Pensions Explained: Your questions answered

What is a pension?

It is a special type of savings plan, with important tax breaks, in which you can build up money in order to provide yourself with a pension. It is a long-term arrangement, so you can’t dip into it before you retire.

Why have a pension?

It's good news that we're all living longer, but it does mean that we may have to pay for long retirements. The basic state pension is a start, and it may be supplemented by other benefits you may be entitled to, but it's not likely to be enough to give you the standard of living you want.

You should seriously consider having your own pension. Whether that's through your employer, a personal pension or both, is up to you.

However, you still need to be aware that the value of your investment can go down as well as up and you may not get back the amount you invested.

How do I fund my retirement?

You can choose to fund your retirement through a pension, which can:

  • Supplement your state pension
  • Give you greater financial security during your retirement
  • Give you a tax-free cash sum when you retire

A pension is a good way to invest for your retirement. You make payments into your pension plan, many employers will also pay into it and the government chips in with tax relief, which also boosts your pension pot.

Your retirement and you
Any state pension you receive may not be enough to fund the lifestyle that you want. You may also be entitled to other benefits. However, if you retire in your early sixties, it's possible that you may live for another thirty or so years. You need to be sure that you've put enough into your pension to provide you with a reasonable income during your retirement.

The more you can save during your working years, the better standard of living you could have when you retire. This means that the earlier you start paying into your pension, the better. You can save more money over a longer period of time and your pension fund will have longer to grow.

However, the value of your investment can go down as well as up, and you may not get back the amount you invested.

What is a Personal Pension?

If you are self-employed or working for an employer who does not provide a pension than you can start contibuting to a Personal Pension Plan.  You will pay contributions to this plan and will be entitled to claim tax relief on the contributions you pay up to certain specified limits. These plans are provided by financial institutions with professional fund managers who will invest money on your behalf so that it has the potential to grow in value.

Please note the value of investments can go down as well as up and you are not guaranteed to get back the amount you invested. When you retire you can normally take up to 25% of your fund as a tax-free lump sum and use the rest to provide an income. Tax rules may change in the future.

What is a Personal Retirement Savings Account (PRSA)?

If you are self-employed or working for an employer who does not provide a pension than you can start contibuting to a PRSA. You will pay contributions to this plan and will be entitled to claim tax relief on the contributions you pay up to certain specified limits. Your employer can also pay contributions into a PRSA on your behalf. These plans are provided by financial institutions with professional fund managers who will invest money on your behalf so that it has the potential to grow in value.

Please note the value of investments can go down as well as up and you are not guaranteed to get back the amount you invested. When you retire you can normally take up to 25% of your fund as a tax-free lump sum and use the rest to provide an income. Tax rules may change in the future..

What is a Company Pension?

You are in a company pension scheme if you join your employer's trust-based defined contribution.

  • You make regular payments during your working life.
  • Your payments are then invested in your choice of one or more of a range of professionally managed funds and remain invested until you retire.
  • The investment performance of the fund(s) will determine how much money you may have available when you are ready to retire. Charges and investment performance will affect the fund value. However, the value of investments can go down as well as up and you are not guaranteed to get back the amount you invested.
  • The money built up is used to buy an annuity or another product which provides you with an income for the rest of your life. Your pension income will be taxed as earned income.
  • You can usually take up to 25% of your pension fund as a tax-free lump sum or an amount equivalent to 1.5 times your salary at retirement (provided you have 20 years service with your employer), which means you will receive a smaller pension. Tax rules may change in the future.

Usually, your employer also pays into the scheme. If you can join your employer's scheme it's usually a good idea to do so, particularly if the employer pays towards your pension fund – some schemes are very generous.

Unfortunately, no one can know how much your fund will be worth when you retire or how much income you will receive each month. A pension scheme lets you invest in a range of funds, giving your money the best chance of growing to give you a decent fund for your retirement. You need to understand more about the funds to make the best choices about where to invest your pension payments. You should also talk to a financial adviser.

What are funds?

Funds are a way for you to pool your money with other investors so you can:

  • Take advantage of buying in bulk.
  • Spread your money across lots of different investments.
  • Get the services of an expert who you wouldn't normally have access to.

You can usually choose which funds to put your money in. There are lots of different types of fund and there are many options to choose from; if you're not sure which one(s) to pick a financial adviser will be able to make recommendations for you.

