Thinking about pensions can be intimidating, especially if you’ve yet to set out your own retirement goals. So, let’s start with the basics. Here we look at the different types of pensions available in the UK to help you decide which options are right for you.
For most people, their first contact with pensions happens in the workplace; by law most employees must be offered one. Your employer must automatically enrol you into a pension scheme and make contributions to your pension if you’re eligible for automatic enrolment. To be eligible, you must be aged between 22 and state pension age, earn at least £10,000 per year, and ‘ordinarily’ work in the UK.
For employees, a company pension scheme can be one of the simplest ways of putting some money away for retirement. Your employer, with the support of the pension provider they’re using, should be able to help you set up your company pension scheme quickly and easily when you start working for them.
One of the great benefits of a company pension scheme is that the company may match your pension contributions. For example, if you pay in 5% of your salary to your pension pot, they may match this by paying in the same 5%, giving you a total pot of 10% of your salary for each year you pay in.
In some instances, you and your employer may agree to use ‘salary sacrifice’ (sometimes known as a ‘SMART’ scheme). Under the scheme, you may give up part of your salary and your employer pays this straight into your pension. In some cases, this will mean you and your employer pay less tax and national insurance.
As with other types of UK pension, you can also get great tax benefits with a company pension scheme. Tax relief is linked to the highest band of income tax you pay.
The basic rate of income tax is 20%. If you are a higher-rate taxpayer, you can claim an extra 20% tax relief on top of this to a combined rate of 40%. For additional-rate taxpayers, relief can also be claimed at an extra 25% to a combined rate of 45%.
Defined contribution versus defined benefit
There are two main types of company pension scheme – defined contribution and defined benefit (also known as ‘final salary’).
With defined contribution, the size of your eventual pension pot is dependent upon the amount of money paid in and how the scheme’s investments have performed during that time.
From the age of 55 (rising to 57 from 2028) you may be able to take up to 25% of your total pension pot tax free. The rest is taxed at your ‘marginal’ rate of income tax when you take it out.
Another option at retirement is to ‘buy’ a guaranteed income – known as an annuity – for the rest of your retirement years. Alternatively, you can leave your money invested in the stock market, access it later or take an income from it as it (hopefully) grows in value – known as ‘drawdown’.
Since April 2015, Pension Freedoms reform has offered those 55 and over more options in accessing their defined contribution pension pots, including cash withdrawal – treated as taxable income – giving people much greater flexibility in how they use their money.
In summary, the annuity gives you a fixed guaranteed income whereas drawdown will vary depending on the performance of your investments, and you can draw all the money out of your pension and be left with nothing.
Defined benefit (or final salary) pension schemes work differently, guaranteeing you a certain amount of money each year once you retire. The amount you get is usually based on your final salary when you leave the company and the number of years you worked there. Some companies offer a career average scheme, where the benefit is based on your average salary rather than your final salary.
These schemes have historically been very popular in the private sector and with some established large businesses but have become less common in recent years as they have proved costly for employers to maintain. It’s now quite rare to join a company and find they’ll offer you the chance to join a defined benefit pension scheme.
What happens if I move jobs?
As you move between jobs, you may have a number of options regarding what you do with your company pension. Depending on the type of scheme your company pension is in, you may be able to continue paying into it once you leave the company, or you may be able to transfer it to another pension pot, or simply leave it where it is, in which case the money will remain invested and be there for you in later life.
You may also wish to consolidate your pensions in to one, easily manageable pot. The government’s Pension Tracing Service can aid you if you have mislaid details of previous workplace schemes. However, this will only help you find contact details of schemes, rather than specific individual pension accounts.
You may also choose to start your own personal pension, sometimes referred to as a private pension or a SIPP (self-invested personal pension). This involves making regular or lump sum contributions to a regulated financial provider, such as Nutmeg, that invests the money on your behalf.
Personal pensions are open to anyone and there is no requirement to be employed. If you’re working, then your employer may choose to make contributions to it as well. You will still get the extra 20% tax relief from the government, which could rise to 40% or 45% if you pay higher or additional-rate income tax.
If you have a Nutmeg pension, we automatically claim the basic tax relief on your behalf and add it to your pension pot, so you don’t have to worry about this. However, for higher-rate or additional-rate taxpayers, to claim the extra tax relief you’re entitled to you must do this through your annual tax return or by notifying HMRC and completing a Self Assessment tax return form.
Personal pension schemes can be a great way for anyone to invest for retirement, regardless of whether they already have a workplace pension. They can also be especially useful for people who are not working, are self-employed, or they’re not eligible to join the company scheme, for whatever reason. The amount of money available in your pension pot once you retire will depend on how much you have put in, the performance of the investments and any administration costs.
As with defined contribution pensions, you may be able to take up to 25% tax free at the age of 55 (rising to 57 from 2028). You can then choose between buying an annuity for a fixed income in retirement, opting for drawdown, or taking all the money out at once, treated as taxable income.
