Retirement is a long way away.
No, it’s not. Right now, in the UK the age to retire is increasing to 68, and I am very certain that by the time I reach 68, it would have increased again. When I was in university, and was offered the chance to have a pension, I didn’t take it. In my mind, that was money that I could put in my savings for my final year. I didn’t process the benefit back then. Now in full time work, I am striving to contribute as much as possible to my pension, so then I can have access to some cash in retirement.
This is the third post in the series of financial decisions to consider, and I am talking about pensions. They are very confusing, and I’ll admit companies don’t do a good job of trying to actually explain it to you. No does the education system. So, as I gain more insight and clarity, I’ll keep creating more updated posts. Also, I am not a financial advisor nor a pension expert. I recommend continuing with further research if you require more specific information.
What is a pension?
It’s a pot of cash that you will have access to when you stop working, for retirement. This will be what you live off to go on holidays, buy groceries and anything you need to purchase, after finishing work. The system we live in is that you work for 40+ years and then you retire and that money is meant to last until you die. With better healthcare and aging population, that money is now required to stretch further than our predecessors.
The pension is an investment account managed by your employer. The money you and your employer contribute gets thrown into the stock market. The idea is that since you don’t access it for about 40+ years, you ride the wave to retire with hopefully more money than you put in.
How to access it?
You can’t access your pension (in the UK) until you reach 55 (57 from 2028). When you contribute to the pension it’s taken before your income is taxed. This does mean when you actually start using it, some of it will be taxed. There are a few ways that you can take the cash you have in your pension, and I describe them below.
Firstly, from the minimum age (55 now or 57 from April 2028) you can take out a 25% cash lump sum, tax-free. You have access to this before taking part in any of the products below.
Annuity
This is where you receive your pension as an income, either monthly or annually. With this option you can choose it to increase yearly so you can keep up with inflation or it can remain fixed. There are options to set the duration you receive the money, and also if your partner receives part of the amount too. There is also the option to protect the value of your pension. This means when you pass, that protected amount will be paid as a lumpsum after subtracting the amount of payments received.
If you leave a beneficiary to receive the remaining payments, and you pass before 75, the payments will be tax-free. However, if you pass after 75, then the payments will be taxed at their income tax level. If you don’t have a beneficiary in place, the payments just stop.
Cash-out
You let you cash come to you as a regular fixed income for 3 – 25 years, and this suggested as a good option if another income source is coming in the future. (Go side hustle I guess). With this option you have to take your 25 % tax-free cash lump sum at the start, as you won’t get the opportunity to take it ever again. You can’t change the amount you receive every year, it’s a more tax-efficient option (also makes it rough when inflation increases). When the money finishes you need to have a plan if you’re still walking the earth.
Fixed-term
This is similar to the cash out, however you get a lump sum of cash after your chosen time period has finished. At the end you can change how you use the remainder of the cash. Again, with the 25 % tax-free lumpsum, you need to take it at the start, or else you get the tax-free benefit. The payments are taxed like normal income, but the amount is dependent on your circumstances. The higher income you choose, the smaller the cash lump sum at the end.
Drawdown
This allows you to keep your pension invested after taking the 25% tax free lumpsum. You can withdraw any amount when you feel like it, but the management of your funds may be subject to charges. There are risks attached to keeping your money invested, which means you aren’t guaranteed what you put in. When you run out of cash, it’s finished.
Sources
How to contribute to it?
In the UK, if you’re under 22 you have the option to contribute to your pension. This is something that was offered to me when I took my industrial placement year in 2019. I chose not to sign up but had a few friends who did. The way I saw it was I would be missing out on the cash that would be in my account, and that I could access there and then. This was reflective of my upbringing, where money was tight quite often. To receive a paycheque every month with the amount I was getting paid, I wanted to experience it all.
I don’t regret it, though I do wish I had the financial education that I have now, back then. I might have contributed even just a little bit. This is because it’s free money. I contribute portion of my salary, and then my employer is obligated to give in something as well. In some jobs it can be up to 50% more that the employer contributes. So, if I put in £5, the company would put in £10, and I have a total of £15. Even though I only put £5. It’s beautiful. But I know my reasons, and I’m okay with them. (Also, the example of £5 is not realistic, just hypothetical)
Now I am over 22 years old, I am automatically opted into a pension, and I can request to change how much I contribute. I started off with the minimum contribution, and then increased it to the maximum, which yielded the highest employer contribution. The money comes straight out of my pay, before tax and therefore, before it reaches my actual bank account. So, I don’t need to worry about it, it’s practically managed externally.
How to manage your pension?
All accounts should have the ability to be modified. The employer chooses default investment pots for all employees, but we can change them if we like. My provider has an app where I can manage where my money is invested, and read up on extra information. Since I am not close to my minimum age, I have shifted my pots to be riskier. Having more risk, can also mean greater gains if it’s successful. The idea is that as I progress closer to retirement age, I modify the investment pots. The older you get, the safer you need to go, as low risk, collates to low gain. But if you made lots of gains whilst you were younger and then moved them to more stable pots, you would still have a lot more cash than if you stayed in high risk, and something went wrong in the markets.
What about retirement?
This is a financial decision worth thinking about. When you’re young it doesn’t have to be often, but a little time dedicated to it, will make future you so grateful. At the end of the day it’s your choice.
Moral of my story:
- It’s not as far as you might think – Have you seen how fast time is flying by you? Blink and you will be making the decision to retire.
- There are different options available to you – Do your research. It’s all dependant on what you want in your life and how you want to live the rest of your life.
- It’s free money! – If you work for a company, they have to contribute to your pension, and its free money, take it. Life is already a rip off as it is.
- High risk = higher potential gains, low risk = lower potential gains – Mixing between the 2 can help you make the most out of your pension. Make your money work for you, whilst you work for it.
