We’re delighted to offer answers to pension FAQs / the most frequently asked questions about UK pensions. This information can be shared with employees to help them have a better understanding of the importance of investing for their future.
What is a pension?
A UK pension is a financial arrangement designed to provide a regular income for people during their retirement years. It serves as a long-term savings vehicle that helps people to build funds over their working years, leading to better financial security when they eventually stop working. Contributing to a pension means that money is set aside and cannot be accessed until the person is at least 55 years old.
One notable feature of pensions in the UK is the system of auto-enrolment, where employers are legally required to automatically enrol their eligible employees into a workplace pension scheme. Auto-enrolment has been instrumental in encouraging retirement savings by ensuring that workers benefit from both their own contributions and those made by their employers, helping them to save for a more secure financial future. Many pensions now can be accessed electronically and they're known as digital pensions.
Why should I invest in a UK pension?
Investing in a UK pension is a wise financial decision for lots of reasons.
Compound interest: Pensions allow you to benefit from the power of compound interest. When you contribute to your pension fund, your money is invested and any returns generated on those investments are reinvested. Over time, this compounding effect can significantly grow your retirement savings. The earlier you start contributing, the more time your investments have to compound, making it an effective way to build wealth for your future.
Tax advantages: Many pension plans offer tax benefits. Contributions to pensions are tax-deductible, reducing your taxable income in the year of contribution. The earnings within the pension fund grow tax-free, providing you with a more tax-efficient way to save for retirement.
Employer contributions: One of the most significant advantages of pensions is employer contributions. Auto-enrolment was introduced in the UK in 2012, rolling out first across large employers then all businesses.
Employers are legally-bound to offer pension plans as part of their employee benefits package and contribute a percentage of your salary to your pension fund as well as making a contribution themselves. This boosts your retirement savings without any additional effort on your part.
Security in retirement: Pensions provide a reliable source of income during retirement. Unlike other savings or investments that might fluctuate with market conditions, a pension offers a stable income stream, ensuring that you have financial security in your retirement years.
Long-term focus: Pensions are designed specifically for retirement savings. The rules surrounding pension funds prevent early withdrawals, which helps you maintain a long-term perspective on your financial future and prevents you from dipping into your retirement savings for short-term needs.
Diversification: Pension funds are typically managed by professionals who diversify investments across various asset classes to minimise risk. This diversification can help protect your savings from market volatility and economic downturns.
Reduced reliance on the state pension: By investing in a pension, you reduce your reliance on government-provided retirement benefits like the State Pension. This can be especially important as these benefits may not be sufficient to maintain your desired standard of living in retirement. The State Pension does, however, boost your retirement income if you have made contributions throughout your working life.
Investing in a pension is a smart choice for securing your financial future. Pensions offer lots of benefits, helping you build a substantial nest egg and enjoy peace of mind in retirement years.
What is salary sacrifice and how does it work?
Salary sacrifice is a financial arrangement where an employee agrees to exchange part of their pre-tax salary for specific non-cash benefits offered by their employer. This practice is commonly used to access various employee benefits in a more tax-efficient manner.
Under the salary sacrifice arrangement between the employee and their employer, the employee agrees to reduce their gross (pre-tax) salary by a specific amount. This reduction is often used to fund certain benefits, such as pension contributions, childcare vouchers or for the purchase of technology equipment like laptops or bicycles through employer schemes.
The funds that would have been part of the employee's gross salary are redirected to cover the cost of the chosen benefit. For example, if an employee chooses to sacrifice a portion of their salary for a pension contribution, the sacrificed amount is invested in their pension fund.
The key advantage of salary sacrifice is the reduction in taxable income. Since the sacrificed portion of the salary is not subject to income tax or National Insurance contributions (‘NICs’) because it’s ‘withdrawn’ before tax and National Insurance is calculated and deducted so the employee pays less tax and NICs. This can result in significant savings for the employee. It can also benefit the employer as NICs are not applicable on the value of the salary sacrifice.
It's crucial to carefully consider the implications and benefits of salary sacrifice before entering into such an arrangement, as it may affect your overall financial situation and entitlements. While it can offer tax advantages and access to valuable benefits, it may not be suitable for everyone. Seeking financial advice or consulting with your HR department is advisable to make an informed decision on whether salary sacrifice is a good option for you.
How much should I be saving for my retirement?
There's no one single right answer to this question, because it depends on when you want to retire and the lifestyle you want to enjoy when you get there. If you want to retire early then you’ll need quite a lot more in your pension than perhaps you may imagine. This is because your time in retirement and enjoying your pension is likely to be as long, if not longer, than the time you spend working and building it up.
When you do pay into a pension the money you contribute is effectively locked into the pension until you retire, currently only accessible from age 55 onwards. It’s prudent to contribute money you can afford while balancing it up against the needs for your retirement.
