Introduction to Saving for Retirement
Unless you think you could get by on the Government's guaranteed pension 'credit' (currently £145.40 per week) when you retire, you
need to give some thought as to how you'll survive financially during retirement.
This doesn't necessarily mean starting a pension, there are other ways to provide for retirement, but it's unlikely state provision will become more generous so try to
have some sort of plan. We're tending to live for longer and projections suggest there will be fewer people working to support retired folk in years to come, placing an ever
greater strain on the state pension system.
What age can I retire?
The earliest age that you can receive a state pension is currently 65 for men and progressively rising from 60 to 65 for women between now and November 2018.
This is then due to increase to 66 by 2020 and then to 67 by 2028 and 68 by 2046 for both men and women, reflecting the fact that we're all, on average, living longer.
Of course, there's nothing to stop you retiring earlier or later if you want to. Retiring earlier means you'll need to have a way of supporting yourself. If you retire later you could either start receiving your state pension or defer it to increase the amount you'll finally get.
If you have a pension then the earliest you can take it is age 55.
The real question for most of us is 'What age can I afford to retire?". Sadly, the answer is probably very different to the age at which you'd like to retire, especially as
employers can no longer force you to retire at 65.
Use our Retirement Age Calculator to estimate the age at which you might be able to afford to retire.
Ways to get retirement income
Note: the Government intends to replace the basic state pension and S2P with a flat weekly pension of around £144 from April 2016, requiring at least 35 years of qualifying National Insurance contributions.
State PensionS2PPension CrOccupationalPersonalEquity ReleaseSavingsWork
The basic state pension is a weekly pension from the Government, currently £110.15 per week, provided you've worked at least 30 qualifying years.
The state second pension (S2P), previously called the 'State Earnings-Related Pension Scheme' (SERPS), provides a top-up (for employees only) to the basic state pension based on earnings over your
working life.
If you have little, or no, income or savings the Government's Pension Credit should ensure you receive a minimum weekly income of £145.40 (including the state pension).
A pension provided by your employer. 'Final salary' schemes, which pay a pension based on your years of service, are an attractive, but dying breed, while 'money purchase' schemes are similar to personal pensions. You receive tax benefits on the money you pay in.
Stakeholder/Personal Pensions/SIPPs allow you to save money into a pension pot and convert it into an income for life when you retire. You receive tax benefits on the money you pay in.
If you own your home, or its value is far greater than your mortgage, you could release some of this value to pay for retirement. One option is to sell and then buy a cheaper home, using the
balance to live on. Alternatively there are various 'equity release' schemes (beware potential catches!), which aim to give you money now while letting you continue to live in your home.
If you've built up savings and/or investments you can use these to provide an income. If you need more money you can always withdraw some capital, but this could then reduce your income and
you need to be careful it doesn't run out.
Individual Savings Accounts (ISAs) have some appeal because any gains and income they produce is not taxable. Property has also been a popular retirement investment in recent years.
A last resort for many, but a practical solution to being strapped for cash during 'retirement'.
As of
May 2011 9.0% of all men and women over 65 were still working - a change on year of
2.3%. Source: ONS.
The key to saving and investing for retirement is being able to enjoy an income and/or capital withdrawals, preferably without having to pay too much tax. The table below shows the pros and
cons of popular options:
| Ways to save and invest for retirement |
| Saving / Investment Type |
Pros |
Cons |
| Savings Account |
- Safe, very unlikely you'll lose money.
- Easy access to your money when you need it.
|
- Inflation could reduce your spending power over time.
- Interest is taxable.
|
| Stock Market |
- Provides scope for both income and capital growth.
- Dividends tend to rise over time, potential for a growing income.
- Gains could be tax-free if within your annual CGT allowance.
|
- Risky, you could lose money.
- Dividends are taxable.
|
| Gilts / Corporate Bonds |
- Can provide a steady income with limited potential for capital growth.
- Gains on gilts are tax-free.
|
- Some risk, you could lose money.
