Pensions might seem complicated but the basic idea is a simple one. It’s worth understanding the benefits of saving into a pension scheme because your State Pension might not be enough to live on.
Why are pensions important?
Why have a pension? Millions of people aren’t saving nearly enough to give them the standard of living they hope for when they retire.
If you fall into this category, you have three choices.
You can:
- retire later
- start saving more
- lower your expectations of what you’ll be able to afford in retirement.
It’s important not to rely on the State Pension to keep you going in retirement.
Even if you’re eligible for the full State Pension of £203.85 a week for the tax year 2023/24, this is far below what most people say they hope to retire on.
Did you know?
The maximum State Pension is a lot less than the amount most people say they hope to retire on. For 2023/24, it’s £203.85 a week – or £10,600 a year.
The advantages of saving into a pension
When you’ve decided to start saving for retirement, you need to choose how you’re going to do it.
Pensions have many important advantages that will make your savings grow quicker.
A pension is basically a long-term savings plan with tax relief. Getting tax relief on pensions means some of your money that would have gone to the government as tax goes into your pension instead.
If you save through a defined contribution pension scheme, your contributions are invested. This is so they grow throughout your working life and then provide you with an income in retirement.
Generally, you can access the money in your pension pot from the age of 55, but this will increase to age 57 from 6 April 2028.
How tax relief can help build up your pension pot
When your income is over a certain level, the government takes tax from your earnings.
You can see this on your payslip. If you put money into a pension scheme, it qualifies for tax relief.
This means that as well as the money you’re putting in, some of your money that would have gone to the government as tax now goes into your pension pot instead.
This is one of the benefits of a pension over a traditional savings account, and is why pensions are so important.
Even if you don’t earn enough to pay tax, you may still be able to make contributions up to £2,880 a year with tax relief making them up to £3,600.
Extra money from your employer
To help people save more for their retirement, employers now have to enrol their workers into a workplace pension scheme. This is called ‘automatic enrolment’.
In some cases, your employer will contribute to your pension regardless of whether you pay into it. In other cases, they’ll require you to pay in too.
Even if they require you to contribute too, then, unless you can’t afford to contribute or your priority is dealing with unmanageable debt, staying out is like turning down the offer of a pay rise. It’s worth paying into a pension to get that extra money to use later in life.
A tax-free lump sum when you retire
You can usually take up to a quarter (25%) of your pension savings as a tax-free lump sum.
If you’ve built up your own pension pot in a defined contribution scheme (instead of a defined benefit pension scheme– also known as a final salary scheme) – you can use the rest of your pot however you choose when you reach the age of 55. This will increase to age 57 from 6 April 2028