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What is a pension?

Despite being a nation encouraged to invest in pensions from the get go, there is much confusion over what a pension is and how it works.

Pensions: defined

According to the Oxford English Dictionary a pension is ‘a regular payment made during a person’s retirement from an investment fund to which that person or their employer has contributed during their working life.’

Whilst on the face of it, pensions can seem like boring admin, without one, you face a future with no income. Pensions are an integral part of working and saving lives to ensure that you have sufficient funds to enjoy life away from work.

Do you understand your pension?

From the get go it is said that everyone must invest in their pension. Fresh from school or university and positioned in your first role, you’re often quickly placed into a pension plan, which sees you paying a portion of your wage into a pension pot.

Its widely acknowledged that this type of saving isn’t seen for decades, and this time horizon means many people neglect them. How many of you are guilty of absent-mindedly contributing the minimum and just leaving the risk level at the automatic selection?

There seems to be an assumption that everyone knows what a pension is, how it works, and the fact one is needed. But with over 15 changes to the pension system in the UK in the last five years, and countless rumours on changes to the tax benefits, it’s difficult to keep up to date.

As you go from job to job, you’re now accumulating pensions. If you’re in job six, you likely have six different pensions, but how much do you know about these pensions? What are the charges, where are they held, what are the returns? This is information you should know, but when you have children to fund, and a mortgage and bills to pay, pensions are often at the bottom of the list.

But pensions are something we all need to be thinking about. To live off the annual London retirement salary of £34,473, you would need a pension pot of about £430,000. That means if you start saving from the age of 20, you would only need to put away £50 per week. However, if you only start paying into your pension from the age of 50, you would need to be saving over £350 per week or £19,500 each year.

When we look into pensions, they aren’t as intimidating as they may seem. Here we take a look at what a pension is and how it works.

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The pension basics

According to the Pension Regulator, a pension scheme is a type of savings plan to help you save money for later in life. It also has favourable tax treatment compared to other forms of savings.

As well as any money that you put into your pension, you’ll also get a top-up from the government in the form of tax relief. Anything you will have paid in tax on your income (that you then save into a pension), gets the tax back and that’s added to your pension pot.

Retirement can seem a long way off and investing in a pension is often pushed to one side whilst immediate expenses take priority. Yet time can easily creep up on us and when retirement comes, and once housing, bills and food are taken into account, often the basic state pension is just not enough. Essentially, the earlier you start paying into your pension, the more you can spend on the fun things in retirement.

Optional or compulsory?

Introduced in 2012, a scheme by the Pension Regulator makes it compulsory for private sector employers to automatically enrol their eligible workers into a pension plan which they must also pay into. This was designed so that workers don’t miss out on valuable pension benefits because their employer didn’t offer them a pension.

This type of enrolment is gradually being phased in across the country, it started with the largest UK employers. The regulator pledges that by February 2018, the majority of private sector employees will be enrolled in a workplace pension scheme unless they opt out.

However, this isn’t the only type of pension, and it’s unlikely to provide all the funding you need. In fact, there are several types of schemes – some run by your employer and others that you can set up independently. Further to this, saving into one pension scheme doesn’t mean that you can’t save into another or have other investments like ISAs.

A continued income

Everyone in the UK is entitled to the basic state pension, no matter what they earn. But as it stands, the new state pension only provides up to £164.35 a week, which adds up to around £8,500 a year. A pension scheme will provide you with income on top of your state pension which allows for a more comfortable living.

Moneyfarm will be launching a pension soon, you’ll be able to see exactly what you have from your phone. Pensions don’t have to be confusing. If you can’t wait for our product to launch set-up a general investment account and we can transfer your investment into a pension once it launches.*

*Up to a maximum of £40,000.

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