Intro to Pensions

Pensions – they’re not exactly an exciting subject are they? Unfortunately though, if you plan on enjoying retirement to any extent, they are an essential requirement that you need to plan for. A pension is an investment vehicle that is designed to provide you with an income after you have retired.

Residents of the United Kingdom are likely to qualify for the basic state pension. Though it is relatively small, many pensioners are living off the state pension as their primary income. Currently the state pension is based on the number of years you have been making National Insurance (NI) contributions. To earn a full state pension, men currently need to have been making contribution for 44+ years, and women for 39+ years. The current state pension in the UK, is the only state pension in the developed world that would put people living off it under the poverty line. If you plan on being able to do more than put a roof over you head during retirement, then you need to invest in some other type of pension.

In addition to the basic state pension, there is also a second state pension. The State Earnings-Related Pension Scheme (SERPS) was established in 1978, and the additional pension you received from this would be based on the level of your National Insurance payments – the more you earn, the more NI you pay, the higher the pension you received would be. The SERPS pension was replaced by the Second State Pension in 2002. This was designed to improve the pension income for people on lower incomes. For people on higher incomes, you will be glad to hear that it is possible to opt out of the second state pension, and pay lower NI contributions.

As well as state pension(s), many people take out pensions with their employers, known as company pensions. You normally pay a percentage of your salary into the pension, and because the government wants to encourage people to do this, they allow pension contributions to be made before tax, so you only have to pay tax on the salary left over after you have paid into your pension. Many company pensions are based on the final salary you receive while working with the employer – known as Defined Benefit – but these pensions are being phased out. They are being replaced by Defined Contribution pensions, which are based on the amount you have paid into your pension, the more you pay in, the more you receive. Company pensions also have the benefit that your employer will often also pay into your pension on top of the payments that come out of your salary.

If you aren’t employed, are self-employed, or employed by a company that doesn’t provide a company pension, you will be glad to know that there are also personal pensions available. Anyone can start a personal pension, and as with company pensions, payments into these are tax free. If you are a higher rate tax payer, and pay money into a personal pension, the government will also pay in the tax you would have paid on the money you put into the pension.

Pensions are just one vehicle for financial planning for retirement. You may be unattracted by the inflexibility of pensions, and prefer to build up other sorts of investments to provide income during retirement. You could put away money into an ISA, which also benefits from tax breaks, or invest in property. You could invest in a number of buy-to-let properties with the intention of having the mortgages paid off by the time you retire, then use the rent from tenants as your income. This method of planning is much more flexible than a rigid pension, which may be a good thing or a bad thing depending on your atitiude to money. You make like having complete control over your investments, but you may also find having a large pot of readily available money to hard to resist dipping into before retirement.

Though for many they are about as unexciting as you can get, pensions (or other investments) are essential to be thinking about now. It may be years or decades before you retire (and currently, retirement ages seem to be rising almost a year every year!), but it takes this long to invest properly for your retirement. If you dont have any long term financial planning in place now, make it a top priority in sorting it out!