal pension pot, which they then convert into an income at retirement.
What is a personal pension?
Personal pensions are savings schemes that you arrange yourself, or with the help of a professional adviser. You pay in sums of money – and usually have some control over the decisions being made (about where to invest the money).
One type of personal pension is a stakeholder pension. This is a form of defined contribution personal pension and is relatively straightforward. They have low and flexible minimum contributions, capped charges and a default investment strategy if you don't want too much choice. Some employers offer them, but you can start one yourself.
A self-invested personal pension (SIPP) is another type of personal pension. A SIPP is a pension 'wrapper' that holds investments and gives you more flexibility with the investments you choose. You can start to draw your retirement income from your SIPP when you reach 55 years old, the government has stated that the minimum pension age will increase to 57 in 2028. A SIPP can be more complex to set up, and you need to be more certain of the way you feel about managing a portfolio of investments over time (although a professional adviser can give you some support with this).
What are my pension investment options?
When you take out a pension, you may get to decide how you want your money to be invested (depending on the type of arrangement that you take). If this is the case, you will be asked to make choices by your pension provider, and will need to think carefully about how you balance the risks you feel comfortable taking, with the returns you would like to see on your money.
What sort of investment options should I choose?
We can't tell you how to invest your money – you need a professional financial adviser to do that. But we can tell you that when you invest in a pension, it's likely you'll be offered a choice of things in which to invest in – from simply saving the money as cash to investing in stocks and shares.
Some people choose to invest their money in what's known as managed funds. These investments are managed by a professional fund manager on behalf of the investor. They invest in a number of different assets according the predetermined investment mandate. Managed funds can be country specific (such as a UK growth fund); they can be asset specific (such as UK bond fund); they can be risk specific (such as cautious managed) or they can follow an investment objective (such as UK income fund).
What are my options if I have a personal pension?
If you choose a personal pension, stakeholder pension or self-invested pension plan (SIPP), you'll have a say in how your money is invested. You'll be given a range of options and investment strategies to choose from.
Don't worry – although your pension provider might not be able to give you professional financial advice, their customer service teams or consultants will try to make the process as simple as possible. There is also usually a default option, so you don't have to choose if you don't want to. Instead, the fund can be invested in a broad range of funds, that appeal to as wide a range of people as possible.
What if I have a workplace pension scheme?
If you have a workplace or occupational pension, your position is different. If your pension is a final salary or defined benefit pension you will not need to make any investment decisions. If you have a defined contribution or money purchase pension your employer may offer you a default investment fund or you may be able to choose an investment fund. This will depend on your employer’s pension scheme.
Having said that, you may still have to make some decisions that affect your income in the future. If you decide to make additional contributions, for example, that could boost your pension pot.
What if I have a SIPP?
A SIPP (self-invested personal pension) is usually chosen by people who want more control over how their money is managed. Most SIPPs give you access to a wide range of assets from which to choose, and you'll need to be more confident about making investment decisions that can have a significant effect on the value of your pension savings. As with any financial products, we would recommend speaking to a professional financial adviser before you invest in a SIPP. That way you can ensure you are aware of all the features and benefits that a SIPP can offer you.
What else should I think about?
Don’t be afraid of shares
If you are investing for the long-term, it’s not a bad thing to take some risks if you feel comfortable in doing so. If you only choose conservative investments, such as cash or bonds, your investments may not grow as well as you’d like or need. Shares can offer you the ability to grow your money over time, but remember shares are subject to market fluctuations and past performance is never a guide to the future!
Think about diversifying
It’s not a bad idea to spread your money across different assets, sectors or indeed geographic regions if you can. Many basic managed funds do this for you already, but if you want to take a more active part in your investments, it’s worth considering how you have spread your risk across the investments you have made.
Check for fees and charges first
Some pension providers and investment companies charge more for some investments than others. They may charge you an initial fee, or an annual management fee, and this can eat into any growth you make on your investments. It might also be worth exploring using an intermediary for your pension rather than going direct to a provider as this can be cheaper.
Buying a pension
Do you fancy the idea of living on under £200 per week when you retire? It's a very small amount of money to survive on, but that's the prospect facing you unless you make additional pension arrangements, either by setting up a personal pension or by being part of a company scheme.
Doesn’t everyone get a pension?
Most people get the State Pension once they reach the state pension age. However, how much you are entitled to will depend on if you reached State Pension age before 6 April 2016, or if you reached State Pension age on or after 6 April 2016. How many years you have been paying National Insurance (NI) contributions also influences if you qualify.
