Why should I start thinking about a pension?
A pension fund is often referred to as a retirement plan, and it is a savings or investment fund designed to provide its owner with a nest egg upon reaching retirement age. There are a few different types of pension plans, which is why it is important to understand how the plans work and which benefits they offer. The general idea behind a pension plan is that the owner of the plan should make monthly contributions to the fund until he or she reaches retirement age. The money that was accrued via monthly contributions can then be paid out to the owner in the form of a lump sum or monthly payments. Recent research has shown that a high percentage of self-employed people are not covered by any type of personal or state pension plan, which leads to concerns over the retirement funding of this part of the population.
When should you start saving for retirement?
Research has shown a tendency among entrepreneurs to delay saving for their golden years. The reason for this is simple: as an entrepreneur, there is always a more pressing need than preparing for something 40 years away.
Nevertheless, a few years extra in paid pension premiums can result in a significantly larger retirement income so, no matter your age, you should start to squirrel a little away every month. The rule of thumb is that the older you are when you start contributing to your pension plan, the larger the monthly amount you should pay.
Freelancers, given the variable nature of their employment, often swing from boom to bust in terms of steady income, but by apportioning a set percentage of every pay check to your pension plan, you can easily build up a useful pot of cash to support your retirement.
What is the difference between state and private pension plans?
There are three options for pension plans in the UK: state, personal/private and company/private. Depending on your employment status, you can pay into a combination of these plans to ensure the best possible payout upon retirement.
State pension
Introduced after the Old-Age Act in 1908, a state pension was designed to offer a weekly payment to those who have reached the SPA (Sate Pension Age) to support them after they have stopped work. Entitlement to a state pension is determined by whether or not you have made enough NICs (National Insurance Contributions) during your employment. The amount of state pension you are entitled to is normally determined by the number of years that you actively contributed to the state pension scheme. It is important to note that you are entitled to a state pension even if you are receiving other pension-based incomes and that you can delay receiving the state pension even if you have reached SPA. Since the state pension scheme is effectively funded by the taxpayers, all taxpayers are normally entitled to receive a state pension when they reach the SPA limit.
Company/private pension
In 2018, a government initiative introduced auto-enrolment for employees who work for a company. A set percentage of your salary is taken out of your pay in the same way that PAYE and NICs are deducted. Unlike the state pension, you can opt-out of this pension, although the company will also make a contribution to your pension pot and, depending on your rate of tax, you can claim a certain amount of tax relief against your contribution.
Personal/private pension
If you decide to opt-out of your company pension, or you are a freelancer who does not have a company pension, you can open a personal pension plan to fund your retirement. There are a vast number of options for personal pension plans, so it is always advisable to do some research and take professional advice as to the best choice for your needs. Just like a company pension, you can claim tax relief on your contributions, although you will be responsible for making the payments in the same way that you pay your NICs and income tax.
How do pension plans work?
For the non-self employed, pension plans are a form of “forced saving” and requires that employees pay mandatory monthly contributions to the scheme. In larger companies, the pension scheme is normally administered by the HR department and employees are automatically registered for the scheme once they start working in the company. A set monthly percentage of the employee’s salary is deducted and paid into the pension fund. This payment is often matched by the company and appears on the employees pay-stub as a fringe benefit. When an employee reaches the official retirement age, they can begin drawing a monthly pension from their retirement fund but this drawing is normally less than their average monthly salary. It is important to note that pension schemes are interest-bearing so the money that is paid into them does grow somewhat over time. The income from a pension plan is not necessarily enough to live off so it might be necessary to supplement your income with other sources once you reach retirement age. In order to overcome this problem, many people choose to make additional voluntary contributions to their workplace pension funds and increase the monthly income they can expect to receive in later years.
Here are some frequently asked questions concerning pension plans
Is it compulsory to have a pension plan?
In most cases, people who are employed by a company and pay PAYE are auto-enrolled for pension and do not have a choice in the matter. This measure was introduced to ensure that people put some money away for their retirement. If, however, you are self-employed or working as a freelancer, enrolling in a pension scheme is completely voluntary. Although a traditional scheme may not be well suited to a self-employed person, there are several other options that are great for building up your own pension pot.