- Interest is taxable.
|
| Individual Savings Accounts |
- Interest and gains are tax-free.
- Dividend tax saving for higher rate taxpayers.
- ISA income does not affect the age-related income tax allowance.
- Wide choice of underlying investments available.
|
- Some of the underlying investments can be risky.
- Annual limit on how much to can contribute.
- No tax relief on contributions unlike pensions.
|
| Property |
- Good source of income if successfully rented.
- Bricks & mortar tends to be a good long term investment.
|
- If you need to sell, it could take some time to get your money.
- Gains likely to exceed CGT allowance so taxable.
- Ongoing maintenance costs could be high.
|
What will I get?
This can vary markedly depending on your situation. Use our 'How Much?' Retirement Calculator to estimate how much you might get in retirement.
Pension Tax Benefits
One benefit of using a pension to save towards retirement is that the Government effectively pays you to contribute by giving an initial 'tax-relief' on contributions.
Pension income, when taken, is taxable but the initial tax-relief can nonetheless provide a welcome boost.
| Tax relief on pension contributions - equivalent net cost shown |
| Gross Contribution |
Non-taxpayer* |
Basic Rate Taxpayer |
Higher Rate Taxpayer** |
| £100 |
£80 |
£80 |
£60 |
| * Limited to a gross contribution of £3,600. ** Assuming sufficient higher rate to reclaim. |
Tax relief is given on pension contributions of up to your earnings or £50,000 a year (including any employer contributions), whichever is lower (falling to £40,000 from 6 April 2014). Find out how much tax relief you might get on
your contributions using our Pension Contribution Tax Relief Calculator.
Pension funds do not have to pay tax on gains or interest, but thanks to a Gordon Brown 'stealth tax' dividends received by pension funds (through investing in shares)
have not been 'tax-free' since 1997.
When you retire you can take up to 25% of your pension fund as a tax-free lump sum. However, pension income is taxable as normal.
To view a comparison of pension tax benefits versus individual savings account (ISA) tax benefits, click here.
How the tax relief is given depends on the type of pension:
Company & Public Service PensionsPersonal Pensions
Your employer usually makes contributions directly from your pay before deducting tax, so you enjoy the full relief straight away.
You normally contribute money net of basic rate tax and the pension provider claims this back from HMRC. If you are a higher rate taxpayer
you can claim the additional tax relief either via your annual self-assessment tax return or by applying directly to HMRC.
Pension Unlocking
Provided you're age 55 or over, you can take the tax-free cash from your pension before you retire, this is known as 'pension unlocking'.
However, unless you're really desperate for cash this is almost always a bad idea, especially if you have a 'final salary' pension. You could severely impact your pension income when you retire and some pension providers will charge you a penalty for doing so.
Beware of financial advisers who suggest you unlock your pension, as some charge excessive fees in the process.
If you do go ahead then choose an independent adviser who'll carry out a comprehensive analysis and clearly outline charges and commissions. At least you'll know exactly what you're letting yourself in for.
Ways to buy a pension
Pension ProviderEmployerFinancial AdviserDiscount Broker/Platform
Some providers offer their pensions, especially stakeholder, directly. However, there's generally little to be gained compared to buying through an adviser or discount broker, you might even find the fund choice is restricted versus the same pension sold through an adviser.
If you have an occupational pension through your employer then you have the option to buy and top-up your pension through them.
Can be beneficial if you're not sure what you're doing, provided you find a good one. Advisers can no longer take commisisons, so will charge you a fee and should offer lower cost products
without commission built in.
Usually a good option if you know what you want, as they'll normally refund most commission or use commission-free products and instead charge an admin fee. Just be sure to keep a
handle on your pension, as discount brokers tend to provide little, if any, ongoing service.
Pension Mis-selling
Pensions have historically enjoyed a miserable reputation, with many people being 'ripped off' by unscrupulous salesmen and pension providers.
