If you’re working, you’re usually paying National Insurance contributions (NICs). This means you’ll be eligible for a basic State Pension.

It’s a start but it may not be enough to give you the standard of living you want. So you’ll need another source of income as well.  There are other types of pension, either offered through your employer or ones you can start yourself.  They are all long-term investments which you usually pay into throughout your working life. Depending on the type of pension, your employer may also pay in to it. You get tax relief on money you pay in, and your money is invested in stocks, shares and other investments to try to make it grow.  When you retire, your pension fund is usually converted into pension income which is paid to you till you die.

You don’t have to stop work to take a stakeholder or personal pension.  You can take a pension from your employer’s occupational scheme and carry on working for that employer, as long as scheme rules allow this. 

• Your retirement can last 20 or 30 years – maybe longer, so you need to be prepared
• You may be living on your retirement income a long time.  Try to think about how much income you’ll need. Work out how much you’ll want to spend (using today’s price levels).
• If you decide to use a pension to save for your retirement, it may be a good idea to start one as soon as possible. If you put it off by just a few years, you could end up with a much   smaller pension.
• Find out if your employer offers a pension scheme and whether they contribute to it.
• You cannot take your money out of a pension until you are at least 55.  Many schemes give you a statement each year with details of your possible income at retirement.

Different Types of Pensions

• Basic State Pension

Your National Insurance Contributions (NIC) go towards building up a basic State Pension. The State Pension age is currently 65 for men and between 60 and 65 for women depending on when you were born. It may, however, increase in the future.  The amount of State Pension you get is based on the amount of NIC you have paid. You may not even get a pension if you’ve paid less than the minimum though this may change in the future.  In some cases you may be credited with NIC if you are not working.  Your local social security office can tell you if you are entitled to credits.  Or you can choose to pay voluntary contributions.

• Additional State Pension

If you are (or have been) in employment, you may also be building up an additional State Pension – the State Second Pension, formerly SERPS (State Earnings Related Pensions Scheme).  The amount of State Second Pension you get depends on your earnings and your NICs record.  Anyone earning below a certain amount set by government may be entitled to additional State Second Pension.  Self-employed people cannot build up a pension through the State Second Pension.  Some people who cannot work through long-term illness or disability, or carers, may get some State Second Pension.

• Salary-related occupational pensions

Your employer may provide a salary related pension scheme. They are also called defined  benefit pensions because the benefit (your pension) is worked out using your salary and the length of time you have been a member of the pension scheme.  Usually, the employer contributes to the scheme and there are trustees to look after scheme members’ interests.  The scheme trustees and manager, not you, usually make all the investment decisions.  How they work?  You build up a pension at retirement that depends on:

How many years you have been a member of the pension scheme;
The earnings that your pension is based on (often averaged over the last three years before retirement);
The proportion of those earnings which you get as pension for each year of membership. The most common are 1/60th or 1/80th of your earnings for each year of membership.

The benefits of these schemes are that:

The pension is based on your length of membership and salary, so you have a fair idea of how much your pension will be (as a proportion of your earnings) before retirement;
Your employer should ensure there is enough money at the time you retire to pay you the pension.
Your employer normally contributes;
You get tax relief on your contributions;
Scheme investments grow generally free of income tax and capital gains tax;
Your pension benefits are linked to your salary while you are working, so they automatically increase as your pay rises;
Your pension income from the scheme will normally increase each year in line with the RPI (Retail Prices Index) or a set percentage, whichever is the lower.

Is there a risk?

Some salary-related occupational schemes have become insolvent and there hasn’t been enough money in the employer’s pension scheme to pay the pensions they had promised to their current and former employees.  The Government set up a Pension Protection Fund in April 2005 to provide some protection for members of salary-related schemes.

• Money purchase pensions

The pensions listed below are all money purchase pensions:

Occupational defined contribution pensions – some employers offer these schemes.
Group personal pensions.
Stakeholder pensions and individual personal pensions.

How they work

Money purchase pensions build up a pension fund using your contributions (and your employer’s contributions if they make any), plus investment returns (if any) and tax relief.  It helps to think of money purchase pensions as having two stages:

Stage 1: The fund is invested, usually in stocks and shares and other investments, with the aim of growing the fund over the years before you retire. Remember though that the value of investments may go up or down.

Stage 2: When you retire, you can take a tax-free lump sum from your fund and use the rest to secure an income – usually in the form of a lifetime annuity.

A lifetime annuity is an income you buy with your pension fund when you retire. The amount of pension you’ll get at retirement will depend on:

How much you pay into the fund;
How much your employer pays in (if anything);
How well your invested contributions perform;
The charges taken out of your fund by your pension provider;
How much you take out as a tax-free lump sum;
‘Annuity rates’ at the time you retire;
The type of annuity you choose.

