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Pensions can be intimidating thanks to financial jargon and frightening headlines, but don’t let that put you off starting your retirement savings. Here we break down the steps to starting a pension.
This article refers to defined contribution pensions. For information on final salary pensions see our guide to defined benefit pensions.
When should I start a pension?
It is never too late to start a pension. However, the earlier you start the better, because you will need to set aside less each month in order to build a healthy retirement fund. For example, a 25-year-old who starts setting aside £165 a month into a pension (including tax relief and employer contributions) could have a pension pot worth around £250,000 at age 65, assuming 5% annual growth. Someone who starts saving at 40 would need to set aside £420 a month to match that pot at 65.
What type of pension should I have?
There are two key pension types – defined benefit and defined contribution.
Defined benefit pensions – also known as final salary or career average pensions – are rare in the private sector but if you work in the public sector (as a teacher, police officer or for the NHS, for example) this will likely be the scheme offered by your employer.
They provide you with a guaranteed income in retirement, based on your salary and the number of years you were in the scheme.
Defined contribution pensions are the more common type and involve you saving into a pension alongside government tax relief and employer contributions if it’s a workplace scheme. When you retire you can take what you’ve saved and turn it into a retirement income.
With a defined contribution pension there are a few ways you can save. You may be able to choose from:
- A workplace pension – This is set up by your employer and, thanks to auto-enrolment, you will pay into it as long as you meet the criteria and haven’t opted out. The best thing about a workplace pension is your employer will make contributions too. There will be a default fund your money can go into or you can select from a range of investment funds yourself.
- A personal pension – Unlike a workplace pension you set this up yourself and make monthly contributions. The number of investment options open to you and charges will vary between providers.
- Self-invested personal pension (SIPP) – If you want the freedom to choose your own pension investments then a SIPP gives you that option. Accounts can usually be run easily on an online platform.
- Small self-administered scheme (SSAS) – If you’re a senior company executive, and want to take full pension investment responsibility for yourself, you may want to consider setting up a SSAS pension.
Although there are a variety of pensions to choose from, it always pays to take advantage of your employer’s scheme because you’ll get the benefit of employer contributions. Personal pensions and SIPPs can make sense if you don’t have access to a workplace scheme, either because you don’t work or are self-employed. A SIPP can be an option if you want to access a wider variety of investments to build savings on top of your workplace scheme, or if you have a number of old pension schemes that you wish to consolidate into one. However, if you go for the latter you do need to check you won’t lose any valuable benefits or be hit with expensive transfer fees.
» MORE: What is a pension transfer?
What should I invest my pension in?
This is a difficult question to answer as choosing investments is a very personal decision. There are many assets that you can hold in a pension including:
- Bonds
- Cash
- Funds
- Property
- Shares
You may have a pension where the provider chooses your investments for you based on your risk profile. You answer a range of questions to decide how much risk you are willing to take with your pension in order to maximise your returns.
Alternatively, you may be able to choose an investment portfolio from your provider taking into account personal preferences such as risk and ethics.
With workplace schemes if you do not make an active decision, your money will be invested into a default fund.
Deciding what to invest your pension in is a hugely important decision as the returns you get will ultimately determine your standard of living in retirement.
You may be able to get advice through your workplace pension scheme or you can speak to an independent financial adviser (IFA).
» MORE: Everything you need to know about pensions advice
How much should I pay into my pension?
If you have a workplace pension, then the government lays down a minimum contribution that you must make. This is currently 5% of your qualifying salary. Personal pensions will also have a minimum contribution set by your pension provider.
However, if you only make the minimum contribution, you probably won’t save enough to enjoy a comfortable retirement. Try to save as much as you can, while being careful not to leave yourself short for other things since you can’t access money in your pension until you are 55.
A starting point to think about how much you should be saving is to take the age you start saving into your pension and divide it by two, giving you the percentage you ‘should’ contribute to your pension. So, if you are 30 when you start saving, put 15% of your salary into your pension. If you are 40, set aside 20%. This is only a rule of thumb, and it should be tailored to your own personal situation.
The great thing about working with a percentage rather than a set figure is that as your career progresses and you get pay rises, your pension contributions won’t get left behind.
It’s good to keep in mind that if it’s a workplace scheme, your employer will also contribute to your pension and whatever the pension you are in, tax relief, equal to the rate of income tax you pay, can boost your contributions even further.
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