The root cause was the sky high upfront commissions that insurers paid to advisers for selling their pensions, often equal to the first two year’s worth of contributions. This often led to advisers shackling their
clients to onerous regular premium pensions rather than suggesting a series of ad-hoc one-off contributions which would have normally been more flexible and cost effective (but paid far less upfront commission).
High commissions also led to the 'pension transfer scandal' of the 1980s and mid 1990s, whereby advisers recommended individuals move from perfectly good occupational pensions into personal pensions, often leaving them worse off while the adviser typically pocketed thousands of pounds of commission.
This led to the Financial Services Authority (FSA) ordering advisers and insurers to review pension transfer cases and, where necessary, pay compensation to the victims.
Thankfully the pension industry has generally cleaned up its act and commissions are now banned where advice is given, but this doesn't excuse the events of the past and many individuals continue to
suffer as a result.
Because insurers paid out crazy upfront sales commissions on regular contribution pensions, they used a variety of cunning ways
to claw back this money and ensure a fat profit over the life of the pension policy.
Common practices included:
- Contributions for the first two years being classed as ‘capital units’ and suffering an annual charge of 4% throughout the life of the pension.
- Subsequent contributions having a 1% annual charge.
- Underlying funds with a 5% bid offer spread and 1-1.5% annual management charge.
- Penalties for transferring to another provider, ensuring the provider could recoup costs not yet deducted up until retirement.
- Additional charges for stopping premiums or retiring early.
If you started a personal pension or retirement annuity contract (RAC) before the mid to late 1990s then there's a fair chance it suffers from the types of charges outlined above.
'A' Day
6 April 2006 was the day the Government turned the pension world on its head by introducing 'pensions simplification'. The aim was to replace the vast number of complicated rules for different types of pension
with a single set of rules applying to all pensions. By and large it has succeeded. For more details of current pension rules click here.
Nest
Because the majority of the working population is not saving enough to enjoy a comfortable retirement, the Government is trying to improve matters with the
introduction of the 'National Employment Savings Trust' (Nest).
Under Nest employees aged over 22 are automatically enrolled (although they can opt-out) and will need to contribute 4% of their salary unless they choose to
opt out. In turn, employers must contribute 3% and the Government contributes 1% via tax relief (higher rate relief is given where appropriate). Prior to October 2018
the minimum contribution has been relaxed to 2% of which employees must pay at least 1%. (5% and 2% respectively between October 2017-2018).
Will this solve the pension crisis? Probably not, but it should at least do more good than harm.
Annual contributions are capped at £4,500 and based on earnings between the ‘Lower Earnings Limit’ and ‘Upper Earnings Limit’ for National
Insurance Contributions, currently £5,668 and £41,444 a year respectively.
The default investment option is a 'retirement date' fund that actively reduces risk as you approach retirement. There are also 5 other funds available: Ethical, Shariah, Higher Risk, Lower Growth and
Pre Retirement. Charges are 0.3% a year with a 1.8% initial charge on each contribution.
Transfers in or out of Nest are not be allowed, which could prove an issue for employees who build large pension pots in future and decide they want greater investment choice.
While Nest should actively encourage all employees to make provision for retirement above the State Pension, which is largely a good thing, there are potential flaws:
- An 8% total contribution may not be enough to provide employees with a comfortable retirement income.
- Many employers, unhappy at the prospect of higher employment costs, may simply pass on some or all of the 3% cost to employees via a reduction in salary and/or other benefits. This has already occurred in Australia, where a similar system has stifled wage increases.
- Employers who would otherwise contribute more than 3% into a pension for employees could be tempted to cut back to this new level.
- The Government has a poor track record at encouraging individuals to save (Stakeholder being a good example), so will individuals simply choose to opt out in droves?
- Who will pay for employees to receive advice on investment choice? History suggests the public are mostly unwilling to pay for advice.
- As underlying investments are largely trackers, is it a good idea for the nation’s retirement prospects to hinge on the share price performance of a handful of large companies?
