A complete guide to pensions and how they work
Understanding pensions can be quite an overwhelming topic to tackle at any age and whichever pension options you decide to look into, it can be quite a daunting task deciding which one is best for you.
Whether you’re thinking about workplace pensions, private pensions, looking at retirement planning or you’re thinking about late-life planning, there are many aspects to pensions that you need to try and understand.
In our extensive guide to pensions, we’ll take you through everything you need to know about planning for retirement and making sure that you get the best pension plan for you.
How does a pension work in the UK?
In the UK, pensions work by an individual contributing a percentage of their earnings into a pension scheme each month.
Depending on the type of pension you have and the benefits that your place of employment offers, some workplaces may match your contribution. So for example, if you pay 5% of your earnings into your pension pot each month, your employer may match that so you get 10% each month.
What is a pension pot?
A pension pot is the amount of “savings” you accumulate over the years of contributing to a certain type of pension called a ‘defined pension’ contribution scheme.
If you are employed, your employer will also likely contribute to your pension pot. You can then use this pension pot to get an insurance policy (known as guaranteed income - annuity) that “pays” you an income when you decide to cut down the number of hours you work or if you want to stop working altogether. You will need to check the terms of your pension, however, as there may be an age limit as to when you can take it out or other limitations, for example.
When was the state pension introduced?
Once known as the “Old Age Pension”, the basic state pension was introduced into the UK in 1908.
In 1946, a State Pension was implemented for everybody through the National Insurance Act which meant that everybody could benefit from a State Pension on a contributory basis. Men were eligible for their pension at aged 65, whereas women could take it at 60 years old.
Types of pensions
There are three main types of pensions that you may wish to look into, these include:
- State Pension
- Defined Benefit Pensions
- Defined Contribution Pensions
In the section below, we’ll take you through each of these types of pensions so you can get a bit more information on each one in order to determine which one might be best suited to you and your needs.
State pension definition
A State Pension is the most common type of pension in the UK. It is paid by the government and provides you with a secure income for life, which increases each year by at least the rate of inflation.
You contribute to your State Pension by paying National Insurance throughout your working life. In order to benefit from the payments from your full State Pension, you will have needed to have contributed to your National Insurance payments for at least 35 working years.
The standard flat rate for State Pensions for the 2020-2021 tax year is £175.20 per week; the new flat-rate State Pension was introduced in 2016.
This may not seem like enough to live on, so many people choose to get a private pension during their life or make other investments to make sure they will have enough money when they retire.
Defined benefit pensions
If you work in the public sector or you’re employed by a large-scale company, then you’ll likely have a defined benefit pension.
A defined benefit pension is related to your salary and it pays you a secure income for life, which also increases each year. How much money you get from your defined benefit pension depends on how much money you earn and how long you’ve been part of the pension scheme.
Defined contribution pensions
Defined contribution pensions work by you building up a pension pot throughout your working life which you can then take an income from when you decide to cut down on working or when you stop working altogether. This type of pension includes numerous types of pension schemes including personal, workplace and stakeholder schemes.
In order to start taking money out of your defined contribution pension, you must be at least 55 years old and you can usually take out at least 25% of your pension pot without paying tax on it.
The amount of money that you can benefit from with a defined contribution pension depends on factors such as how much you pay into your scheme yourself, how much your employer contributes (if you’re employed), how well your investment performs and how many charges you pay for being part of a defined contribution pension.
Is it worth starting a pension at 55?
Many people would argue that it’s never too late to start a pension. After all, any contributions you make towards your pension that you can enjoy later in life is worthwhile, so starting one at aged 55 is better than never starting one at all.
In the UK, you cannot legally withdraw anything from your pension pot until you’re at least 55 years old anyway, so you might as well get one started whenever you can.
Of course, the earlier you start your pension, the bigger the payouts you’ll enjoy when you come to retire, so it’s worth looking into a pension almost as soon as you start your working life in order to reap the full benefits of having a pension.
How to find out how many pensions I have?
You can find out how many pensions you have, as well as how much money you’ve got in your whole pension pot by contacting the Pension Tracing Service.
The free database contains over 200,000 personal and workplace pension schemes, so you should be able to find all the relevant information that you’re looking for.
Alternatively, you can also check your pension statement; your pension provider should send out a statement to you once a year, so all your relevant pension information should be on there. You could also just directly contact your pension provider to find out any details about your pension that you want to know.