Lets talk pensions...the main rule; the earlier the better when it comes to starting a pension.
You stop earning an income at retirement; you either live on:
- a pension, and / or
- savings, and / or
- income from any assets you own (income from rent on a house)
Savings don't go very far. Assets are normally expensive to buy upfront.
This leaves pensions to live on in old age.
One of the best "future you" investments is your pension.
A pension is a tax efficient form of long term saving; money is invested now (which you cannot access) to provide you with a future income, worth more than what you initially invested.
There are three types of pensions:
- state pensions
- private pensions, and
- workplace pensions
(at the moment) State Pension is a monthly payment by the government intended to ensure the populate that have reached State Pension age have enough money to support themselves in their old age.
Why Is State Pension Terrible?
- Age: state pension is provided to you at 68...old
- Income: £159.55 a week is the amount you receive (£8,296 a year). National Insurances determines the amount of pension you receive; career breaks or time off work where you don't contribute to national insurance reduces the pension you get. Many people take home less than £159.55 a week.
- Changes: state pension is always subject to having the age increased, or the amount reduced in payments. It's one of the easiest areas to cut.
The government needs us to save our own money so they don't have to support a huge ageing population; tax benefits have been set up to promote this.
Private And Workplace Pensions
This leaves private and workplace pensions; both provide excellent tax benefits.
I'll cover workplace pensions in the next blog on pensions. With regards to private pensions, some commonly known institutions are Scottish Widows, Aviva, Legal and General.
How Does the Tax Benefit Work?
The amount varies in line with your tax bracket, and what you would have earned before tax; the government will add this tax free allowance to your private pension.
I appreciate this sounds complicated / unlikely so lets break it down.
If you are a basic rate tax payer, you pay 20% tax. If you put £80 into a pension, the government will say, before tax, that amount was £100. You therefore get £20 of cash from the government into your pension scheme. The amount in your pension pot is therefore £100; £80 from you, and £20 free cash from the government.
The pension provider will invest the £100 on your behalf (stocks, shares, bonds etc); when you set up your pension you normally select your risk profile (i.e if you are younger you might select a higher risk profile as you are happy to take more of a gamble that the amount you earn in the future will give a greater return).
Basic rate tax payers (salary up to £45k) get £20 back for the £80 they put in (pension pot is £100).
Higher rate tax payers (salary up to £150k) get £40 back for £60 they put in (pension pot is £100).
Additional rate tax payers (salary > £150k) get £45 back for the £55 they put in (pension pot is £100).
- You can access this money when you turn 55 (13 years earlier than state pension);
- You can make regular or lump sum payments into a private pension; if the investment is a lump sum, there is a yearly cap.
- There are salary caps, annual allowances and lifetime allowances:
- Salary caps: you only receive a taxable benefit if you put in an amount equal to or less than your salary in the year, and / or
- Annual Allowance: £40,000. You only get tax relief up to this amount for the year. If you haven't used this allowance in the last 3 years you can carry it forward.
- Lifetime Limit: If you are a high earner, £1M is the lifetime limit for the taxable benefit.
Who Should I Choose?
There are a lot of avenues for finding a private pension provider:
Comparison sites like:
Citizens Advice Bureau also provides strong pension advice.
Finally, the fantastically brilliant Martin's Money Saving Expert provides a very comprehensive guide to pensions and suggestions for private pension providers.
Photo from the beautiful unsplash.com