Like many people, you may find the concept of pensions to be complicated. However, the fundamental idea behind them is relatively straightforward. You must understand the benefits of saving into a pension because although the state pension is a good backup, it is unlikely to provide you with sufficient income when you retire.
The importance of saving for retirement
The sad fact is that millions of people in the UK are not saving sufficiently to provide themselves with a decent standard of living in retirement. If you are one of these people, you have three basic choices to make. You can either
- Delay your retirement
- Start saving more
- Adjust your expectations.
As alluded to earlier, the state pension will provide you with a lot less than most people will need in retirement. The full State Pension 2021-22 is £179.60 per week, equating to £9,339 annually. Therefore you should not rely on this as your sole source of income for when you retire.
Advantages of pension savings
Having decided to start saving for your retirement, you must choose how you will do this. The most common method of providing a retirement income comes from saving into a pension. There are certain advantages associated with pensions that you will not get from other investments. These advantages allow your investments to grow more quickly than they otherwise would. Planning for your long term future is crucial; when considering your pension, take on expert advice from a specialist such as Portafina.
Basically, pensions or long-term savings plans that qualify for tax relief. Receiving tax relief on your pension contributions means you get back some money that would have typically gone to the government. Instead, this money gets invested into your pension fund.
Saving for your retirement through a device known as a defined contribution pension scheme allows your contributions to get invested and have the opportunity to grow throughout your working life. Upon retirement, they should be sufficient to provide you with a source of income. In most cases, you can access your pension funds from age 55.
How are your pension pot is topped up through tax relief
As you are probably aware, when you earn over a certain amount of money, the government takes an element of it in income tax. This amount is visible on your monthly payslip. If you are paying into a pension, the amount of your income that you contribute qualifies for tax relief. Therefore money that would have typically gone to the government gets invested into your retirement pot.
Certain personal and stakeholder pensions offer tax relief even if you are earning below the tax threshold. The same also applies to certain types of workplace pensions, but not all of them.
Employer top-up contributions
Automatic enrolment or auto-enrolment means that employers are now required to enrol all qualifying employees into a workplace pension automatically. The aim behind this is to help as many people as possible to save for retirement.
One significant benefit of a workplace pension is that your employer also makes contributions to your retirement funds. As you would not typically receive these contributions if you were not enrolled in a workplace pension, you can consider it free money. Therefore opting out of a workplace pension is equivalent to refusing the offer of a pay rise or similar financial benefit.
Tax-free lump sum on retirement
Typically pensions offer a tax-free lump sum of cash when you retire. This amount generally equates to a quarter of the value of your total pension fund. With defined contribution pension schemes, you can use the remainder of your pension pot as you choose from the age of 55. You can either take it as further cash lump sums or leave it invested in your pension to provide an income when you retire. You should consider the implications of taking too much of your money in lump sums, as doing so could leave you short on other retirement income.
Conclusion
Whether or not you have started saving for your retirement, you should consider the benefits of pensions. The sooner you start saving into a pension, the better, as it will give your funds more time to grow and provide you with an income sufficient to sustain the retirement lifestyle you desire.