What is a Pension?

Retirement may seem a long way off, and a pension might not seem like the most pressing financial consideration, but investing for retirement at any age is very important.

Understanding Pensions, Annuities and Retirement Saving Plans might also seem overwhelming at first, but we’ve put together some jargon-busting information below on the various types of pensions to help.

Simply put, a pension is a type of long-term investment plan which allows you to save money for your retirement years. Depending on the amount you want to save and access, pensions can be a tax-efficient form of savings when compared to other options available.

There are a range of options available when you are able to access your pension pot. For example, you can either opt for a fixed income, or a flexible taxed income, or take out some or all of the money as a cash lump sum.

Up to 25% of the money in your pension can be taken as a tax-free cash payment. When you can access the money saved depends on the specific rules of your pension, usually, you will need to be at least 55 years old.

You can also sell the remainder of the pension to an insurance company in exchange for a regular fixed income that you will receive until your death. This is called an Annuity.

There are three different types of Pension schemes – your employer may offer some, and others can be set up by you, and you can invest in multiple pension schemes at the same time.

State Pensions

The State Pension is a payment that the government will make to you on the basis of your National Insurance Record once you attain payable age.

The current state pension eligibility age is 66 years old for men and women, for those born after 5 April 1960 there will be an increase to 67 years old.

To be eligible for State Pension, you must have a minimum of 10 qualifying years where you make National Insurance (NI) contributions or are deemed to have paid it.

The basic state pension in the tax-year 2022-2023 is £185.15 a week. The amount you receive may differ depending on individual circumstances.

Company Pensions

All companies are required to offer a workplace pension. Employees can choose to join a company pension scheme and make contributions towards it every year. In addition, employers will also contribute towards your pension scheme.

There are two types of company pension schemes.

Final salary scheme: The final salary scheme is also known as a defined benefit pension. It is dependent on your final salary and the number of years you have enrolled in the pension scheme.

Money purchase scheme: Money purchase schemes are also known as defined contribution pension schemes. Typically, you and your employer will make contributions into your pension pot. The amount you contribute, returns on the investments made with the pension funds, and any charges deducted when you access the pension, will all determine the pension that you receive when you retire.

Each one of these schemes has its own perks to offer, and your choice should depend on your immediate and long-term financial goals.

Individual Pensions

Many financial services companies offer Individual Pension schemes where you control the amount you invest. These are not connected in any way to your employment status.

There are three types of individual pensions.

Personal pensions: often used as a catch-all term personal pensions typically offer lower charges than stakeholder pensions but don’t have the same level of control over the investment options available to customers as self-invested pensions.

Stakeholder pensions: Similar to personal pensions, stakeholder pensions are ideal if you are self-employed or can save only small sums of money at this point in time. Some of the benefits of stakeholder pensions are limited charges and penalty-free transfers to other pension plans.

Self-Invested pensions: A self-invested pension scheme provides you greater control over your investments. These are usually chosen by people who have a fair amount of financial acumen and like to make their own investment decisions.