- A large proportion of the target market is probably in debt. Should they be clearing these first given debt interest is likely higher than potential pension investment returns?
- Although there’s no doubt individuals need to save more, saving rather than spending could adversely impact the economy.
Retirement Jargon
Here's some of the more common retirement jargon you might come across:
| 'A' Day | 6 April 2006, the day the government pension simplification rules came into effect. |
| Annual Earnings Allowance | The amount that you contribute into a pension each tax year and enjoy tax relief (capped at your annual earnings if lower). |
| AVC | Additional Voluntary Years, a way of increasing your potential occupational pension by contributing money into investment funds. |
| Death In Sevice | A benefit, similar to life insurance, paid by occupational final salary pensions should you die while still working. |
| Deferred annuity | An annuity that starts paying an income for life in future, not straight away. |
| Final Salary Scheme | An occupational pension scheme where your pension is linked to your salary and the number of years you've belonged to the scheme. |
| Group Personal Pension | A type of occupational money purchase pension scheme, where individual pension policies are administered by an insurance company. |
| Guarantee Period | If an owner dies soon after buying an annuity, income continues to be paid for the duration of the guarantee period, e.g. 5 years. |
| Impaired Life Annuity | Pays a higher income than usual because the owner has a shorter than average life expectancy, e.g. smokers or those with a history of illness. |
| Income Drawdown | Leaving your pension fund invested when you retire and drawing an annual income within set limits. |
| Index-Linked Annuity | Pays an income for life which increases each year with inflation. |
| Investment-Linked Annuity | Pays an income for life, the exact level depending on the performance of a particular investment. |
| Joint Life | A pension annuity that continues paying an income (to a spouse or depenents) when the pension owner dies. |
| Level Annuity | Pays a fixed income for life. |
| Lifetime Allowance | The amount your pension fund is allowed to be worth when you retire or die without having to pay a penalty tax. |
| Money Purchase Scheme | An occupational pension scheme where your pension depends on how much money is contributed during your career, investment performance and annuity rates when you retire. |
| Occupational Pension | A pension scheme offered by employers to their employees. |
| Open Market Option | The right to shop around for the best deal on a pension annuity, you're not obliged to buy from your pension provider. |
| Paid in Advance | The annuity income is paid at the beginning of the payment period, e.g. month/year. |
| Paid in Arrears | The annuity income is paid at the end of the payment period, e.g. month/year. |
| Pension Protection Fund | Introduced by the Government in 2005 with the aim of protecting employees in final salary schemes (against their employer becoming bankrupt). |
| Pension Tax Credit | A state benefit that's effectively a minimum income guarantee for those age 60 and over. |
| Protected Rights | The part of a pension fund which was used to contract out of the State Second Pension (or SERPS). |
| Protected Rights Annuity | The part of a pension fund used to contract out of additional State Pensions (SERPS /S2P), must buy a protected rights annuity. |
| Purchased Life Annuity | An annuity bought with your own money, not using your pension fund. |
| S2P | State Second Pension, a 'top-up' to the basic state pension (for employees only) based upon NI contribution history and earnings over your working life. |
| Single Life | A pension annuity that stops paying income when the pension owner dies, there's no income for their spouse or dependents. |
| SIPP | Self Invested Personal Pension, a money purchase type pension that allows you to hold any investment that is allowed to be held within a pension. |
| Small Pension Funds | Pension funds that do not exceed 1% of the lfetime allowance at retirement, allowing you to take the whole amount as a tax-free cash sum. |
| Stakeholder Pension | A money purchase type of pension that has high flexibility and low charges. |
| State Pension | A weekly income paid by the Government to the vast majority of the population once they reach retirement age. |
| Tax-Free Cash | The sum of cash you can take from your pension fund, tax-free, when you retire. Currently 25%. |
| With Proportion | If income is paid in arrears and the owner dies before the next payment, the balance owed is paid to their estate. |