The idea of even thinking about pensions and retirement at 21 seems bananas at first, but really, your 20s are a great time to start putting away some funds for later in life. This might be through a Self-Invested Personal Pension (SIPP) or auto-enrolment in a Workplace Pension scheme after getting your first job. Advisors from Hargreaves Lansdown and The Society of Pensions Consultants encourage young people to start saving as soon as possible to ensure greater financial freedom later in life, especially given that the age you can receive your State Pension has increased.
Pensions, especially with new changes to State Pension rules, are a complicated and headache inducing area of personal finance. For my final piece of the summer, I’ve tried to break down the basics for you, but as always, please take stock of your own financial situation and consult independent financial advisors/your employer before making big decisions.
What are pensions?
Firstly, pensions are essentially a tax-sheltered wrapper for your money, meaning that whilst you often won’t be able to access it until a certain age threshold, you will not have to pay tax on some of the money saved there. You can usually choose to get 25% tax free and you get the rest as regular payments.
Generally, the earlier you start the better as this means you can save less per month than you would have if you started later in life. Moreover, if you choose to invest your pension, your money will have longer to grow and may see better returns in the future. The most attractive reason for starting early, for me at least, is the possibility of retiring younger.
Naturally, the amount you are able to put towards your retirement pot will depend on monthly earnings, outgoings and other savings goals like property deposits or a vehicle. There is a general guideline for pension contributions:
Take the age you start your pension and halve it. Then put this % of your pre-tax salary into your pension each year until you retire.
So if I start contributing to my pension at age 22, with a starting pre-tax salary of £24,000 per annum, I would put 11% of my salary away. If I miraculously get a pay rise in three years to £35,000, I would still put 11% of £35K into my pension pot (which could be a SIPP, or directly into your workplace pension).
For every contribution you make to a pension, the government will pay 20%, increasing the amount of money you have saved. This is called basic-rate tax relief, which you receive only if you contribute as much as you earn in the current tax year across all your pensions. If you are a higher-rate tax payer, you can claim even more tax relief through your tax return.
The annual limit for contribution is £40,000 which includes total value of all contributes as well as basic-rate tax relief added. If you haven’t used your allowance from previous years, you can carry it forward into the current tax year.
There is also a lifetime limit on your pension, currently set at £1,073,100. This will rise with inflation, anything above this number will incur a tax charge.
According to the new rules, I and everyone else born after 6 April 1978 can receive a State Pension when I’m 68. The full new State Pension is £175.20 a week, but what you actually receive is based on your National Insurance record. You need at least 35 qualifying years to the the new full State Pension (if you do not have an NI Record before 6 April 2016).
For a year to qualify you need to either:
- Be employed and earning over £183 a week from one employer
- Be self-employed and paying NI contributions
- Be receiving National Insurance Credits in lieu of working due to Childcare, Jobseekers Allowance, Carers Allowance etc.
- Be paying voluntary NI contributions if you don’t meet qualifying criteria to keep working to increase your State Pension amount
Workplace Pension Scheme
A workplace pension is a scheme that has recently been made mandatory for the large majority of employers. Essentially, when you pay in a certain percentage of your wages, your employer will also make a contribution to your pension.
If you are over 22 and earning over £10,000 per annum you will be auto-enrolled into your workplace pension. Usually your contribution of a minimum of 5%, automatically deducted from your wages, is matched by your employer’s minimum contribution of 3%. Total contributions have to be at least 8% but can be more. Under 22, you won’t be automatically enrolled, but if you earn over £6,240 a year you can opt into the scheme.
What you and your employer pays in depends on the kind of pension plan you’re on, either defined contribution (a pension pot based on how much is paid in) or defined benefit (usually a workplace pension based on your salary and how long you’ve worked for your employer).
Furthermore, the government also adds to your workplace pension in the form of tax relief if you pay Income Tax. If you have any questions about your workplace pension going into a new role or company, email or call HR directly to discuss it in more detail.
Self-Invested Personal Pension (SIPP)
Some people choose to, in addition to their workplace pension, also keep money aside in a SIPP. Your contributions to your SIPP are still subject to annual and lifetime limits on pensions, but offer an opportunity to grow your money free from UK income and capital gains tax.
SIPP providers often let you pick between investing in a ready-made portfolio based on the level of risk you’d like to take and investment priorities, or let you pick your own individual investments such as funds, trusts and shares. You can change investments as and when you see fit. As usual with any investment, your capital is at risk – your investment value can go down as well as up. A SIPP requires more responsibility and commitment to regularly reviewing your investment performance.
From 2028, after you reach your 57th birthday you will be able to withdraw your money – even if you are not formally retired. You can take up to 25% of this tax-free and further withdrawals are taxed as income. How you withdraw your money is up to you, and worth reviewing in more detail when the time comes as there are various options. When you pass away your SIPP can be passed to your beneficiaries, and in the majority of cases this will be free from inheritance tax.
So that wraps up my final column piece for the summer, it’s been a pleasure sharpening up my knowledge and hopefully providing a useful resource to help you on your way to financial liberation. Best of luck building those fuck off funds, finding the best deal for cocktail hour, and budgeting for fun and the future! I’ll be back in Michaelmas Term with more forays into personal finance- see you then!