6 Things You Must Know When Starting A Pension

6 Things You Must Know When Starting A Pension

If you are looking to be paid more, starting a pension can be a great way to do it. When you put money aside into a pension pot, the government effectively tops it up through tax relief.


In addition, if you are employed and put into a workplace pension, then your employer will contribute towards your pot as well.


Pensions can seem distant and irrelevant, particularly for many young people. Yet we all hope to grow old one day, and when that time comes wouldn’t it be great to spend your later years in comfort? Or, better yet, in luxury?


Here are 6 things you absolutely need to know about pensions:


#1 Know How A Pension Works


A pension is actually quite a simple idea. It’s a place where you can put your money aside for your retirement, without that money being taxed.


When you eventually decide to retire – which, since 2014, is anytime after you reach aged 55 – you can start taking the money out.


You can either take the money out gradually, and keep the rest invested until you need it. Or, you can use the money to buy something called an “annuity,” which is a financial product giving you a guaranteed lifetime income in retirement.


Of course, since building a pension pot means putting money aside now, this does mean that you are forsaking having access to that money in the short term. Think carefully, therefore, about your budget prior to putting into the pension pot.


#2 Know How Tax Relief Works


Remember, the government will effectively “top up” whatever you put into a pension pot.


This does not mean you put in, say, £100 into a pension and the government gives you £20 back. Rather, the government works out how much your pension contribution would have been worth, had no Income Tax been applied to it. They then give you back the difference.


For instance, suppose you are a higher-rate taxpayer. That means some of your earnings are subject to 40% Income Tax. If you wanted to put £60 into your pension, you would have actually had £100 to put in had you not been subject to this 40% tax.


So, in this case the tax relief would be £40.


#3 Know How Much You Need To Contribute


The State Pension gives everyone a basic income in retirement from the government, depending on their National Insurance contributions. However, the amount you get is nowhere near enough for most people to survive – let alone thrive – in retirement.


You therefore need to be setting money aside yourself into your pension.


Under the government “auto-enrolment” scheme, all employees in the UK are now automatically opted into a workplace pension, to much they and their employer much contribute. However, you should try and go beyond that if you can.


As a general rule, divide your current age in half and use that figure as a percentage to work out what you should be contributing. So, someone aged 30 should probably look at putting 15% of their salary into a pension each month.


However, this is just a general rule and it’s important to speak with a financial adviser prior to making any big investment decisions. Make sure you budget carefully, and do not expose yourself to any unnecessary risks.


If you are wondering what the maximum amount is you can put towards a pension, you need to look at your salary. You only get tax relief on your contributions up to this point.


For instance, suppose someone is on £25,000 a year, and they have £30,000 in savings. If they wanted to put all of their savings into a pension, only £25,000 would receive tax relief.


With regards to total pension savings, in 2018-2019 you can receive tax relief on a pension pot worth up to £1,030,000. Anything above this amount will not receive tax relief.


#4 Look Into Salary Sacrifice Schemes


It’s slightly off-topic, but still relevant to the subject. Putting money into a pension is subject to tax-relief, but another way to save on tax is to consider salary sacrifice schemes.


This is how it works. You sacrifice some of your take-home pay, and your employer puts that money towards a benefit of some kind.


For instance, you could give up some of your pre-tax salary so your employer pays for your gym membership. This effectively means you pay less tax, because your take-home pay is less.


In this scenario, your employer will also pay less National Insurance contributions, and so has an incentive to participate in the salary sacrifice scheme.


#5 Make Sure You Understand the Different Pension Types


Few things in life are ever simple, and the same holds true for pensions. Confusingly, there are a number of different types and it’s important that you understand how they work.


Final salary pensions, for instance, do not involve you and your employer putting money aside each month into a pension pot. Rather, your employer promises to pay you an annual salary once you reach retirement. This is usually based on factors such as your years in service and what your annual salary was.


Defined contribution pensions are the more common type these days, and reflect the kind of pension arrangement we have been talking about so far. Sometimes called a workplace pension, this scheme involves both you and your employer contributing towards a pension pot.


The state pension is the pension given to you in retirement, by the government.


#6 Know Where Your Money Will Be Going


So, you know that contributing to a pension involved putting money into a pension “pot.” But where is that pot exactly, and how does it work?


For employees paying into a workplace pension, the company will often manage your pension pot and what the money is invested in. You can, however, choose what level of risk you want to take with the available investments.


Sometimes, your employer will not manage your money themselves, but will outsource this to a fund manager. In this case, you can still select your acceptable level of investment risk.


If you set up your own personal pension, however, then you also get to choose who manages your money.

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