A pension scheme is a long term, tax efficient savings plan which is designed to give you an income when you want to retire, in addition to the State Pension.
Everyone receives a State Pension currently from about age 67/68 provided they have paid at least 10 years National Insurance Contributions.
A full state pension is £185.15 per week (£802 per month) (£9,627 per year) (2022/2023) and is achieved if you have paid 35 years of full National Insurance Contributions.
The State Pension increases to £203.85 per week (£883.35 per month (£10,600 per year) in April 2023
There are two main types of pension schemes:-
A personal pension is a fund built up from contributions made from your income (or other assets) and/or payments from your employer. These contributions are invested to achieve potentially more growth than you would otherwise receive if you saved in a bank or building society account.
For every £100 you save into a pension fund the government adds £25 to it if you are a basic rate tax payer and a further £25 tax reduction of your income tax liabilty for that year if you are a higher rate tax payer.
For every £100 your employer pays into your pension your employer reduces its profit, pays no National Insurance contribution and receives corporation tax relief.
Therefore a personal pension benefits from growth not only on your own contributions but also that of the government contributions (tax relief) and also any company contributions, which over the long term, benefit from compound returns ie growth on growth each year.
For every £100,000 of pension accumulated over the years, you could, in general terms, receive about £5,000 per year of additional income to the State Pension.
The income you receive from Personal Pensions will depend on how much has been invested into it, how long the contributions have been invested for and how well or badly the investments have performed over and above any charges applied.
A defined benefit scheme is a promise from your employer of a future income which will increase with inflation. The income you receive will depend on the number of years you work for the employer, the amount of your earnings (either average earnings or final earnings) and a factor specific to your scheme.
Common factors for these schemes are usually…
an 80th scheme promises ½ of your final salary at a normal retirement age of 60 or
a 60th scheme promises 2/3rds of your final salary at a normal retirement age of 65 or
a 57th scheme offers you 70% of your career average salary at a normal retirement age of your state pension age (currently either age 67 or 68).
– if you want to retire earlier than the normal retirement age there is usually a penalty of about 5% for each year prior to the normal pension age.
For example if your average or final salary is £50,000 and you have worked 30 years then
– an 80th scheme would offer £50,000 X 30/80 = £18,750 per year income.
– a 60th scheme would offer £50,000 X 30/60 = £25,000 per year income.
– a 57th scheme would offer £50,000 X 30/57 = £26,315 per year income.
There is no investment risk with this type of scheme as the factors used to calculate your future income are ‘defined’ and guaranteed at the outset. Therefore it is necessary only to understand your annual statements, which explain the specific rules of your scheme to understand what your income will be from the scheme at retirement.
– If you are employed, your employer will offer you a pension scheme when you join.
– If you are self employed, a company director, or you own your own Ltd Company, you can start your own pension very easily into which you or your firm can pay into. The earlier you start, the longer the contributions will have to grow and benefit from compound growth.
If you have built up a number of personal pensions it is usually a good idea to look at amalgamating them into one fund as it is much harder trying to manage several different pension funds than managing only one fund and also because older funds will often have higher charging structures and perhaps out of date investment strategies. You need to be a little careful when amalgamating funds because some older funds may have some valuable guarantees that, after consideration, may be worthwhile keeping.
If you want a review of your Pension(s) or would like to understand more about how pensions work; get in touch with our advisers to arrange an initial consultation.