The word ‘pension’ describes the income which is provided to somebody when they are in retirement. A ‘pension plan’ is the investment vehicle which is commonly used to build up the funds which are then used to pay out the income.
Pensions are just one of those things that too many of us don’t understand – which means we often don’t set one up or don’t opt for the best scheme.
Here follows a rough guide to the basics of Personal Pension Plans and how they work – hopefully dispelling some myths along the way. (N.B. Schemes rules can vary slightly between different pension companies, so always check these with the company you are using).
Am I eligible to start a Pension Plan?
- If you live in the UK you can start a pension plan.
- There is no minimum age.
How much can I pay into my Pension Plan?
- If you do not have any taxable earnings, the maximum that you can contribute to your plan is £3,600 per tax year, or £300 per month.
- Otherwise you can contribute 100% of your taxable earnings, to a maximum of £50,000 per tax year.
- Some pension plans will allow you to contribute as little as £20 per month.
- You can pay regular payments, and/or lump sums.
How much should I pay in?
- The best way to start to answer this is to work out how much you can afford to pay in. Then you can order a ‘pension projection’ from insurance companies, or via an Independent Financial Adviser. This will give you an idea of how much your pension could be worth at retirement given certain assumptions.
Am I committed to my payments?
- No. Most pension plans will allow you to change the amount you pay into your plan without any penalty. You can also stop and start your contributions whenever you need to.
When can I access my pension fund?
- Not until you are 55. (There are exceptions to this rule, if for instance you are terminally ill).
What happens if I die before I am 55?
- The full value of your fund would be paid out to whoever you have nominated as your beneficiary.
Why don’t I just use a normal savings account?
There are a number of benefits of using a ‘Pension Plan’ to build up your retirement pot:
- You receive Basic Rate ‘Tax Relief’. In English, this means that if you pay £50 per month out of your bank account into your pension plan, the government will top up the payment to £62.50. They are repaying the tax that you have already paid, as an incentive. (You will receive this even if you do not pay any tax.)
- If you earn over £42,475, you will get Higher Rate Tax Relief on your contributions. Using the above example, you would claim an additional £12.50 back via your tax code. This would result in a payment of £62.50 only costing you £37.50.
- Because the money is locked up until you are 55, the temptation to use the funds for other things is removed. Without this discipline, many people would find it a challenge to build up a fund for something so far away!
- There are a number of different ways that your money can be invested within your pension plan. But you do not have to get involved with this (unless you want to). The last thing you need is to lie awake at night worrying about how to invest your pension money! The most important decision for you to make is how much investment ‘risk’ you are happy to take. Most pension companies have simple guides to help you through this process, or again you can talk to an Independent Financial Adviser.
How will I know how things are going?
You will get a statement from your Pension Plan provider at least annually. Many companies now allow you on-line access to your account so that you can track your progress.
What actually happens when I retire?
- Whilst you can start taking benefits from your pension when you are 55, you are not obliged to! The longer the delay, the larger your pension pot is likely to be.
- You can take 25% of the value of your pension fund as a tax-free lump sum. The remainder you take as income (which is taxed accordingly).
This piece is only intended as a ‘rough guide’. It is important to look at all your options – for example your employer may offer a Company Pension. Professional Independent Financial Advice should be sought where possible.
Henrietta Oxlade is an Independent Financial Planner with Radcliffe & Newlands and MyFamilyClub’s in-house finance sage! She has been advising individual clients since March 1988, which is why many of her clients consider her part of the family. If you want to contact Henrietta, email us on [email protected] and we’ll put you in touch.