UK Pensions Guide

Our pension is something that we must all consider at some point in our life.

Preferably we should give some thought to it earlier on in our working life, so that we have adequate time to contribute to it which we can then take advantage of when we retire.

You may already have a pension or are perhaps considering contributing to one.  The difficulty is however that there are so many different kinds of Pension available on the market place, and all of them gave very different names and work in different ways.

At Unlock My Pension, we want to help you understand Pensions.  Here we set out what the different kinds of pension are, how they work and what you can do with them.

What is available?

In the UK there are three different kinds of Pension:

  1. The State Pension;
  2. The Defined Benefit Pension; and
  3. The Defined Contribution Pension.

These three different kinds of Pension share one common characteristic: they are designed to provide you with a regular source of income that you will use to live when you are no longer working.  The similarity however ends here as each kind of Pension operates differently.

What is the State Pension?

The vast majority of people living in the UK will be familiar with the State Pension.  You will have been amassing your State Pension for the vast majority of your working life, through your paying your National Insurance (NI) contributions every month.

In terms of the value of the State Pension that you will receive, this will largely depend on how much you have paid into it over the course of your life.  It is generally the case that the value of your State Pension will be in line with the level of inflation.

It is not uncommon that people do experience breaks in their working life, either through a change in job or as a result of illness.  In those situations while you may not have been working and making your NI contributions, you will in most circumstances be entitled to NI credits which would make up for the missing contributions to the State Pension

The rules for when you will be entitled to the State Pension tend to change over the years.  Ultimately the date that you will become entitled to start withdrawing your State Pension will depend on the year that you were born.  If you begin to withdraw your State Pension before 6 April 2016 your entitlement will be under the current rules mentioned above.  If however you withdraw your Pension on or after 6 April 2016, your State Pension will be a flat-rate calculation based on your NI contributions and credits.

What is a Defined Benefit Pension?

Many people may already be involved in a Defined Benefit Pension.  These are sometimes known as ‘Final Salary Pensions’ and are often made available to employees working in the public sector, or large organisations in the private sector.

The value of your Defined Benefit Pension will depend on how long you have been working for that particular organisation, and the salary that you have earned.  Alternatively, the value of the pension  may be the average of the salary that you have enjoyed while you have been contributing to the pension over the course of your career.

It is important to note that unlike the State Pension, Defined Benefit Pensions are paid by your employer and it is their responsibility to ensure that there is enough money available when you retire to pay your pension.

The point at which you can start to use a Defined Benefit Pension will depend on the agreement that you entered into – it will specify the age that you can start to withdraw it.  In most circumstances the age will be 65 however, some Pensions may allow for you to withdraw the pension earlier.  It is important to keep in mind that if you can access the Pension earlier, this could dramatically reduce the value of your entitlement.

What is a Defined Contribution Pension?

These are sometimes known as ‘Money Purchase Pensions’, and tend to become accessible when you turn 55.  You can then use this money to provide an income in retirement by purchasing an annuity.  However as of April 2015 you will have greater freedom in accessing your pension, meaning you could withdraw the total pension as a lump sum.  This would however be liable to income tax.

As of 2012 every UK employer is now obliged to enroll their employees into a Defined Contribution Pension Scheme.  Your employer will deduct your contributions from your salary before they are taxed, and along with their own contribution, this will be invested in the stock market to increase in value through your working life.  The Government will normally provide some tax relief to the pension contributions too.  The value of your pension is difficult to predict and will depend on a number of things including:

  1. The level of contributions you make to the pension – normally you can ask to increase your contributions;
  2. The level of your employer’s contributions – this will vary from scheme to scheme;
  3. The length of time that you contribute to the scheme; and
  4. The performance of the investment – it is very difficult to predict how well investments will perform in the stock market and much will depend on the level of risk that you are prepared to accept.

There is a lot of decision making involved in planning for a time when we are no longer working.  In practice most people will have an entitlement to a State Pension and a Defined Contribution Scheme.  However the decision of how, and when to use these should be taken carefully as you must make sure that there will be enough money for you to be comfortable for the rest of your life.  The level of money that you wish to retire on will ultimately depend on the kind of lifestyle that you want.  Furthermore you must take into consideration that some of your pension pot may be liable to taxation, and this should be factored into your decision making.

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