#4 - Why a Pension is super important

Pensions are really important.  I can't overstate how important they are. You may think you're too young to worry about your retirement as it's years away, or maybe you've been working a while and never paid into one and now your wondering if you've made a big mistake. Well either way you need to read on as I'm going to breakdown some of the information around pensions and how great they are.

What is a Pension?

A pension is a way of saving for retirement, you generally save a regular amount which is invested over a long time to allow the contributions to grow as much as possible.

In the UK you get a state pension but it's not likely going to be enough to give you a comfortable retirement.  The new state pension, which is for men born on or after 6 April 1951 and women born on or after 6 April 1953 pays out a maximum of £179.60 a week or £9,339.20 a year. From April 2022 the amount goes up by 3.1% to £185.15 or £9,627.80 a year.

This is the most you can get and it requires you making 35 years of qualifying National Insurance contributions (it used to be 30 years). If you have fewer years of contributions you will get less money. You can check your national insurance contributions online via the government website Check your National Insurance record - to see how may qualifying years you have and I would encourage everyone to do this, especially those who are approaching retirement in the next 10 years.

£9,627.80 a year is not a lot! Do you think you could live on this small amount?

In retirement, people often need less money due to having fewer expenses. It's likely that any mortgage you had will be paid off, children will likely have finished school moved out and be paying their own way and you may even have downsized the family home to something a little smaller giving yourself some cash. This is all good to know but a comfortable retirement is estimated to cost at least £19000 for a single person and around £26,000 for a couple. I think this highlights really well that relying on the state pension to support you in retirement isn't a valid option, you will struggle to manage on just the state pension.

Realistically you need to have around an extra £10,000 a year to top up the state pension to give you a comfortable retirement. This could be from various sources such as a work pension, personal pension or other savings that you've built up whilst working.

Work Pensions

Every employer is now required by law to provide a pension scheme for most employees and to enrol them in the pension scheme. Employers must contribute at least 3% of your salary into your workplace pension and you’ll have to contribute at least 5%. This employer contribution is the equivalent of getting free money from your employer and for most people opting out of the pension will be a big mistake.

Private Pension

If you are self employed, don't have or want a work pension or want to save extra for retirement away from your work pension you can always pay into a private pension.

Money paid into a workplace pension is deducted from your wage before you see it so you don't pay income tax on what you contribute. If you pay into a private pension you do this after you've paid income tax so your pension provider will claim back the tax and add it to your pension.

A very simple example for a basic rate tax payer would be:
As a basic rate tax payer you pay 20% income tax, so when you earn £100 you only receive £80 after the tax is deducted. But this means that if you decided to pay £100 into your pension it would only cost you £80!
If you have a workplace pension your employer would pay in £60 as well. This means that with a workplace pension the cost to you is £80 but you're getting £160 paid into your pension. That's pretty amazing and probably one of the only times you are going to get free money.

What happens when you die?

This is a good question and most pensions let you leave your pension to a nominated beneficiary. Some can be left to whoever you nominate whilst others maybe restricted to a spouse or significant other or child under the age of 23.
This is why pensions are so great, but there are downsides, the most obvious being you are restricted to when you can access the money. The government can, will and has already changed the age at which you can claim your state pension and also your workplace / private pension and in future could change this again.

Pension age used to be 60 for women and 65 for men but this has been changed and now women's pension age has been made equal to men's and the government has also raised the state pension age for both men and women to 68. This change means that many people will need to work longer before they can access their state pension. Private pensions are also affected so depending on your age you may find out you can no longer access your private pension at 55 but may have to wait longer perhaps till age 58. I'd suggest checking with your pension provider to get the latest information that is relevant to your circumstances.