Mastering your pension
lovemoney staff
Updated on
6 February 2024
If you’ve not yet put any money aside, you might be wondering whether there’s any point in a pension.
After all, you’re doing enough to qualify for a State Pension, or you might simply plan to rely on your property to pay for things in retirement.
This would be a huge mistake: the fact you don’t pay any tax on pension contributions makes it an obvious choice.
Still not convinced? The best thing to do is look at what a pension offers compared to what it costs before deciding whether it’s right for you (spoiler alert: it is).
A pension is a pretty straightforward concept. You set some money aside each month, while you’re still earning, so you’ll have enough to look after you when you aren’t.
So why do so many people find it daunting?
Jargon is a huge problem.
The pension industry is riddled with it: from AVCs to SIPPs, we’re all faced with information that’s really simple, but sounds incredibly complex.
Don’t be put off. Understanding a few key terms can go a long way to clearing up any confusion. And if you don’t understand anything, simply look it up! All the information is freely available.
Your workplace pension is one of the most important parts of your pension strategy.
Why? Aside from the tax benefits mentioned earlier, your company also has to put some money into your pension (and sometimes matches your contribution).
It's effectively free money!
Like most things in life, there are some restrictions that apply, so make sure you understand exactly how company pensions work.
Thanks to auto enrolment, you should already be part of your work scheme but it couldn’t hurt to check.
In short, this works by automatically deducting 5% of your salary before tax and topping it up with a 3% contribution from your company.
If you’re older than 18 but younger than 39, you could also get a bonus of up to £1,000 a year paid towards your retirement from the Government.
Known as the Lifetime ISA, or LISA, it’s a savings or investment product designed for anyone looking to buy a home or boost their pension pot.
It pays a bonus of 25% on top of anything you put in the account.
However, you aren’t allowed to deposit more than £4,000 a year (hence the £1,000 bonus we mentioned above).
Assuming you’re using it for retirement and not buying your first home, you’ll only be allowed to access your funds when you’re 60.
If you need to access it sooner you’ll be hit with a 25% fee, wiping out the bonus.
Despite these restrictions, it’s still a generous offer by anyone’s standards.
If you don’t qualify for a LISA or you’re self-employed, or simply don’t fancy any of the above options, you could consider the Self-Invested Personal Pension, or SIPP.
It might not have the Government bonus or employer-matching of the earlier options, but it does give you the flexibility to manage your pension fund yourself.
Normally with a personal pension your investment choices can be limited, but with a SIPP you can invest almost anywhere you like.
Note that you’ll still get the same tax relief of any other pension fund.
More people than ever are investing for their retirement, which is great news.
But as pensions become more mainstream, more and more people are starting to ask where their money is being invested.
Rather than funding weapons, big oil firms and so on, we want to know that our retirement funds are being used as a force for global good.
As a result, we now have the option of investing in ‘ethical pensions’.
Sadly it’s not quite as straightforward as shifting your capital into the first ethical fund you find: performance can vary hugely for starters, and it’s often difficult to work out just how trustworthy a fund’s credentials are – some can be just plain misleading.
So you’ll need to do your research.
We all dream of retiring early, or at the very least retiring with a sizeable pot of cash.
Don’t make that task all the more difficult by letting investment firms take a huge cut out of your pension pot.
In fact, thousands of us could retire earlier if they simply reviewed the fees being charged on our retirement and investment plans, says Hannah Goldsmith, founder of Goldsmiths Financial Solutions.
“The financial services industry charges fees on all investment products – that’s how they get paid for the advice they offer and the work they do setting up and managing funds and portfolios.
“There is nothing wrong with that – but most people have no idea what these fees are, and they have virtually no understanding of the impact these fees have on the value of their retirement fund.
“I am not aware of any other situation where individuals buy a service without understanding the full impact of the costs they will pay.”
Keep a close eye on fees and watch your pot grow faster.
