The sooner you start considering your pension, the better life will be when you quit the nine to five.
Retirement may seem a long way off, but the contributions you make to your pension pot in your early years have the most impact in later life. And given the bad news surrounding pensions in recent years, it's worth making sure you're clued up.
Pensions are boring. Why now?
The earlier you start a pension scheme, the more you'll save. The money you save aged 25 could be worth up to eight times the money you put in aged 45 when you come to redeem it - this is called compound growth. So for a secure retirement, the earlier you think about a pension, the better. Sarah Hindley, 23, says: "I've just started my first job and I've put pension planning on the to-do list - this way I won't leave it until I'm 30 and it'll be sorted."
Why it pays to plan ahead
Figures show that if a 21-year-old pays £75 a month into a stakeholder pension, they could achieve a retirement fund of £337,000, which would buy a pension of £12,700 a year in retirement, according to HSBC. However, if they wait until 30 to start contributions of the same amount, they would have a fund of just £171,000 or £6,470 a year in retirement.
Why bother with a pension?
Pension schemes are very tax-friendly. The government wants you to provide for your own retirement, so depending on your tax bracket, instead of taxing you, for every £80 you put in a pension the Government actually adds £20. Nice! Also, they stop you getting your hands on the money until retirement so you don't fritter away your money.
Rob Smith, 25, says: "I know that whatever contributions I make to my pension are boosted by the government and that means I'm effectively saying 'no' to free money if I don't pay into it."
Where will my retirement income come from?
Most of us don't want to work till we drop and there are already plans to raise the retirement age to 70. The money to look after you in retirement comes from a few places:
- The Government. If you're working, you pay National Insurance Contributions. Some of that goes towards your state pension. The bad news is that state pensions aren't very generous - in 2009-10 single pensioners get £95.25 a week for a Basic State Pension. Find out more about pension rates on the DirectGov website.
- Your savings and investments. If you become very successful, you might just have enough to live on. But that's a gamble, and besides you'd probably rather use your savings to enjoy your free time rather than for survival.
- Your employer. Most large companies have company pension schemes. You pay a certain amount from your salary into the scheme (with tax relief), and the good news is, your company will usually contribute on top of what you put in. If you leave the company, you can continue the scheme, leave it on hold, or sometimes transfer it to a private scheme. Some lucky people (e.g. civil servants) have final salary pension schemes that guarantee an income based on their salary when they retire, but these are very rare, and are rapidly being phased out.
- A private pension scheme. Irrespective of where and when you work, a private scheme is your own private retirement nest egg. It's portable between jobs, and usually flexible (try to get one that is!) Most people these days use a private scheme.
Why all the bad news?
Recent turmoil hasn't made people want to lock their money up for the long-term. Pension companies invest in the stock market; and that has crashed far worse than city experts expected - particularly when the financial crisis hit. So in the past year, many pensions companies have admitted that they won't be paying out as much as they had promised. Indeed some are on the verge of bankruptcy. So you must get professional advice before committing to a pension. You can find an independent financial adviser at Unbiased.co.uk.
How much should you save?
As a guide, a minimum of 10% of your salary needs to be saved each month over your working career. If you are putting less than this away, you need to top up later down the line.
What's a Stakeholder pension?
These are a low-cost pensions, which the government introduced in 2001. They're not different from normal pensions, but are designed for low-earners, because they have very low management charges. They haven't been too successful, mainly because they also don't necessarily offer the best rates of return and most pension charges have been brought into line now.
What's a SIPP?
Self-invested personal pensions (SIPPs) are also a good way to build a fund for retirement. A SIPP is a tax-efficient pensions account where you can hold shares, funds and cash.
SIPPs are a wonderful vehicle because they allow a great deal of flexibility in what you can invest in. However, SIPPs require time and effort, and their charging structure makes them more expensive than stakeholder and private pensions.
Mix and match
It's important to build up investments to compliment your pension. This is particularly important if you want to retire early, because you can't access a pension until at least age 55 and you really want to put off dipping in to it for as long as possible to allow it to grow.
ISAs are good because your savings can grow tax free, and unlike pensions, which are subject to income tax, you can withdraw from an ISA anytime free of tax. The limit for the amount you can invest in an ISA changes every year, so make sure you check the limits with your bank or with a reputable website registered with the Financial Services Authority.
What's an annuity?
When you retire and pick up your pension, an annuity is a scheme that pays out your pension in regular chunks, like a salary. To prevent you blowing your entire pension on holidays and horses, you are legally obliged to stick to certain rules for how much you can take out of your pension pot and one way of doing this is to buy an annuity.
Where do I get one?
Start with an independent financial adviser. The consultation should be free, and a good adviser is worth their weight in gold. There are also some great guides, including those provided by Money Made Clear and Directgov.
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