When you consider that you could be retired for upwards of 30 years, it’s easy to see why saving for later life is so important. But how do you get started?
Designed to provide you with an income whenever you stop working, personal pension plans are one of the most popular ways to save for retirement.
Generally used to supplement the basic state pension there are no limits placed on the amount you can set aside in a personal pension plan, and the added bonus is that you'll receive tax relief on any contributions up to your personal allowance.
It is even possible for others to pay money into a personal pension plan for you, which means that partners and family members can help you to save for retirement too.
How do personal pension plans work?
You'll usually take out a personal pension plan with a bank, building society or life insurance company into which you'll make regular contributions over the course of a number of years - generally these will be deducted from your wages at source.
Your chosen pension provider will then take your money and invest it in one or more funds with the aim of growing your pension pot.
You'll receive a yearly forecast which will tell you both how much your pension pot is currently worth and what you can expect to receive at retirement if you keep making contributions at the current rate.
However, the amount of money that you'll receive upon retirement is not predetermined. Instead it depends how much you pay in, how long you make contributions for and, most importantly, how the funds your money is invested in perform.
Most plans are also subject to charges from the pension provider - you will usually be charged a percentage fee for both setting up and running your pension plan. These fees are normally deducted directly from your pension pot so are worth considering when you're investigating your options.
Another factor that determines how much you receive when you retire is the annuity rate.
An annuity is usually bought from an insurance company with the savings in your pension pot. The annuity rate is basically a factor that is used to convert your pension pot into a guaranteed income which is payable for the remainder of your life.
Tax relief on your personal pension plan
Because of the tax benefits that apply, private pension plans are generally considered to be one of the most economical ways to save for retirement.
As well as the fund being free from both income and capital gains tax you can receive tax relief on contributions of up to 100% of your earnings each year - providing this is less than the annual pension contribution allowance.
This means that if you pay the basic 20% rate of tax, you'll receive an extra £20 for every £80 that you contribute to your private pension plan. This also applies to higher rate tax payers although the elevated relief will only apply to the amount of income that is subject to tax at the 40% or 50% rate.
The tax benefits continue up until you retire, when up to 25% of the total value of your pension pot can taken as a tax free lump sum - providing this equates to less than the lifetime contributions allowance.
If your total pension is less than £18,000 then you are entitled to take whole amount as lump sum, again with up to 25% tax free.
When can you get the money?
Once you have paid money into your private pension plan it has to stay there until you retire. The earliest you can draw on your pension is 55. However, most people tend to wait until they are 60 or 65 before retiring. Should you wish you can even put off taking your pension until even later.
Tempting as it is, you should remember that taking retirement early means that your pension pot will have less time to mature and, by the same token, will have to last you much longer.
How much should I pay in?
Obviously, the earlier you start to contribute to a private pension plan, the more time your pension pot has to grow. For this reason it makes sense to try to pay a realistic percentage of your earnings into your pension throughout your working life.
However, remember that a pension is a long term investment from which you'll be unable to withdraw funds early should you need it. For this reason it's important not to tie up all your spare cash in your pension fund and instead keep some more easily accessible in case your business or personal circumstances change in the future.
Start by thinking what kind of an income you will need in retirement. Will you still have a mortgage to pay off? Will you be downsizing? Will you have a son or daughter to put through university?
A rather scary rule of thumb is that you should take your current age, half it and then base the percentage of your salary that you pay into your pension scheme upon that i.e. if you’re 30 you pay 15% of your wages in.
While this figure may seem alarming, it certainly drives home the importance of planning for your retirement sooner, rather than later!