As we work through our careers, occasionally switching companies along the way, it can be all too easy to forget about old pension funds you might have built up.
After all, it’s unlikely to be front of mind as you embark on an exciting new role.
Nonetheless, it’s a costly mistake to make: there’s a staggering £20 billion worth of forgotten pension cash waiting to be collected.
The first thing to do is track down your old pension funds (learn how here) and then work out what to do with them.
A common option is to simply consolidate them with existing funds, but this might not always be the best option.
You’ll know by now that the earlier you start saving for retirement the better off you’ll be.
But even if you’re late to the pension party, you can still build up a decent pot if you’re diligent and willing to make sacrifices.
In short, make sure your savings are on track and review them regularly.
So it’s vital you ensure you’ll be entitled to the full State Pension when it comes time. (you’d be surprised how easy it can be to lose out on thousands of pounds).
Obviously, you’ll want to know well in advance if you’re doing something that could jeopardise your pension, so take the time to get a State Pension forecast.
This will tell you how much State Pension you’ll get, when you can get it and how to increase it if possible.
Thanks to pension freedoms introduced a few years ago, savers over the age of 55 are essentially able to do whatever they like with their pension funds.
Previously, you could take 25% in a tax-free lump sum, and then (usually) buy an annuity with the rest, which provided a lifelong income.
Now you can take the whole fund in one go if you wish, and use it as you like.
If you do, 25% will still be tax-free, while the remaining 75% will be taxed as income, so either at 20%, 40% or 45% (based on current Income Tax brackets).
You can still use it to buy an annuity if you'd prefer, or keep it invested and withdraw some money each year via income drawdown.
The choice is yours! While these freedoms are great news, it’s vital you understand the impact that freedoms will have on your financial planning.
You could end up with a massive tax bill as a result, or simply overspend and run out of cash too early. Think carefully before you make any decision.
Unless you have a Final Salary or Defined Benefit pension, chances are you will be amassing a lump sum for your retirement.
It’s entirely up to you what you do with it, but there are essentially four main options:
Most people are keen to secure an income for life with at least part of their pension pot.
One sensible approach is to establish what your guaranteed income you can expect from things like your State Pension.
Then you can calculate your essential expenditure – like paying monthly bills – and use an annuity to close the gap.
Once you have covered the essentials, you then have the freedom to explore other options with the rest of the pension pot.
You might want to give serious consideration to paying for financial advice as you near retirement.
As we’ve run through above, you’ll have a load of different options when it comes to accessing your funds, so you’ll want to make sure you choose the right one.
As always, do some research before choosing an advisor: there are some dodgy people out there!
While the Pension Lifetime Allowance has now been scrapped, the taxman still has many other ways to eat into your hard-earned pot of cash.
Our guide below really is a thorough explanation of how you can withdraw your money while paying the lowest possible tax bill.
You’ve put in the hard yards, saving diligently for decades. Now is not the time to undo all your hard work!
Sadly, there are many simple mistakes that pensioners make which eat into their available funds. Make sure you don’t follow the same path.
Pension freedoms have been a revelation in terms of how we manage our finances in retirement. Sadly, they've also triggered a boom in pension fraudsters.
A pension scam victim typically loses a staggering £91,000, according to the Financial Conduct Authority (FCA).
It's therefore vital you learn to spot the tell-tale signs that you're communicating with a conman before your retirement savings pot is wiped out
One of the big changes following the introduction of the pension freedoms has been how pension savings are treated for tax purposes when the plan holder dies.
Previously any funds passed on as an inheritance would have been taxed at a rate of 55%.
Now pensions are now treated much more favourably by HMRC, and people now have the opportunity to pass on pension wealth through the generations in a tax-efficient way.
There are some key differences between how pensions are treated on death depending on the type of pension, whether people are drawing an income using an annuity and, critically, age.
Make sure you understand exactly what will happen to your hard-earned funds by reading the following comprehensive guide.