In A Nutshell - What Is A Pension?

older man and woman

What do you understand about pensions? Defined contribution, SIPPs, Stakeholders? Will you still get a State pension and is it worth anything? We've pulled together a very high level quick guide that includes some of the buzz words you keep hearing.

As we start out in work post-school, college or university, pensions must seem a very very long way off. The idea of saving now for possibly 45 years time seems an anathema to most, especially when it means you have less "take home" pay. So when do we all start to take notice and actually put money aside?

Recent Government legal changes mean that all employers have to make provision for an employee to have a pension saving plan through work. There is a legal requirement for a workplace pension scheme and both the Government and your employers pay in to this. You may also then pay in to further increase the amount you are saving.

What Is A Pension?

In essence, a pension is a long term savings pot that you can access when you retire. The only real difference is that this is a savings pot that you, your employer and the Government can all pay into - excellent!

They are important as when you retire and no longer have a job, you need to have income to pay for your living, rent, home and holidays etc.

Types of Pension

As well as your State Pension (from the government when you reach retirement age) there's 2 main types of pension:

These are :

  • Defined Contribution : How much you have paid into your pension pot
  • Defined Benefit (Final Salary or Career Average) : This is based on your salary and length of time working for employer

 

The Defined Contribution Pension

Probably the most common pensions now, the contribution from you and your employer are invested throughout your life and those funds are used to buy a 'pension' or other benefits at the point at which you retire. The idea of buying a 'pension' at this point is for the money to sustain the period of your life with an annual income, until you die.

What Are Stakeholder Pensions?

If you are considering your future pension requirements, you may wonder what a stakeholder pension is and how they actually work.

Stakeholder pensions generally work in a very similar way to any other pension; you pay money into your pension over a number of years in order to build up a sufficient pension fund for your retirement. However, they differ slightly to normal pensions as the managers/people in charge of your stakeholder pension scheme will invest into the pension fund on your behalf.

The eventual value of your pension fund will be calculated based on the amount that you have contributed over the years, as well as the performance of the fund's investments. If you have a stakeholder pension, it is advisable that you make regular contribution payments wherever possible, however, you can halt your payments for a short period of time if required without any penalties, it just means that your eventual pension fund will be smaller (unless you make extra payments at a later date).

Upon reaching the age whereby the stakeholder pension can be paid out, you can use the money (funds) that you have built up to buy an annuity.

An annuity is a regular income that can be paid for the rest of your life; it can be bought from a life insurance company of your choosing. The majority of people will decide to wait until they are 60 or 65 before they draw on their stakeholder pension, however, you can opt to draw on it while you are still in employment. If you choose a stakeholder pension, they are generally run by an authorised stakeholder manager or trustees who will ensure that the scheme meets the required legal specifications.

What Are SIPPS?

A SIPPS or ‘Self-Invested Personal Pension’ is a UK-government-approved personal pension scheme. Using a full range of investments approved by HM Revenue & Customs (HMRC), customers can make their own investment decisions with SIPPS. SIPPS differ from normal pension plans, as HMRC rules mean that a larger range of investments can be held under a SIPPS, in particular equities and properties.

Investors in SIPPS have the ability to make their own choices as to which assets are bought, leased or sold as part of their plan, and they can decide when is the right time to buy any such assets – and equally, when they should be sold/disposed of, subject to the agreement of the trustees of the SIPP. Any such assets are permitted by HMRC, however, it is important to note that some of them will be subject to tax charges.

Self-Invested Personal Pension schemes are a great option for anyone who has considered taking out a stakeholder pension, but would like to have a say in how their contributions are invested. To this end, if you are thinking about getting a SIPPS, it is generally recommended that you are well-versed in financial and asset matters, as the eventual pension that you receive will be somewhat reliant on the investments made.

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