On average, people in the UK live for 240 months after they’ve retired – that’s the equivalent of 240 missed paycheques. In simple terms, this means that, to reach a desired retirement income of, say, £1,000 a month on top of the State Pension, you would have to accumulate a pot of £240,000 before you retire. According to some estimates, the current average UK pension point is around £50,000.
Putting it in this context, it’s clear to see the scale of the challenge facing the country’s future retirees. The problem is that too many don’t realise just how much money they will need to retire comfortably. And although a large number of people nearing or at retirement age are arguably still not fully aware of how much they need, the problem is much more acute for the younger generation.
Although it might be understandable that saving for more immediate things (such as a property, cars, holidays) will take priority for younger generations, the truth is that people need to be putting aside 15 per cent of their pay from an early age; if you’re late to the game, you will then need to be putting aside the percentage equivalent of half your age in order to achieve a meaningful income in retirement.
One of the reasons for the lack of pensions awareness could be the system’s perceived complexity; ‘confusing’ is the word I most frequently hear from consumers who have questions about their pension. This is perhaps unsurprising, especially when considering the amount of changes the system has undergone in recent years. Just getting to grips with the financial jargon associated with pensions can be a hurdle for many people looking to plan for their retirement.
To help, we have put together a jargon-busting guide to some of the most frequently used terms:
The annual allowance is the limit to how much an individual can contribute into a pension each year while still receiving tax relief. The annual allowance for most people is £40,000. However, for those with total income in excess of £150,000 p.a. the annual allowance can drop to as low as £10,000.
This is the maximum amount that you can hold across all of your pension pots without facing any tax implication. Although it is currently set at £1m, the level has been subject to change under different governments over the years. If you look like you’re are going to breach the £1m mark or have done so already, you should consider speaking to a financial adviser to seek advice on ways of protecting yourself and mitigating any tax charges.
Defined contribution pension
The most common type of pension used today and may also be known as a Personal Pension, Group Personal Pension, Master Trust or Money Purchase Scheme. It can be arranged by an individual or could be a workplace pension scheme from your employer and money can typically be accessed from the age of 55. The money you and your employer pay in is invested by your pension provider, and the pot you receive depends on how much you have put in and how well investments have performed over the lifetime of the pension.
A government initiative that encourages people to save for later life through a pension scheme at work. It is compulsory for employers to automatically enrol eligible employees into a qualifying workplace pension scheme. The employer must also make contributions (this is currently a minimum of 1.0 per cent of your qualifying earnings until 6 April 2018, rising to 2.0 per cent until 6 April 2019 then rising to 3.0 per cent).
Final salary (or defined benefit) pension
No longer widely open to employees, the defined benefit pension was often referred to as ‘gold plated’ due to its apparent generosity. The amount you receive is based on how many years you have worked for an employer and your final salary as at the date you left employment or retired, paying out a secure income for life and increasing each year.
Under rules introduced in 2015, there are now more flexible options for withdrawing money from your pension plan after the age of 55. Before the so-called pension freedoms came into force, many people just took out an annuity; these days, it’s possible to withdraw the whole sum or small amounts in cash, while income drawdown means your provider will move your investment into funds designed to give the income you desire. Though be wary that taking too much too early could leave you without an income for later in life.
The world of work has changed considerably in recent years, and the idea that a person has just one or two jobs in their lifetime doesn’t really ring true for a lot of people. As a direct result of changing careers multiple times in their life, many people will have amassed a number of different pension pots through various employers along the way – consolidating these into one pot is therefore a useful way to keep an eye on your investments in one place. These are known as pension transfers.
The new found freedoms have made annuities less attractive, but for many people they will still be central to planning for retirement. To put it simply, annuities offer you either a guaranteed income for life or for a fixed number of years. The income that you receive is dependent on how much you have saved and requires a detailed assessment of your life expectancy. Enhanced annuity rates are available to those in poor health or with a shortened life expectancy and you should always take advice when considering your retirement options as you are making a decision that will determine your income for on average the next twenty years or 240 pay packets.
Self-Invested Personal Pension
A self-invested personal pension (SIPP) is a defined contribution plan and it allows you to invest in a wider range of assets including purchasing commercial property. A SIPP allows people to take responsibility for choosing the investments or they can, of course, work with a financial adviser. As a result, this option is only wise for the investment-savvy or those who have access to independent financial advice.
Tax-free lump sum
From the age of 55, you can take 25 per cent of your pension pot as tax-free cash sum. You can take the tax-free cash sum in one go or spread it over a number of years. This can be a great option for people that want to pay off a mortgage, make a trip of a lifetime, reduce their working hours or maybe help their children with their first steps onto the property ladder. If you are taking a tax-free cash sum then you should note that this will reduce your income in later life.
In recognition of today’s mobile job market, you have the option upon leaving your employer to transfer your current pension pot. The pension administrator or provider will provide you with a transfer value that includes any benefits accrued. It’s important to consider any guaranteed benefits that you may be giving up prior to transferring any pensions.
Elliot Silk is head of commercial at Sanlam UK. This article was originally published on our sister website Money Observer.