Why save into a pension?
Pensions might seem complicated but the basic idea is a simple one. It’s worth understanding their benefits, because your State Pension – while providing a foundation – may not be enough to live on. You need to save more.
The importance of retirement savings
Did you know?
The maximum basic State Pension is far below what most people say they hope to retire on.
More than half of people in the UK either aren’t saving at all for their retirement or they aren’t saving nearly enough to give them the standard of living they hope for when they retire.
If you fall into this category, you have three choices;
1: You can adjust downwards your expectations of what you’ll be able to afford in retirement
2: You can start saving more
3: You can retire later in life
Don’t rely on the State Pension to keep you going in retirement. The maximum basic State Pension of £110.15 (tax year 2013-14) a week is far below what most people say they hope to retire on.
The advantages of saving into a pension
Once you’ve made the decision to start saving for retirement, you need to choose how to do so. Pensions have a number of important advantages that will make your savings grow more rapidly than might otherwise be the case.
A pension is basically a long-term savings plan with tax relief – your regular contributions are invested so that they grow throughout your career and then provide you with an income in retirement. Generally you can access the money in your pension pot from the age of 55.
How tax relief tops up your pension pot
Once your income is over a certain level, the government takes tax from your earnings. If you put money into a personal pension scheme, it qualifies for tax relief. This means that as well as the money you’re putting in, some of your money that would have gone to the government as tax now goes into your pension pot instead. The government will still put tax relief into your pension pot, even if your income is too low to pay tax.
Top-ups from employers
The government has introduced a new law designed to help people save more for their retirement. It means that employers must start to enrol their workers into a workplace pension scheme if they are not already in one. It’s called ‘automatic enrolment’ and is gradually being made compulsory for all employers.
If your work gives you access to a pension that your employer will pay into, then unless you really can’t afford to contribute, staying out is like turning down the offer of a pay rise.
Of course, if your employer will contribute to your pension regardless of whether you pay into it, then you should join the scheme whatever your financial circumstances.
A tax-free lump sum when you retire
When you retire, you can take up to a quarter of your pension pot as a tax-free lump sum. The rest of your savings must be used to provide an income, which is taxable.
The next step – see how much you need to save
Follow the link below to use the pensions ready-reckoner. This will estimate how much you’ll need to save each month to generate the kind of income you’d like to retire on.
Your first pension – the options
Once you’ve decided to start saving into a pension, you’ll need to decide where to save. There are many different providers to choose from. Please feel free to contact us to find out how we can help you make the right decision.
Setting up a personal pension
If you don’t have access to a workplace pension, then you’ll need to set up your own personal pension. Unlike a workplace pension, where the decision you face is whether or not to join a single scheme chosen by your employer, with setting up your own personal pension the decision is much broader because there’s a wide range of options on the market to choose from.
There are three types of personal pension:
- Standard personal pensions, where you make regular monthly payments into a plan usually with wide range of investment strategies chosen to suit different needs and attitudes to risk.
- Stakeholder pensions, which are a form of personal pension with low and flexible minimum contributions, capped charges and a default investment strategy if you don’t want too much choice.
- SIPPs (self-invested personal pensions), which tend to be suitable for larger contributions. They give you a large degree of control over the way your pension fund is invested, but this brings extra risks with it if you’re not an experienced investor.
Investing your pension savings
Part of the process of setting up your pension will be to decide how your pension savings are invested. Blue Ocean Investment Company can help you set up your pension and choose the right fund selection to match your investment risk profile. Typically, your pension monies will be invested in a different range and mix of assets (shares, cash, property and bonds) and therefore offer different levels of risk and potential growth.
Many pension contracts include the option of a ‘lifestyle fund’ or ‘target-date fund’. These have investment profiles that shift over the years. They typically start off weighted towards assets that offer higher potential growth, but also higher risk. As you approach retirement they then shift towards lower-risk assets, to minimise the chances of your pension savings taking a hit from stockmarket declines when they no longer have the time to recover before you retire.
Tax relief on your annual pension contributions
If you’re a UK taxpayer, in the tax year 2014-15 you’ll get tax relief on pension contributions of up to 100% of your earnings or a £50,000 annual allowance, whichever is lower.
- For example, if you earn £20,000 but put £25,000 into your pension pot (e.g. by topping up earnings with some savings), you’ll only get tax relief on £20,000.
- Similarly, if you earn £60,000 and want to put that amount in your pension scheme in a single year, you’ll only get tax relief on £50,000. Any contributions you make over this limit will be subject to Income Tax at the highest rate you pay.
However, you can carry forward unused allowances from the previous three years, as long as you were a member of a pension scheme during those years.
If you are not earning enough to pay Income Tax, you can still get tax relief on pension contributions up to a maximum of £3,600 a year.
The annual allowance is reducing from £50,000 to £40,000 in the tax year 2014-15.