Stakeholder vs SIPPs
There are two main types of personal pension, each with its own set of subtle differences. You may have heard of stakeholder pensions. These are essentially a form of personal pension that need to meet certain criteria. For example, annual administration charges can’t exceed 1.5% of your pot in the first ten years, and they must accept contributions as low as £20.
With stakeholder pensions you can also be allowed to miss payments or stop making contributions for a period of time without incurring a penalty. For these reasons, they are often very well suited to people who want some degree of flexibility.
Self-invested personal pensions (SIPPs) are a type of personal pension aimed more at people who understand and are happy to take on the risk of investing in financial markets.
These schemes offer considerably more autonomy and flexibility; you can take control of managing your own investment portfolio and make your own decisions as to where your money is invested, bearing the responsibility that entails.
A discretionary wealth or investment manager like Nutmeg can be enlisted to make investment decisions on your behalf through a standard personal pension. However, doing your research is key as the services on offer, the way they’ll manage your investments and the charges will differ.
The state pension
The state pension is a valuable source of income for many retirees though, as we’ve made clear in our FAQs, understanding exactly how much you are likely to receive, and when you’ll receive it – provided you are eligible – is not always clear.
The ‘new’ state pension was introduced in 2016 and is applicable for any man born on or after 6 April 1951, or woman born on or after 6 April 1953. Eligibility depends on the number of years of national insurance contributions you have made; this being usually deducted from your pay packet automatically.
You need to have accrued at least 10 years of national insurance contributions to receive this state pension, while this rises to 35 years to receive the full amount. People with between 10 and 35 years of national insurance contributions will receive a smaller amount; the exact amount is on a sliding scale with more years meaning a bigger state pension.
This full state pension is currently £185.15 a week (£9,627.80 a year), though the amount has been rising annually based on wider economic factors, such as inflation.
You can check how many years you have totted up on the Government Gateway website. It is possible you may have gaps in your national insurance contributions, perhaps as a result of a career break, in which case you can make voluntary payments to catch-up.
For men born before 6 April 1951, and women born before 6 April 1953, it is the older basic state pension scheme rules that apply. The full basic state pension is £141.85 per week. You usually need a total of 30 qualifying years of national insurance contributions or ‘credits’ to get the full amount.
So, when exactly can you take the state pension? This all depends when you were born. Those born before April 1959 will reach their state pension age at 66, however the state pension age is rising so people born after 5th March 1961 will wait until age 67. For those born after 5th April 1978, the current law outlines a state pension age of 68, though this is not set in stone and the rules could change.
Some commentators have questioned whether the state pension will even exist in its current form 20 years from now, with some suggesting that if could be means tested in the future.
A commitment to your future
Retirement may be edging closer, or remain many decades away, but the earlier you commit to investing for the future, the better position you’re likely to be when it finally comes.
The pension(s) that’s best for you will depend on a number of factors: your employment status, your age and retirement plans, and so on. A mix of different pension products may be best for you.
According to the last ONS Wealth and Assets Survey, almost one third of people in the UK did not expect to have any pension provision beyond the state pension when they retire – in isolation this is not a level of income that is likely to provide for a comfortable retirement.
The same research found that one-tenth of the population held more private pension wealth than the rest collectively. It highlights significant inequality, with low income the most common reason for not paying into a pension. Among working-aged people yet to retire, those who were self-employed, had a long-standing illness or disability, or were from minority ethnic groups, had lower pension wealth on average than their counterparts because of lower participation rates and smaller pension pots.
We’ve recently carried out our own research in understanding the UK’s pensions landscape, revealing that on average people approaching retirement age face a £271,000 pension shortfall. Do download our in-depth analysis and insight on pension provision in the UK amid the unfolding cost-of-living crisis.
Recent years has also seen fresh momentum in tackling the gender inequality – research suggests that differences in private pension provision is the main reason for the ‘gender gap’ in pensions, placing some woman at a disadvantage due to their domestic roles and lower pay.
Stepping into the pension glow
As a provider of personal pensions, we at Nutmeg believe that investing for your retirement can be one of the most prudent and tax-efficient ways to meet your retirement goals. A personal pension can co-exist with workplace and state pensions, potentially giving you a far greater pot to make the most of your later years, whatever your plans.
Nutmeg’s award-winning pension, voted Boring Money’s Best Buy Pension 2022, can help you to manage your retirement planning in an easy and cost-efficient way.
The income you receive at retirement is based on the amount you have contributed and the performance of those investments. With Nutmeg, you can either open a personal pension and contribute yourself or transfer existing personal or workplace pensions into one easy-to-manage pot. You can choose how your pension is managed and what level of risk you’re happy to take.
Those needing extra help, may also make use of our financial planning service to create a retirement plan that will help you reach your retirement goals. Book a free call to speak to the team to understand your options.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A pension may not be right for everyone and tax rules may change in the future. Please note that during any transfer, your investments will be out of the market. If you are unsure if a pension is right for you, please seek financial advice.