Sorting your pension can seem incredibly daunting and all-too-easy to push to the bottom of the to-do list. And let’s face it: who wants to think about getting older? But it’s not nearly as complicated as you might think – and the sooner you start, the easier it will be.
Your future self will thank you for taking a little time now to get your retirement savings on track. Plus, there’s no feeling like seeing your pension pot grow – and knowing your future is sorted. Here’s our introduction to pensions to help you take control.
What is a pension?
Most people don’t want to work forever, so you need to save throughout your working life to build up enough money for life after work.
Perhaps it’s better to think of it as a future fund. Building it up now gives you more choice further down the line. You could quit work sooner (or gradually reduce your hours), have more money to travel, help your family and generally enjoy yourself – and the sooner you start, the younger you’ll be able to do that.
Pensions have been around for about a century. They used to be funded primarily by the government and (later on) by employers when life expectancy was lower and therefore people’s retirements were relatively short. With people are now living longer and retirement lasting many years, there’s only so much the state and businesses are willing to pay in.
Today, the state pension is only a small part of most people’s retirement income and most private employers contribute a small amount to workplace pensions (though some public-sector workers can still get a generous deal).
That means most of us will have to pay more into our pension pot if we want to enjoy a long and happy retirement. But actually, if you start now – even with small amounts – it isn’t difficult to build up your pot.
How does a pension work?
Pensions have several different features, that combined make them a no-brainer for saving for retirement.
1. You receive tax relief from the government
Pension tax relief is probably the biggest advantage of a pension – it is basically free money from the government. The tax you would normally pay on income is waived if you pay this cash into your pension. If you’re a basic rate taxpayer it only costs you £80 to add £100 to your pension, or only £60 for higher rate taxpayers and £55 if you’re a top rate taxpayer.
2. It’s invested for the long-term through funds
Pension contributions are pooled into big collective funds with other people’s pensions. These funds are then invested in assets (an asset is simply something that can be converted to cash) that are expected to increase in value over time. These assets could be shares in companies, known as equities, or government or corporate bonds, which are a kind of IOU to investors who lend the money to companies or to the government.
Due to their size, pension funds end up having a massive stake in the economy. They can use their power as major shareholders to make sure companies are well-run, sustainable and profitable.
While investing is riskier than saving, it’s unlikely you would be able to save enough for your retirement with cash alone. By putting money into a pension you are investing over the long-term, which gives you the time to ride out the market ups and downs. Generally the longer you invest, the more likely it is that you’ll have positive returns, though there’s no guarantee that will always be the case.
The chart shows return on the FTSE All World and the Bank of England base rate from 2008 to 2018. £1,000 invested in 2008 would have been worth £2,384 ten years later. Remember, past performance is not a reliable guide to future performance.
3. Your pension is super-charged by compound returns
When you save or invest money, you typically receive a return on the amount each month or year. If you leave it untouched, this cash interest or investment gains will itself earn a return. This is known as the magic of compounding. When you leave your returns to compound over time, your money can grow exponentially all by itself. Applying this to your pension you’re likely to see even more incredible results.
Remember, the earlier you start, the more time your money has to benefit from compounding. As an example, if you were to invest £10,000 aged 40 and benefited from an average return of 7%, you’ll have £41,406 when you’re 60. Start ten years earlier at 30 and you’ll have £81,451 when you’re 60 – almost twice as much.
Remember, past performance is not a reliable guide to future performance.
4. If you’re a full-time employee, you get an employer contribution into your workplace pension
Auto-enrolment rules have made it a legal requirement for employers to contribute to employee’s pensions if you are also contributing. At a minimum, you are required to pay in 5% of your earnings and your employer is required to pay in 3% of your earnings. It could be more, depending on how good your scheme is and how generous your firm. Your contributions into a workplace pension are taken directly from your pay. While this is an opt-in scheme, opting out means you would essentially give up that free money from your employer completely. And remember, all contributions will receive pension tax relief!
5. Pensions funds within the UK are protected by the Financial Services Compensation Scheme
Generally speaking, pension funds within the UK are covered by the Financial Services Compensation Scheme for up to £85,000 per eligible person, per firm. With pensions, you usually invest in funds via a platform (like Moneybox), so if the company was declared bankrupt, your money would still be held separately by the underlying fund or bank and would be safe. Do remember though, the FSCS doesn’t cover you if your investment performs badly. Moneybox and its Pension Provider (Gaudi Regulated Services Limited) are covered by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person for claims relating to investment products. learn more about our FSCS Protection.
How do pension fees work?
You will need to pay charges while you’re investing – and the level of these could really impact how much is eventually left in your pot.
Fees on workplace pensions are capped at 0.75 per cent. For other kinds of pension, costs differ from provider to provider. The most common are:
- An annual management charge or platform fee – usually a single percentage charge, which falls as your fund gets bigger;
- A fund management fee – fixed service charges, which cover things like setting up the plan, annual administration, income withdrawals and buying funds
- Transaction fees – sometimes you’ll pay a fee for buying and selling investments.
- Exit fees – some providers will charge to move your pension to another provider, though this is rare.
The level of fees can depend on what funds you invest in. Active funds tend to be more expensive because they involve managers making personal calls about where to invest. Passive funds (often known as tracker or index funds) are usually cheaper because they are invested to closely track indices, such as the FTSE 100.
Costs often drop once your pot reaches a certain level (such as £100,000). So, usually it will be cheaper to have everything in one big pot than pay for a clutch of smaller ones.
Over time, costs can take an amazingly large slice off your future fund without you even realising. So, make sure you aren’t paying over the odds on any of your pension plans. Check out our pension fee comparison.
If transferring your pensions, you should consider the charges and benefits before transferring to Moneybox, and whether the risk and reward profile of the investments offered matches your needs.
Please note Moneybox cannot accept a transfer from a pension your employer is currently paying into or a pension with guaranteed benefits. Remember, you can’t withdraw from your pension until you reach the minimum pension age (currently 55).