Understanding Pensions: Commonly Asked Questions

Annie 10th Sep 2024 No Comments

Reading Time: 7 minutes

Pensions can be very confusing – and we seem to be expected to just know how it all works! So, we’ve put together this FAQ guide for the most commonly asked pension questions to try and help you wrap your head around your pension.

What Is a Pension?

Understanding Workplace Pension Auto Enrolment

Do I Have to Have a Workplace Pension?

Can I Merge Pensions?

How Do I Get a Private Pension?

Can’t I Just Get the State Pension?

How Do I Get Money From My Pension?

Do I Pay Income Tax on My Pension?

Are There Alternatives to a Pension?

I Think I’ve Lost My Pension

More Pension Questions Answered

What Is a Pension?

A pension is a retirement fund that you save into until you reach retirement age. When you stop working, you will still need an income to pay for your bills – and holidays and luxuries! A pension income is designed to replace a salary income when you retire.

You can’t touch it until you’re at least age 55 (this can also change in the future, so check here). The money goes into stocks and shares investments, which are managed by a platform or pension provider on your behalf. The idea is that your money should grow over time, as investments usually do – however, there is always a risk as with any investment that you don’t get out what you paid in.

However, there are processes in place to make sure that you aren’t likely to face a pension crisis. If a pension provider goes bust, your money is protected by the Financial Services Compensation Scheme, and if your employer goes bust, they can’t touch your pension (you just won’t get anything else paid into it from them). A pension is, generally, one of the safest ways to set up a retirement nest egg.

Understanding Workplace Pension Auto enrolment

Most people will have been offered a workplace pension since the introduction of auto enrolment. This means that all eligible employees will be automatically enrolled in the pension scheme that their company chooses. You’re eligible if:

• You’re 22 or older
• You’re classed as a worker (not a self employed contractor)
• You earn at least £10,000 a year
• Your usual place of work is in the UK

Your workplace pension is a great way to build towards your retirement fund, because your employer must contribute to your pension too – and that’s not part of your salary, it’s extra. The minimum they must contribute is 3%, and you contribute 5% of your monthly salary. That means you get 8% for the value of 5% in your pension pot – AND the Government then tops that up, too. The amount of tax relief varies – but for example, if you pay £40 a month, your employer pays £30, then the Government will also top up by £10. So, for your £40 salary sacrifice, you get £80 total into your pension.

You won’t be enrolled if you’re not eligible, or if you earn less than £520 a month (or £480 over 4 weeks) or £120 a week.

Do I Have to Auto Enrol?

No! You don’t have to auto enrol in your workplace pension. Your employer must process the automatic enrolment, but you’ll receive a letter to tell you that they’ve done that and how to opt out.

Opting out means you won’t lose any salary each month to your pension – but it also means you won’t get your employer contributions, or the Government tax relief top up.

Can I Merge Pensions?

Having several jobs can often mean you end up with lots of different pensions at various providers. The good news is that you can transfer your pensions at any time! Consolidating your pension can help reduce the management fees on the account, which can help minimise the reduction on lots of small pension pots from different jobs.

However, before you transfer pensions into one provider, it’s worth looking at the management fees of each. You might be better off keeping a couple of providers or moving everything to a particular one, if the platform and management fees are lower. If you’ve got lots of different pensions, talk to an independent adviser to find out what is the best route for you. You can find an adviser using the free matching service at Unbiased.

How Do I Get a Private Pension?

Some people prefer to set up their own pension. This might be because you’re not keen on the workplace offering or you want to contribute more to be tax efficient. Or, you might want to diversify your portfolio to mitigate the risk of investments fluctuating over time. Or, you are self employed or not eligible for a workplace pension.

First, if you do get a workplace pension, you can’t ask for a different provider from your employer. What you can do, however, is regularly transfer your workplace pot into your private pot if you wish – or you could keep the workplace pension and set up a different provider yourself.

Finding a pension provider can be challenging, as it depends a lot on your circumstances. If you have several decades left to retirement, you can afford to find a riskier portfolio to make the most of your cash over a longer period of time. If you’re retiring in the next ten years, a safer low-risk investment fund is better.

Because this is so dependent on each person’s circumstances, seeking independent pensions advice from Unbiased can help make the right decision.

Can’t I Just Get the State Pension?

