Everything you need to know about pensions
October 14, 2022
Produced by Peppy, information provided by The Money and Pensions Service
On average, women in their twenties today are on course to retire with £100,000* less in their pension pot than a man the same age.
1. What age should you start thinking about your pension?
Starting a pension is like planting trees. The best time to do it is 20 years ago. The next best time is now.
Most pensions are what we call “defined contribution”. In this type you pay into a pension pot throughout your life and the money is invested until you retire. The investment is an important aspect of the pension because we would hope and expect that, over a long period of time, your investments will grow faster than inflation, and so that investment growth is putting extra money into your pension for you. The longer your money is invested, the more investment growth it has – and then you get growth on the investment growth. It’s like a snowball gathering more snow as it rolls down a hill. The younger you are when you start to pay in, the bigger the hill and the bigger that snowball will be.
Top Tip:
Even starting to save into a pension later in life can be really worthwhile. You are usually getting free money (see below). The key question to ask yourself is “would this £50 be more useful to me now or when I’m retired?”
2. Is a pension REALLY worth it?
So, the first part of the question is “do we really need to save for retirement?” Well, the full State Pension is £9,627.80 a year for 2022/2023 and the average income target for retirement for people aged over 50 and still working is £25,000 a year, so there’s a big gap there to be filled somehow. A private pension is also really useful if you want to stop work before your State Pension Age.
The second part of the question is, “why a pension rather than savings?” There are some really important reasons why a pension is a good way to save for retirement.
Free money part 1
Tax relief – As a basic rate (20%) tax payer, for every £80 you pay into a pension, the government adds another £20. So you have £100 invested that will grow tax free until you retire. You can get a quarter of that pot totally tax free at retirement. You will pay tax on the rest if your income is over the tax threshold.
Free money part 2
Employer contributions – most employees are entitled to contributions into their pension from their employer (see below).
If you need to make a new claim for means tested benefits at any point before state pension age, your pension won’t be counted as savings. If you had £20,000 saved in a bank account or ISA, you wouldn’t be entitled to Universal Credit. The same money in a pension wouldn’t affect it; and the money in a pension is locked away until you retire. There’s no temptation to spend it. You are therefore making sure that money’s there for when it’s needed.
3. How much should I put in a pension?
People often talk about there being a rule of thumb that says the amount you need to save into a pension is half your age when you start to pay in.
So, if you are 20, you need to save 10% a year in total, and if you are 50 when you start paying into a pension, you need to save 25% a year. These figures include the tax relief and a 3% employer contribution, so a 10% total might actually only cost you as a basic rate taxpayer 6% of your salary each year. The employer and government won’t increase their contributions as you get older, so a total 25% contribution would cost you over 17% of your salary each year.
Of course, these are rough guidelines and, depending upon your circumstances, there will be times when you can’t afford that much, and times when you can afford more. Just remember the snowball effect of compound investment returns. There are a number of tools to help you keep track of how much pension you have built up – Like this one.
4. Tips to keep track of your pension pot?
Most of us will have a number of different jobs over our lifetime and join a number of different pension schemes, so it’s important to keep track of what you’ve got. If you have current pensions that you know about, put the basic details somewhere safe. That could be keeping hold of paperwork, noting a reference number and contact details in a notebook or making sure you save emails. Many pension providers have online accounts now to make it easier to see exactly what you have saved with them. Set up an account and note down your user number, password etc somewhere safe.
If you have lost track of pensions you can use the Pension Tracing Service, a government resource, at https://www.findpensioncontacts.service.gov.uk/
or call 0800 731 0193, to look up your employer or original pension company. Or, have a look at the MaPs website for more ideas.
5. Pensions and being self employed?
If you’re self employed, you won’t benefit from employer contributions (although if you’re a Limited company, the company can make contributions as a business expense). But, you do still get tax relief on your contributions. Self employed people are much less likely to contribute to pensions. Unless you’re building up other assets, you may struggle to retire before State Pension age. A pension can provide a safe asset that is separate from your business.
MoneyHelper’s free mid-life review appointment for the self employed.
