What are pensions?
In simple terms, a pension scheme is just a type of savings plan to help you set aside cash for later life. It also has favourable tax treatment, compared to other kinds of savings.
There are several types of pension schemes. Some may be run by your employer, others you can set up by yourself. And saving into one scheme doesn’t mean you can’t save into another or use other tax-efficient savings plans like ISAs.
At retirement, you can draw cash from your pension pot or trade in the cash with an insurance company for a regular income until death, called an annuity.
Since 2015, from the age of 55, you’ve had the ability to access your pension plan more flexibly, taking as much or as little cash as you like, at whatever point you like.
For you to start reaping the benefits of your pension there will be several options available to you. These may include being able to take a tax-exempt cash sum and the added security of being awarded a regular income.
Different types of pensions
1. Defined Benefit Pension schemes
If you possess a defined benefit pension scheme, you’ll get a specified income when you arrive at the scheme’s retirement age. This income is determined using a system that takes into account your salary and length of service. You may have to pay contributions to the scheme but your employer will also pay contributions on your behalf.
2. Defined Contribution Pension schemes
With a defined contribution scheme, what you get when you retire is not specified in ahead of time. Instead you grow your own pot of cash. You (and your employer if it’s a workplace pension scheme) pay into your pot every month and this cash is invested. So, the final value of your pot will depend on the amount paid in, the charges and the performance of the investments.
3. Automatic Enrolment
Automatic enrolment is a Government initiative that requires all employers to enrol eligible employees into a workplace pension, provided they are not already in one. Employers also have to pay a minimum contribution into the pension scheme for their eligible employees.
You are eligible for automatic enrolment if you:
- Are at least 22 years old;
- Have not reached State Pension age;
- Earn more than a minimum amount a year (currently £10,000); and
- Work (or usually work) in the UK (under a contractual agreement).
4. State Pension
As stated by GOV.UK, you can claim the basic State Pension if you are:
- A man born before 6 April 1951
A woman born before 6 April 1951
To qualify for the basic State Pension you must have paid or been credited with National Insurance contributions.
The most you can currently get is £129.20 per week.
For further information, please visit the GOV.UK website.
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Advantages of pensions
- Tax relief, which comes in two forms depending on whether you’re a basic-rate or higher-rate taxpayer.
- You recover some tax on the cash you put into a pension, while gains from the investments you make with that cash are largely tax-exempt.
- Tax relief on contributions
- You get the tax back you’ve paid on all contributions, if you’re under the age of 75, subject to a yearly allowance.