Pension

Today, we will talk about the age old topic ''Pension.'' One of the most important topics in personal finance.

The meaning of the word ''pension'' has evolved over the year. It used to be synonymous with retirement . You retire and then live off your pension. Usually after 60.

However with the popularity of the FIRE movement, people are not inclined to wait that late and want access to their wealth in their 30s or even 40s.

So now, pension in many cases is not a mandatory part of time as it used to couple decades ago.

But for working class people like us. This is still a million pound question(In literal sense).

We will take deeper dive into the it today.

Before you go into detail lets just make couple of things clear.

Number one: You don't want to spend the last years of your life living miserable and constantly worried about money.

But equally important Number 2: You don't want to the be richest guy in the graveyard.

So in a nutshell you must have a pension plan but that should not be so much so that you forget to enjoy your life.

Anyway , we will talk about how much you need in a separate blog ''Is my Pension enough?'' in detail as there are a lot of factors to consider.

Now let's look at the options for pension and their pros and cons.

Today the main topic are the three types of traditional pension.

1. Workplace Pension.

2. Defined benefit scheme, i.e: NHS pension

3. SIPP or Self invested personal pension.

Few things are common across all type of pensions, so let's discuss these first.

• In all of them, you put a certain percentage of your salary to a pension pot. In most cases your employer usually matches something to your pension ( Except in personal pension or SIPP)

• You don't pay any tax on the amount that you paid into your pension pot. Rest of the income from your salary is taxed. For example , if your gross salary is £48000 per year and you contribute 10% to pension. Your monthly gross is £4000 and you would contribute £400 in pension. So you would pay tax only on £3600 per month as the £400 contributed to your pension is tax free.

• After you retire , you can take 25% of the total money/value of the pension as lump sump tax free but rest of the pension is taxable at usual rate.

  
  

• Almost all pension funds invest your money into Bond or stock market. The type of investment varies massively but just incase you worry about investing , just know that your pension money will be invested in stock market, if you like it not.

So although pension is the most tax efficient way of saving for retirement at the time of earning, it might not be the most overall tax efficient way. This discussion merits a discussion on its own.

Now let's get into the 3 major type on pension , so that you make an informed choice rather than just going with the flow.

Work place pension: (Not NHS pension)

Very common in corporate world. Your employer contributes or matches a percentage that goes into your pension pot. This money is then invested usually stocks and bonds. You normally have a retirement age. Currently it is 55 years, soon to be 57.

Employer match is the most lucrative benefit of this scheme. The match can be anywhere from 3% to 15% (No limit) and in the UK it is compulsory for private companies to offer minimum of 3% match with pension.

For instance if you contribute 10% of your £48k Salary annually and your employer contributes 5%, you total annual pension contribution would be £7200 but only £4800 would be deducted from your £48k salary. Rest is just added extra by your employer.

This is traditional pension and usually you don't have a lot of say in your investment .

The company who will manage your pension is also usually selected by your employer

You usually can choose the type of risk ie: High , low or medium risk you want to take and a chosen company like legal and general or royal London invest your money to get a reasonable return by the time you retire. The risk is defined by the type of investments. Usually stock is considered high risk and bond are low.

So a combination of 80% stock and 20% bond is considered high risk where 80% bond and 20% stock is considered low risk.

So what will be my income?

Income depends on your contribution and investment returns over the years.

For example:

Say on average you are earning £60000 per year. You and your employer contributed 10% of that and you will invest £525 per month.

In an investment with a 7% annual return for 30 years, you would accumulate approximately £615K in your pension pot.

If the return is 10% , your total amount would be £1.09M but if your average return is 3%, you will have about £305k in your pension pot.

Take the reasonable 7% as an example. You have £615 K in your pension pot.

Is that enough , that you will have to decide. You can have a look here ''Is my Pension enough?''

Most of the people in corporate world usually have access to one of these pensions. You have the option to transfer you pension to your new employer if you move jobs or leave it until pension age. Unlike defined benefit scheme , where you can't usually transfer when you move to a different employer. Net paragraph is all about that.

Defined benefit scheme, i.e: NHS pension

SIPP or Self invested personal pension.

All the usual pension scheme is only accessible after certain age. So If you want to retire early , the traditional pensions might not be good idea. In that case property or other accessible investments are viable options.