6. Should I take my employer’s pension and what is auto-enrolment?
Unless you work in the public sector, your employer’s scheme is likely to be defined contribution – a pot of money that you and your employer pay into. The minimum rate that your employer must pay is usually 3% of your earnings between £6,240 and £50,270 a year, but many employers will pay more than this. If you opt out of your employer scheme, you are giving up that free money. https://www.moneyhelper.org.uk/en/pensions-and-retirement/building-your-retirement-pot/joining-a-workplace-pension-scheme
If you work in the public sector, your employer may offer a defined benefit pension. These provide the promise of a guaranteed income for life once you retire. These are also offered by a few companies in the private sector.
7. Who’s holding my money and how safe is it?
The money in your pension is held separately from your employer’s business. There have been horror stories in the past about pensions, but things have changed.
If you’re a member of a private sector final salary type (defined benefit) UK scheme, your pension is covered by the Pension Protection Fund. The worst case scenario is getting a pension at retirement of 90% of what you were promised. If you’re a member of a public sector defined benefit scheme, your pension is secured by the UK government.
If your employer becomes insolvent and you are a member of a defined contribution scheme, there’s no effect on the pension that you’ve already built up as it is held separately from your employer. Your pot can go up and down with the stock market but, unless you specifically choose extremely high risk investments or your pot is subject to very high charges, it’s managed in such a way that you’re unlikely to see significant and long term falls in the value of your pot.
The investments usually cover a wide range of funds and your money will often be moved into safer, steadier investments as you approach retirement so you’re not unduly affected by a fall in the stock markets.
All registered pension schemes in the UK will be regulated by either the Financial Conduct Authority (FCA) or The Pensions Regulator (TPR). To protect investors’ money, there are strict rules that govern the financial strength of companies, as well as the systems and controls they must have in place to protect your investments.
8. What happens when I retire?
You can take private pensions from age 55 – this is due to increase in the future to age 57 and will remain at 10 years below your State Pension Age.
If you’re in a defined benefit scheme, your options are normally limited to when you take the pension and how much of it you use as a tax free cash lump sum (up to a limit). The pension will pay out a regular taxable income for the rest of your life, will usually increase each year and often provides a survivor’s pension if you die and leave a dependent partner or child.
If you’re in a defined contribution scheme, you have much more choice. You don’t have to take the pot as a regular income for life. You could take it all at once, or over a few years, or have a more flexible income for life. A quarter of the pot can be taken as a tax free lump sum. Because this is a more complicated decision, you can book a free Pension Wise appointment by calling 0800 138 3944 if you’re aged 50 or over.
The appointment will last about 60 minutes during which time you’ll receive personal and impartial guidance about your pension pot options including tax implications. Please follow this link for more information.The taxable part of your pension is treated just like a salary, and so the value will be added to any salary or state pension to see what income tax you will pay. Assuming that you have the standard Personal Allowance, the first £12,570 is charged 0% tax, then the next £37,700 (up to £50,270) is charged 20% tax, then it’s higher rate above this. (England, Wales and NI 2022/2023 rates) The calculation is always based on total income between 6 April one year and 5 April the next.
9. Breakdown of the types of pensions in the UK?
The UK State Pension is payable if you’ve paid enough National Insurance to qualify. You need at least 35 years of ‘qualifying’ National Insurance contributions to receive the full new State Pension but if you have 10 years’ or more of national insurance contributions, you’ll be entitled to some UK State pension. https://www.moneyhelper.org.uk/en/pensions-and-retirement/state-pension/how-does-the-state-pension-work-and-how-much-might-you-get.
All other pensions are private pensions and they are split into two types.
Defined benefit (DB) schemes include final salary and CARE schemes.
The employer promises you a certain amount of pension per year based on your service and salary.
Defined contribution (DC) schemes are also called money purchase and this is the type where you (and your employer) pay contributions into a pot. The fund value increases due to the contributions and investment return. This is often called a pension “pot”. You have more flexibility in a DC scheme, but more guarantees in a DB scheme.
