Money

An Idiot’s Guide to Pensions

Start by learning the basics.
January 28, 2017, 2:36pm
Illustration: Elliot Kruszynski

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It's not ideal, is it? Not being able to swipe past your banking app without having a minor panic attack. Is a quick glance through your newsfeed and seeing a graph or catching some economic news making you sweat? You're not the only one. This is a tried and tested coping mechanism among millennials: dealing with the fact you may have a difficult financial future by ignoring it. But the truth is it's not as bad as you think. And if you don't fancy working well into your twilight years, you better begin looking at pensions and get your head in the game soon. So start today by learning the basics.

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Ok, so what even is a pension? 
In the simplest terms, a pension is a long term, tax-efficient investment that allows you to build up money so that you're not crunching numbers, mixing cement or staying late trying to climb the greasy pole into your seventies and eighties. If you have a pension, in one way or another, you should receive money in older age. Good deal, right?

What's the difference between state and private pension schemes?
First up, state pension. Most people in the UK that have made National Insurance contributions for 10 years qualify for a portion of state pension. Contribute for 35 years and you receive the full amount. This is currently worth £155.65 a week (or £8,093.80 a year) to your bank account.

Private pensions are any plans that aren't a state pension. This usually involves you paying into a scheme run by pension providers. Whether paying through your workplace or on your own, you'll receive a pension one way or another when you retire. So far so good.

What are the two major types of private pensions people talk about? 
On the one hand, you've got defined contribution and on the other you've got defined benefit. Defined contribution is the most common. It can be set up personally by you or by your employer, and the money paid in is put into investments. Be aware of any charges for managing your pension and any funds you choose to invest. The amount in your pension will depend on how much is put in and how the investments performs as the value of investments can go down as well as up, and there's a chance you get back less than the amount paid in. When you retire you get to decide how and when (after the age of 55) you withdraw the money and, though you will be taxed, you usually can get 25% of your pension tax free.

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When you retire under a defined benefit pension scheme, you will receive a pension from your employer, based on the time you have been in the scheme and the earnings you have received from your employer while a member of the scheme. You can also have a tax free lump sum payment though you may have to give up some of your pension to pay for it.

I've got a permanent job: am I already saving? 
If you're a permanent employee somewhere, you need to check with your employer what your company's scheme is and what they're offering. By 2018, all eligible employers have to offer pensions to those earning over £10,000 and aged between 22 and the state pension age – so it's possible that your saving has already begun. And under the Government's auto-enrolment scheme, all eligible employees will be enrolled though they're able to opt out. And even if they do, they'll automatically be re-enrolled every three years if they're eligible.

So how much am I, my employer and the government contributing to one of those workplace pensions? 
Really, this depends on which type of workplace pension scheme you're involved with, or whether you've been automatically enrolled or voluntarily opted in. It also depends on the choices made by your employer. It's best to talk to your employer or your pension provider to understand your situation in detail.

If you're a basic-rate taxpayer, you pay £2 income tax on every £10 you earn above the personal allowance, which is set at £11,000 for the tax year of 2016/17. Then with pension tax relief, with every £8 you contribute for your pension, the government hits you back with £2, giving you a total of £10 into your pension. This tax relief is applicable for up to 100% of your salary or up to the annual allowance of £40,000 – whichever is lower. Use the Money Advice Service's calculator to work out your potential contributions and the Government's employer contribution calculator to figure out theirs.

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Now, if you've been automatically enrolled, then you and your employer pay a minimum contribution of 1%, but you or your employer may pay more. Your employer's contribution will rise to 3% of your qualifying earnings by 2019, and your personal contribution will rise to 5% of your qualifying earnings.

And before you scream your head off wondering what that term means, it is calculated from either the amount you earn before tax between £5,824 and £43,000 a year or your entire salary or wages before tax. Your employer chooses how to work this one out.

And lastly, if you've voluntarily opted into a workplace pension, your employer must put in the minimum amount if you earn more than: £5,824 a year, £486 a month, £112 per week, £448 per 4 weeks. You'll usually have to pay a minimum amount for your employer to continue making contributions.

What about if I'm self-employed? 
As self-employment was recorded to have reached a UK record high of 4.5 million in 2014, it appears that a lot of millennials are working for themselves. And in the world of pensions, they're going to have to work for themselves too. If you're self-employed, you'll of course be entitled to the state pension under the same rules as everybody else is, but it's a matter of making your own arrangements and shopping around for private pension schemes.

I want to retire now. When can it happen? 
Alright, we know you're already eyeing up retiring and driving South until you hit a place that doesn't understand the word 'drizzle', but you've got a bit of time to wait. At the moment, the state pension age is 65 for men and 63 for women. If you're under 38 years of age, the current projected retirement age is 68 but this could change. You can actually work your approximate state pension age here. However, things don't always abide to those guidelines. If you adore your work and like the idea of keeping the green coming in when you're old and grey, then you can happily work beyond retirement. In fact, 24% of retirees had plans to and 22% of people yet to retire were open to the possibility*.  The earliest you can usually take your pension is from age 55, but your income is likely to be less than if you waited until state pension age.

So is there any point in me saving and why should I start sooner rather than later? 
Don't be a ridiculous person – of course there is. No matter your age, there's always value in saving, even more so if your employer is willing to contribute. But either way: it's a tax-efficient way of putting aside money for old age. If you find it daunting, you could just start off with a small contribution each month, increasing as your salary does or putting down one-off lump sums when you've got something spare. And the sooner you start, the sooner you could be directing short films, running marathons and having a crack at stand-up comedy.

*Source: Aviva Voice of New Retirement Report 2016 

How much do you think you should be saving for your retirement? Use Aviva's Shape My Future interactive online tool to build your future life and discover how much you might have to live on in retirement.