Most people will be eligible for the State Pension when they retire… but it’s never enough to live on. At the moment, the full State Pension is £221.20 a week – or £11,502.40 a year. This is not enough to live comfortably, especially when rents and mortgages are increasing exponentially along with the cost of living.

There is also the risk that the State Pension may not exist by the time you retire – there will be an alternative, but nobody can predict the future or what kind of safety net there will be for retirees in the next few decades.

A private pension can help supplement the State Pension payments, making life more comfortable when you make retirement.

How Do I Get Money from My Pension?

When you’re 55 (or age 57, after 6th April 2028), you can access your pension. There are a few ways to get money from it.

Drawdown is an income, where you pay Income Tax on 75% of the payment (the first 25% is tax free).

An Annuity is like an insurance policy, which you use your pension pot to buy in a lump sum that pays you a regular income for the rest of your life (or length of the annuity, depending on the terms).

Tax free lump sum is when you take up to 25% of the value of your pension, then take the rest as drawdown when you need it and pay Income Tax on it.

Which one you use will depend on your circumstances. Many people opt for a combination. For example, a tax-free lump sum often helps younger retirees buy an investment property to diversify their retirement income, and they may choose to keep working and leave the rest of their pension invested for several more years until they want to stop working. This gives their pension time to grow more, while they continue to receive income from work and/or an investment property.

An annuity can offer good value if you expect to outlive it! This is because you’re gambling on your pension and how long you expect to live. The guaranteed amount you’re paid is estimated based on when you’re likely to pass away – so if you outlive that expectation, you’ll be getting more money than you paid in. An annuity offers the stability of a guaranteed income every month, which can help with financial planning. However, if you pass away sooner then you’ve given up your entire pension pot, which means it can’t be left to beneficiaries (unless you have a joint annuity with a partner).

Before you even touch your pension, it’s important to speak to an independent adviser. Make sure they are truly independent, and not someone at your pension provider, as they can’t offer Unbiased advice.

Do I Pay Income Tax on my Pension?

Yes, when you start receiving money from your pension, you’ll pay Income Tax. It depends on your total income how much tax you’ll pay, just as when you were working and there were different Income Tax brackets.

You can, however, get 25% of your pension pot tax-free. You only pay tax on the remaining 75% of it. You can either draw the 25% as one big lump sum and then always pay tax on the rest when you get it, or you can choose to get 25% tax-free on your payments.

Are There Alternatives to a Pension?

Yes! Although most financial advisers will recommend that you invest in alternatives alongside your pension, particularly if you’re enrolled in a workplace pension scheme as that gives you extra tax relief and employer contributions as outlined above.

One alternative that works particularly well for the self-employed is a Lifetime ISA. You can only have one, and only pay in £4000 a year. You can open one between the ages of 18-39. The Government tops up your account by 25% of what is paid in each year – so if you pay in the full £4,000, you’ll get another £1,000 for free every year. This is why it can be good for self-employed freelancers, because they can’t get the employer contribution benefits of a workplace pension. You stop paying into the account when you are age 50, then leave it to accumulate interest for ten more years. When you turn 60, you can access the entire amount – and it’s ALL tax free, because it’s an ISA.

You could also invest in buy-to-let property, which will give you a rental income for as long as you want it, then a lump sum if you decide to sell the property at a later date (less mortgage repayment and Capital Gains Tax).

Or, you could invest in other stocks and shares outside of the pension wrapper – many people do this when they reach the annual pension contribution limit  of £60,000. Stocks are like any investment, and can go down as well as up, but a sensible approach with a diverse portfolio can help ride out the peaks and troughs over time.

I Think I’ve Lost My Pension

Moving home and changing jobs means many people lose track of their various pension pots over time. There are things you can do, however, to track down your lost pension.

• Contact your old employer to find out which pension provider they use(d)
• Use the Gretel free pension finding service
• Go through any old paperwork you have to find the pension number, company, or other details

Lost pensions aren’t cashed in by anyone else – they will be there decades later waiting for you. It could take some sleuthing, but your pension account will always be yours, it doesn’t have an expiry date (until you die).

More Pension Questions?

If you need your pension questions answered, we recommend visiting the Government-run website MoneyHelper for the basic information you might need to know.

For something more complicated, find an independent pensions adviser on Unbiased to talk through your current circumstances and what you see for your future retirement.