The benefits of money purchase schemes are that:

You get tax relief on your contributions;
Your fund grows generally free of income tax and capital gains tax;
You may be able to choose the funds to invest in;
Your employer may contribute if it’s a work-based pension.

• Private Pensions

If you’ve checked on the pension schemes offered by your employer or are self employed and have decided on a private pension, you need to shop around for a stakeholder or personal pension.  Stakeholder and personal pensions are money purchase pensions (the pension you get is not linked to your salary). There are some differences between them.

1. Stakeholder Pensions

Stakeholder pensions must have certain features. Some of these are:

Limited charges;
Llow minimum payments;
Flexible contributions;
Penalty-free transfers;
A default investment fund – ie a fund your money will be invested in if you don’t want to choose one.

2. Personal Pensions

Personal pensions are similar to stakeholder pensions, but they usually offer a wider range of investment choices.  Personal pension charges may be similar to stakeholder pension charges but some are higher.  High charges deducted from your fund by the pension provider can reduce the growth of your fund. High charges do not necessarily mean better performance.
 

3. Self-invested Personal Pensions (SIPPs)

SIPPs are a type of personal pension designed for people who want to manage their own fund. Most SIPPs allow investment in a very wide range of funds and investments such as commercial property, offices, shops or factory premises. They often have higher charges than stakeholder and personal pensions.  For this reason, they may only be suitable for people who have large funds and are experienced with investing.

The table below shows the estimated monthly pension, at today’s prices, you would get for different regular monthly contributions.  The estimated pension (annuity) shown assumes
that:

You increase your contributions each year in line with inflation (which we’ve assumed to be 2.5% a year);
Before charges, your fund grows by 7% a year on top of your contributions;
Charges are 1.5% of the value of your fund each year for the first ten years and 1% a year afterwards;
A rebate of basic level tax at 20%;

When you retire the estimates assume you buy an annuity that increases by 2.5% a year with a 50% spouse’s annuity.

Annuity rates assume that the investment return after retirement is 0.8% a year in excess of inflation.

These estimates are not guaranteed – you could get more or less than the amounts shown. The table gives you an idea of how much you need to pay now – as a regular monthly
contribution – to get the monthly income you want when you retire. In particular, the rate of growth of your fund may vary considerably and may be below 7% a year.

Pension Estimator
What you pay per month for the first year (tax rebates will be added to this amount)	£20		£50		£100		£200
Initial monthly pension if you retire at
Current Age	65	60	65	60	65	60	65	60
20	£98	£68	£245	£171	£491	£342	£983	£684
25	£79	£54	£198	£135	£396	£271	£792	£543
30	£63	£42	£157	£106	£315	£212	£630	£424
35	£49	£32	£122	£80	£245	£161	£491	£322
40	£37	£23	£93	£58	£187	£117	£374	£235
45	£27	£16	£68	£40	£137	£80	£274	£161
50	£18	£9	£47	£24	£94	£49	£188	£98
55	£11	£4	£28	£11	£57	£23	£115	£46
60	£5		£13		£27		£54

Contracting out of the State Second Pension

If you are an employee, you are automatically included in the State Second Pension unless you   decide to leave it (called ‘contracting out’), or you are a member of an employer’s occupational pension scheme that is contracted out.  If you decide to contract out:

• You stop building up your State Second Pension entitlement and build up a replacement for it in your own pension instead (for example, in a stakeholder or personal pension);
• HM Revenue & Customs (HMRC) will pay a rebate of part of your National Insurance contributions into your stakeholder or personal pension.
• You will continue to be contracted out of the State Second Pension, unless you decide to contract back in.

If you are contributing to your employer’s occupational pension scheme, and it is a contracted-out scheme, you cannot contract back in while you continue to be a member of that scheme. Check with your employer.

You should make sure you review your decision every year.

The option to contract out may be removed in the future.

Reviewing your plans

Retirement planning is not a one-off task. Once you have started a pension or other retirement savings, you should keep it under review. Review your plans regularly and make sure you are contributing enough to provide the retirement income you want.

Review your plans if your circumstances change For example, if you get a new job, become self-employed, marry or get divorced.

When reviewing your plans your options may depend on how long you have to go till retirement, whether you have to provide for your partner, and the type of pension you already have.

Find out if you’re on track

Are you on target to get the level of income you want in retirement? And has that level of income
changed? Use the previous table for how much you may need to save to get the income you want.

How much State Pension might you get?

Get a State Pension forecast from the Department for Work and Pensions (DWP) by completing
form BR19.