So if I get the state pension automatically, why do I need another pension fund?
For the tax year 2022/2023, the full state pension is either £141.85 if you reached state pension age before 6 April 2016 or £185.15 a week if you reached state pension age on or after 6 April 2016. Based on a study conducted in 2014, this will likely not cover your financial needs.
This 2014 study suggested that most people who have paid off their mortgage when they retire, need around £15,000 a year to lead anything like a comfortable retirement – and that doesn’t include ‘disposable’ income to spend on luxuries or special events. This means you’re likely to need additional income from a personal pension to achieve this figure.
How do I know if my employer has a pension scheme?
If you haven’t been told about your employer’s pension scheme, that doesn’t mean there isn’t one. The government has set up a scheme where employers must start to enrol their workers in a workplace pension if they aren’t already in one. It’s called ‘automatic enrolment’ – so contact your HR department or line manager and do ask for details. If your employer makes contributions based on what you pay into it, you should try to pay in as much as you can afford to, to make the most out of the scheme.
Which pension should I get if I’m self-employed?
If you’re self-employed, you won’t have an employer paying contributions into a workplace pension for you. So you’ll need a ‘private’ pension, such as a personal, stakeholder or SIPP plan. Choose one that offers flexibility in the event that you are out of work for any period of time.
What if I’m made redundant?
If you have a workplace pension, you should find out exactly what type it is in the event you are made redundant. You can usually either leave your pension where it is and draw from it when you retire, or transfer it to a new pension scheme. This could be your new employer’s or you might decide to set up your own personal pension. However, it’s important to get professional advice when making these kinds of decisions, as not only could you be charged to move your pension – you could be giving up some of the benefits your current pension scheme offers.
Can I still pay into my workplace pension if I leave my company?
Some pensions are linked to you and not the company, so you can continue to pay into them. These include NEST, group stakeholder schemes and group personal pensions.
What if I have several pensions?
We all move around employers much more these days, so you may find that you’re signed up to more than two pension schemes over your working lifetime. That’s OK, but it could be worth consolidating your pensions to avoid paying too many fees to different providers. Again, if you do decide to transfer your pension pots, it’s best to speak to a financial adviser. This way, you can make sure you’re aware of any costs or loss of benefits.
What if I think I had a pension in the past, but don’t know where it is?
If you’ve lost track of your previous pension schemes – perhaps you’ve moved jobs several times over the years – it’s definitely worth trying to find out where it is. For workplace pension schemes, you should contact the employer in question. That company will give you the pension details so you can contact the provider directly. For personal pensions, try to remember who the provider was and give them a call and be prepared to give them as many personal details as you can. Alternatively, you can contact the pension tracing service.
Who should I speak to, to buy a pension?
It’s always worth seeking professional financial advice when you are looking to make a long-term financial investment such as a pension. Sometimes employers make financial advisers available where there is a workplace pension scheme, but if you don’t have a financial adviser and would like to talk to one, visit unbiased.co.uk.
There are a number of reasons you may be thinking about transferring your pension savings to a new scheme. Before you do there are some important things you need to think about first.
The first thing you need to do is find out if your scheme is a defined benefit or defined contribution scheme. Your scheme administrator will be able to advise what type of scheme you’re in if you’re unsure.
Defined Benefit transfers
These are also known as final salary schemes. The scheme promises to pay you a guaranteed annual income for life when you retire and this benefit is called a safeguarded benefit. You will need to ask your scheme administrator for a cash equivalent transfer value (CETV) if you want to transfer a defined benefit (DB) pension. This value is only guaranteed for 3 months and you are only entitled to one every 12 months (although many schemes will provide more than this). If the value of your CETV is above £30,000 the trustees of your scheme have to ensure you have taken professional financial advice before you can proceed with your transfer. If you transfer your DB scheme you will give up your future rights to a guaranteed annual income for life so the Financial Conduct Authority (FCA) view is that most people are best advised to keep them.
Defined contribution transfers
The amount you transfer to your new scheme is the value of your existing arrangement. It’s important you check if your existing scheme offers any additional benefits that will be lost on transfer, such as an entitlement to more than 25% tax free lump sum or a safeguarded benefit such as a guaranteed annuity rate.
A safeguarded benefit is any pension benefit that provides a promise or guarantee during the accumulation phase about the rate of income you will receive or have the option to receive. If the value of this benefit is greater than £30,000 the trustees of your scheme or your scheme administrators have to ensure you have taken professional financial advice before you can proceed with you transfer.