10. How to get credits towards your state pension
You don’t need to be earning a large salary, or even working at all, to get credit towards your State Pension. If you’re earning at least £6,396 a year (2022/23), you’ll be credited with a qualifying year, even though you haven’t actually paid any National Insurance. If you claim certain state benefits such as Jobseeker’s Allowance, Employment and Support Allowance, Maternity Allowance, Child Benefit, Carer’s Allowance or Universal Credit you’ll receive National Insurance credits. Even if you’re not entitled to receive payment of a benefit due to household savings or income, you can apply for an appropriate benefit to get the National Insurance credit
Under the new State Pension system you don’t build up any extra State Pension if you’re earning a high salary.
If, for example, another family member is looking after their child aged under 12 years, such as a grandparent under State Pension Age, the grandparent can claim the National Insurance credit .
You can also transfer credits from one spouse or partner to the other if, for example, one parent was working but also claiming the child benefit while the other was caring for the child https://www.gov.uk/national-insurance-credits/eligibility
The pensions pay gap
On average, women in their twenties today are on course to retire with £100,000* less in their pension pot than a man the same age. (Scottish Widows 2020).
Currently, there are 50% more women than men heading towards retirement without any private pension savings. 1.2 million women in their 50s have no private pension wealth and hence will rely on the State Pension system and their partner to provide a retirement income. This represents approximately 5% of all women. In their early 60s the median private pension wealth of women is one third of men’s private pension wealth. By retirement, women would have approximately accrued £51,000, whilst men would have about £157,000 of pension wealth. (Pensions Policy Institute 2019)
The gap in pensions is greater than the gender pay gap for a number of reasons:
- The gender pay gap throughout the working life – as pensions are normally built up as a percentage of salary, a lower salary means a lower pension. The gender pay gap was 15.4% in 2021 and older women are more affected due to a cumulative effect of factors (L&G). The hourly pay gap at age 50 to 64 is 25% (Pensions Age)
- Women take more career breaks – typically due to maternity leave – than men (Scottish Widows). Although there is protection for pension contributions during a period of paid maternity leave, this does not apply to unpaid maternity leave.
- 75% of part time workers are women (Scottish Widows). Not only does this mean a lower salary on which to base pension payments, it can exclude them from being automatically enrolled into workplace pension schemes. People are not automatically enrolled unless they earn the equivalent of £10,000 a year, and the first £6,240 of this can be excluded from being liable for pension contributions. Men aged 50 to 64 work an average of 9 hours per week more than women. In addition, some workplace pension schemes do not currently provide tax relief to workers whose earnings are under the Personal Allowance, although this is provided if a different payroll process is used.
- 1.2 million women (in relationships) with dependent children are currently looking after their family and are missing out on automatic enrolment pension contributions. An additional 1.4 million mothers with dependent children who are employed do not earn above the £10000 threshold to qualify for automatic enrolment contributions (Pensions Policy Institute)
- Women are more likely to take on caring responsibilities and therefore participate less in paid work. Women over 50 are twice as likely to provide unpaid are for others than men. (PensionBee)
- Reduced pension savings of women are compounded by the fact that women tend to live an additional 2 years and need an estimated £50,000 extra to fund this. (Scottish Widows)
- The initial pensions gap in a study by L&G was 17% but doubled by the time women reached their 40s and could be 51% in their 50s and womens’ retirement savings were 56% smaller on average at retirement.
- The L&G study found that male participants over 50 had an average pension pot of £82,311 compared to £43,014 for women. A quarter of women over 50 have less than £5,000 in their pot and are more likely to not know the size of it.
- The pandemic has likely increased the pay and pensions gap due to unpaid caring responsibilities typically being taken on by women.
- Divorce increases the savings gap with women being more likely to waive rights to a partner’s pension and only 3% of people seeking financial advice as part of their divorce.
The new State Pension system from 2016 has significantly improved the gap between the State Pension paid to each gender, but it is not expected to close until people retiring in 2041. 400,000 women start menopause each year and over 70% of them will feel that their performance at work is likely to be affected. 25% experience severe or lifechanging symptoms such that they consider giving up work as a result.
Taking early retirement due to menopause symptoms has a double whammy effect on retirement income – you stop paying into your pension earlier, and have to stretch out the pension that you do have for longer. Even retiring 5 years earlier than planned could reduce your retirement income in some pension schemes by 40% for the rest of your life.