The UK pension system can seem very confusing. All you want is to know what you need to do to one day retire comfortably. Why does it have to be so complicated?
There are many reasons why it isn’t straightforward. However, the good news is that you do not need to feel trapped and overwhelmed by all the jargon surrounding pensions.
In this short guide, our Oxford-based financial planners here at Weston Murray & Moore will be offering you a short explanation about how pensions work. We’ll then present some ideas about how you can start planning for the retirement you eventually want.
What is a pension?
Simply put, it’s a type of income you get once you finish working. You build up this income throughout your working life, for instance, by putting money each month into a pension pot.
The confusion tends to come in when looking at the different types of pension available.
The State Pension
British citizens should all get a state pension when they retire. This is money which you get from the government, and the amount is determined by how the amount of National Insurance contributions you made during your lifetime.
Other types of pension
One common type of pension occurs in your workplace and is called a “defined contribution” pension. Most people are now put onto one through a process called “auto enrolment”.
Here, both you and your employer put money into your pension pot each month in order to save towards your retirement. In 2018-19 you must put in at last 3% of your salary, and your employer must put in at least 2%.
Another important type of pension is the “final salary” pension (sometimes called a “defined contribution” pension). Here, neither you nor your employer put money into a pension pot each month. Rather, your employer pays you an income when you retire. The amount usually depends on factors such as your salary when you retired, and your total years of service.
One other common pension type is the “personal” pension (sometimes called a “private” pension). In this situation, you set up a pension scheme yourself with the help of a pension provider – rather than through your employer.
Can I just rely on the State Pension?
For most people, the short answer is no. In 2018-19, the new full State Pension will give you a maximum of £164.35 per week. That’s around £657 a month – or £8,554 per year.
Even assuming you have fully paid off your mortgage by the time you retire, the children have left come and you no longer face costly expenses like work commuting costs, this is unlikely to cover most people’s expenditure in retirement.
For instance, Which? estimates that you might need between £26,000 – £39,000 per year in order to live comfortably in retirement. That’s a lot more than the £8,554 offered by the State Pension! To achieve this, most people are going to need to make extra retirement plans.
Can’t I just rely on my workplace pension?
You might be able to, but you need to check the benefits your workplace pension gives you.
Remember, in 2018-19 your employer is only legally-required to contribute 2% of your salary towards your pension pot (assuming you are on a defined contribution scheme).
You will have to put in a minimum of 3% – which makes a total of 5%. You then need to look at what this amounts to, in light of your annual salary.
For instance, for a salary of £25,000 this 5% amounts to £1,250. Imagine for the sake of example that this person stays on this salary and contribution level for the next 30 years, to the point where they are thinking about retirement.
At this point, the total contributions would be £37,000 (i.e. £1,250 x 30). The total amount in the pot might be more, however, if this money has been invested sensibly and produced a healthy level of interest growth.
So again, for the sake of argument let’s assume that the money grows 5% each year over the course of 30 years. In this case, the total in the pot could be closer to £85,000.
That sounds like a lot, right? However, you need to consider how this £85,000 might stretch across your retirement – which could last as long as 10, 20 or even 30+ years.
For many people, simply relying on their State Pension and default workplace pension arrangements might not be enough to cover your lifestyle and expenses in retirement. It is therefore usually a good idea to talk things through with a financial planner.
Where a financial planner can help
Part of the trouble of knowing how much you need in retirement is that you do not know exactly what your costs are going to be.
The other challenge is trying to figure out exactly how to plan your finances over the next 20-30 years, in order to save up enough to cover those costs.
A financial planner can offer lots of help in these areas. First of all, they can help you realistically assess how much you are likely to need in retirement, in light of your desired lifestyle and financial goals.
Secondly, they will be able to show you how to realistically achieve those goals through a tax-efficient financial plan. For instance, it might be that your financial planner recommends that you continue building up your National Insurance contributions to get the full State Pension.
In addition, they might advise that you also increase how much you are contributing to your workplace pension, and help you set up an additional personal pension.
Or, perhaps your financial plan will look completely different from this. It depends entirely on your unique financial situations and goals.
Get in touch today if you are interested in arranging a free, no-commitment pension consultation with one of our Oxford-based financial planners here at WMM.