Are all pension contributions tax deductible?
Some retirement savings contributions are tax deductible. This is another important benefit that is designed to motivate people, including freelancers, to save for the day when they retire. Instead of paying all of your tax liability to HMRC, you can invest some of the money in a suitable retirement fund. The tax allowances, however, are not applicable to all types of retirement savings products and it is therefore important to do some research before deciding on a specific product. In general, most contract-based or long-term savings products offer some tax allowances. For details of deductibles, go to the official online resource.
What options do the self-employed have for retirement plans or savings?
While conventionally employed people have the benefit of some aid in their financial planning, self-employed people are personally responsible for ensuring that they are financially secure, even in retirement. Luckily, a whole host of long-term investment products have been designed especially with freelancers in mind. A good option is to invest in a retirement annuity that will pay out once you reach retirement age. In general, retirement annuity products provide similar benefits to those provided by a normal pension plan, which makes it a good solution for those who want to enjoy life during their golden years but don’t have a traditional pension plan. When considering any pension plan, it is always advisable to seek professional financial advice.
What is a retirement annuity plan and how does it work?
Retirement annuity plans or RA’s are a form of secure savings designed to replace or supplement your regular pension. An RA requires that members make regular monthly contributions and is, therefore, a contract-based savings product. When applying to join an annuity plan you have to decide at which age the plan should pay-out. It is not possible to access the savings in this fund before retirement age is reached, and the fund cannot be used as security for loans or any other financial commitment. In the event that you should run into financial difficulties, no creditor may lay claim to the funds in your RA in order to pay unpaid debts, which makes this form of investment very safe.
Normally contributions to RAs are tax deductible, but the eventual payout can be taxed by the government in the same way any other pension fund would be taxed. RAs are a good way for freelancers and self-employed people to ensure that they have enough money to retire, and it is also a great option for people who are looking for a more structured and committed way of saving. While there are other schemes that may provide higher returns than the average RA fund, few offer the same level of security and low-risk investment.
Is your company pension lost if you change jobs?
In general, pensions cannot be transferred from one fund to another, but they are not lost when you stop contributing to the plan. In most instances, people who have a variety of employers during their lifetime will contribute to more than one pension plan and, as a result, they will receive a pension payment from each pension scheme that they contributed to. Because of strict government regulations, pension schemes are required to adhere to legislation that governs how the fund is administered. This is done to make sure that there is little risk of anybody losing their retirement income.
Some pension plans offer the possibility of transferring funds from one plan to another. This option allows employees to move pension funds to a product such as an RA when they leave employment. While it may be beneficial to transfer your pension funds, you should pay attention to the costs and possible returns, and compare them to current costs and returns. It might be a good idea to leave your pension in the current fund and begin building a new retirement income that can supplement your accrued workplace pension when the time comes.
What is the difference between a pension fund and a pension plan?
A pension plan is an individual ‘pot’ that you alone (potentially with an employer’s contributions) pay into for your retirement; a pension fund is an investment product that is paid into by a multitude of scheme members to collectively build a large lump sum. Pension funds then typically invest these sums into suitable companies in order to seek a financial return for all of the scheme members.
Usually administered to by professional management companies, fund managers analyse market trends and decide how and where to invest the money to maximise returns and minimise risks. Because most pension funds are quite significant, fund managers can invest the funds in a well-balanced portfolio that is likely to provide satisfactory returns. Fund managers regularly invest pensions into property because of the stability that this investment type offers. The same financial companies that manage traditional pension funds often manage other retirement products like retirement annuities. Their specialist knowledge makes it more likely that the investment will be successful and deliver returns that can compete with inflation.
What happens to your pension fund if you die before retirement age?
While it may not be the most cheerful thought, it is important to plan for your family’s financial security, even if you are not there to enjoy it with them. Most pension products can be bequeathed to someone so that they can benefit from your retirement savings if you aren’t able to. For products like retirement annuities, a beneficiary can be specified when you contract with the fund. It is important to bear in mind that any pension payouts will eventually become a part of your estate and will be subject to inheritance tax. In order to manage this more effectively, seek the guidance of a financial advisor to minimise tax implications and provide for your loved ones in your absence.