Pension funding is a balance between meeting your needs of today whilst planning for tomorrow. Even a small contribution from a young age can make a big difference over time so starting early and building a contribution up in value, year after year, will help you enjoy a more financially secure retirement.
A good rule of thumb for retirement is to save enough to cover around 80% of your pre-retirement income.
Money Helper has a useful pension calculator that can be accessed here
How much is the UK state pension?
At the time of writing (September 2023), the ‘full’ State Pension is £203.85 per week and it’s paid every four weeks, in arrears. The State Pension is dependent on a worker’s National Insurance record, so for some workers who’ve taken career-breaks and not made contributions for a minimum of 35 qualifying years, the weekly value will be less.
Workers usually need a minimum 10 qualifying years on their National Insurance record to receive any State Pension. The current State Pension age is 66 years old, rising to 67 years old between 2026 and 2028.
Should I consolidate my individual pension plans?
Your pension is there for your retirement, and you should feel like you’re in control of it. Many of us have several different jobs over our lifetime which means you’re likely to have several different pension pots. This makes it pretty difficult to keep track of your retirement savings and plan for the future.
Putting your smaller pension plots together into one makes it easier to plan for your future and can often see a reduction in the ongoing pension plan charges. For employees paid with PayCaptain payroll software, all pension pot are accessible through PayCaptain's pension dashboard.
What options do I have when I reach retirement?
Under current rules you can access your pension from age 55 and you don’t have to stop working to do so.
When your decide to access your pension benefits you can take up to 25% of the value as a tax-free lump-sum, subject to some rules and regulations. If you’d like to do this, it’s advisable to take advice on this from an Independent Financial Adviser.
The remaining 75% of your pension can be used to buy an annuity (a guaranteed income for the rest of your life) or you can keep the pension invested and access it flexibly over your retirement. You can even take all of your pension in one go, but remember that after the 25% tax-free cash amount, the rest of the pension is taxed as income. Taking your pension in one go can push you up into a higher rate for Income Tax for that year. It’s definitely a good idea to take advice when you're thinking about taking your pension benefits as it can help you reduce your tax liabilities.
How much will a pension cost me?
A simple pension set up and run by your employer is the lowest cost option. There are likely to be no upfront advice costs because no one is advising you.
On an ongoing basis you’re likely to pay less than 1.5% of your pension value each year in plan charges and investment costs. The plan has limited investment fund choices where you can either accept the default one offered by your provider or chose between some limited options. These types of pensions are likely to be suitable for people earning up to the Higher Rate income tax threshold.
When you begin to build up a pension fund of around £50,000, then paying for more specialist advice begins to add more value and you might find you benefit from the reassurance gained from having an expert’s advice and guidance.
Financial advisers all have their own individual costs and charges but they will openly discuss these with you in advance of working with them. A broad rule of thumb is to expect to pay between 1% for advice on very large pension values to perhaps 4% on smaller pension fund values.
What happens to my pension if I die early?
No one likes to dwell on the worst that can happen but it’s good to plan for the worst and hope for the best.
If you were to die before you retired, subject to some rules and regulations, the value of your pension can be left to those you care about as a tax-free lump sum. To help ensure it goes to who you want it too you need to complete a “Notification of Wishes” form that your scheme administrator will make available to you.
If you’ve retired, then it can change how the death benefits are paid as you might have bought an annuity which continues on your death, to pay perhaps 50% of the income to your surviving spouse or partner.
If you die after reaching your 75th birthday then it changes how the pension benefits are taxed on death. The Government changes the rules on pensions quite often, so if this is of specific importance then you might want to engage an Independent Financial Adviser to advise you on your own unique personal circumstances.
How does PayCaptain help?
PayCaptain’s core aim is to improve the financial wellbeing and resilience of UK workers. With tools to help employees understand their pay better and make saving easier, PayCaptain offers access to an employee’s pensions through the PayCaptain app.
PayCaptain integrates with a number of pension providers, including Collegia, Penfold and Smart Pensions which means pension investments can be made directly from payroll. In a new development, employees can now access all of their pensions directly from the PayCaptain mobile payroll app. In the PayCaptain pensions dashboard, employees can now add all of their existing pension pots in one place. This makes it much easier for users to understand and keep a track of their total pension-related savings.
PayCaptain is designed to reinforce the positive nature of pension contributions made via payroll, listing them as investments on employee’s online payslips. PayCaptain also makes it easy to see the employer’s contribution going into an employee’s pension each payday for additional visibility and engagement.
An employee contributing to their pension shouldn’t feel like a deduction, but a constructive action for a more resilient financial future. By framing a pension payment as an investment, combined with easy visibility of pension balances in the pension dashboard, it creates much more positivity around long term retirement savings.
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