The differences between funds are usually in the:

  • Way they're managed
  • Assets they invest in
  • The level of risk they take in relation to the amount of reward they're aiming for.

Most funds are managed on a risk basis, from cautious to aggressive. A cautious fund aims for steady growth over a long period of time with little risk of you losing money. An aggressive fund aims for higher growth but this increases the risk of you losing money.

The assets that a fund invests in are also an important factor in the returns you're likely to get. An aggressive fund may invest in companies that have just issued shares and so have the potential to do very well and make a lot of money, but they also have a risk of failure. A cautious fund may invest in Government bonds which provide a guaranteed growth rate. This growth rate may be smaller than you could make on the stock market, but there is less risk to your money.

What can I do with my funds?

Once you've paid money into your pension, you will be unable to access it before you retire, apart from in exceptional circumstances. A pension is designed specifically to provide for your retirement, so you can't draw it out if you're a bit short one month. The government insists on this to balance out the tax savings they give you.

Pensions can be quite confusing and many people find it difficult to understand them. It's important to remember that there are two separate elements to a pension. The first is the pot of money you invest into throughout your working life, which is known as your pension fund. The second is the income you take at retirement. When you retire, you can usually take a percentage of your pension fund as a tax-free cash lump sum. You don't have to take a tax-free cash lump sum, you could choose to use all of your fund to provide you with an income during your retirement. The rest of the money in your pension fund is used to buy a product that will provide you with an income during your retirement.

However, tax rules may change in the future and the value of your investment can go down as well as up and you may not get back the amount you invested.

What happens if I change jobs?

Pensions are designed to be flexible so that if you change jobs you can bring your pension fund with you.

If you had a company pension scheme then moving jobs means that you won't be able to carry on paying into it; your old employer will also stop making payments. Instead you can choose to:

  • Leave the money in your old company pension where it is.
  • Transfer the money in your old company pension scheme into a scheme with your new employer. You should get financial advice before you decide to transfer your old pension to make sure it's the right thing to do.
  • Transfer money in your old company pension scheme into a buy out bond which is a lump sum pension product into which you can pay the proceeds of your old company pension scheme and access the benefits at the retirement age applicable to your old company pension scheme. You should get financial advice before you decide to transfer your old pension to make sure it's the right thing to do.
  • Transfer the money in your old company pension scheme to a PRSA. You should get financial advice before you decide to transfer your old pension to make sure it's the right thing to do.

Other options may be available depending on your old employer's scheme.

If you decide to leave the money in your old company pension you can still join your new employer's scheme. That way, when you come to retire, you can use the money from both schemes to provide your income.

If your new employer doesn't have a company pension scheme you could see if they would pay into a PRSA on your behalf instead.

Can I retire early?

Taking the decision to retire early is a big step. Your pension fund will have had less time to grow, and you're likely to be retired for longer so your money has to stretch a little bit further.

If you're in a company pension the rules of the scheme will determine whether you can retire early or not.

If you are self employed you've got a personal pension plan or a PRSA the earliest you can retire is age 60. If you want to change your chosen retirement date you'll need to check with your pension provider. They'll be able tell you what you need to do and whether there are any special circumstances you need to think about.

You can see how changing your retirement age can affect your pension with our pension calculator.


Action Plan

It's never too early to start planning for your retirement. You can take small, practical steps to work out what position you're in now and what you need to do next. Every month of every year that goes by without you sorting out your pension arrangements could make a big difference to your financial security during your retirement.

Things you need to consider
Here are a few things you need to think about, so you can start laying the groundwork for financial security during your retirement:

How much are your pension arrangements worth now?
You should contact your pension provider to find out how much your pension is worth now. If you don't have a pension, you can use the value of the state pension as a guide.

Will your employer match contributions?
Talk to your employer and find out how much they are willing to pay into your pension plan.

Does your partner have their own pension?
If the answer's no, it may be more important that you make arrangements for both of you.

When do you hope to retire?
The age you take your benefits will greatly affect how much money you should be saving. The earlier you intend to retire, the more money you will have to invest now. Don't forget that you will also receive tax relief on your payments into your pension. Tax rules may change in the future, but for now you will receive tax relief on contributions you pay.

Start now
You deserve a comfortable retirement where you don't have to worry about getting by on a state pension and other benefits. By acting now to sort out your pension arrangements, you're taking the first step to a retirement you can really enjoy.

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