We know pensions can seem incredibly complex and confusing, and we’re determined to try and make them a bit easier for everyone to understand.
We chat to people about pensions all day, so we hope we’ve covered most things you want to know, but this is absolutely a work in progress & if there is something we’ve missed that we need to explain, or something we’ve explained badly, please let us know either via email or by commenting at the bottom!
What is a pension?
A pension is a great place to put money aside whilst you are working, so that you can use it to live when you stop working.
It is a certain type of financial product which has generous tax benefits (because the government wants you to have one, they’ll usually put money into your pension whenever you do)
Why do I need a pension?
Could you live on £8,767 a year? That’s currently the maximum amount the government gives you each year under the state pension, after reaching retirement age (currently between 66 and 68). This could be less if you haven’t been paying in national insurance for more than 10 years.
Most people think that’s not enough and want/need another source of income after they stop work. The most common and tax-efficient way to provide this income this is usually though saving into a pension whilst you are working.
After you turn 55, you can convert whatever you have put aside in a pension during your working years, into an annual income for the rest of your life. It could make all the difference in how you spend over a third of your lifetime!
What are the benefits of a pension?
The main benefit of paying into a pension is that most of the time when you pay in, the government pays in as well (and if you’re employed, your employer probably does too).
This means that paying in even a small amount can result in much more actually ending up in your pension pot. There are almost no other ways of investing like this (where the government and your employer contribute as well).
The government’s contributions are called Tax relief. You can read more about how this works in our Glossary.
I thought the government gave me a pension?
If you pay national insurance tax for more than 10 years, the government does provide what’s known as a ‘State Pension’. You can read more about that in our Glossary, but the important thing to note is that the government only pays you about £8,750 a year, from your late 60’s.
Lots of people think this isn’t enough to live on, or want to stop working full time a bit earlier, so they choose to build up other retirement savings to live on. One of the best ways to do this through a pension.
I’m self-employed – what’s different for me?
The big difference is that if you’re self-employed, just like everything else, you’re left on your own to figure out what you need to do, and you won’t get contributions from an employer.
(People who are employed are usually ‘auto-enrolled’ in a workplace pension scheme, where their employer manages everything for you and contributes on the employee’s behalf.)
You are still entitled to tax relief (government contributions) on your pension, and as long as you pay national insurance for long enough, you’ll still be entitled to the state pension when you retire.
If you’re self-employed and want a pension, you’ll need to set up a personal or private pension. The good news is – you are exactly who Penfold was built for, and you can set up a pension with us in just 10 minutes.
The Penfold Pension was built just for freelancers – we’re looking for beta testers in June 2019. E-mail us at firstname.lastname@example.org to get involved
How much should I save?
This is the killer question! If you sign up for Penfold, we’ll help you figure this out by applying some helpful rules of thumb and making some assumptions about what sort of life you want to live when you’re a bit older.
A quick, popular and simple way of roughly calculating how much to save, is to take the age you start saving into a pension, and divide that by 2. Put this % of your earnings into your pension each year until you retire.
Penfold helps you calculate a more accurate number by deciding how much money you’ll want each month when you are holder, and how much you’ll have to have saved in total to make that happen. We then work backwards to come up with a suggested amount to contribute each month, starting asap!
The key thing to note here is that the earlier you start saving, the less you will have to save. This is because of the awesome effect of Einstein Money (Compound interest).
I can’t afford to save right now!
We hear this a lot, and you shouldn’t panic. Saving anything is better than saving nothing, so getting started by saving what you can afford is a good first step. If you tell us how much you can afford now, Penfold will show you how to increase that over the next few years to get on track.
Also, remember that whatever you can afford (even if it’s only £20 a month) should be eligible for tax relief.
It’s worth noting that if you re in debt, especially at high rates of interest, you should consider whether it would be better to pay this off before starting a pension.
Everyone is allowed £3,600 of tax free contributions into their pension each year, but the maximum amount you can pay in and still get these government contributions is either your annual income, or £40,000, whichever is lower.
Can’t I worry about this later?
We think it’s really important to start saving for a pension as soon as possible. The reason for this is something magical called ‘Compound interest’ (We call it Einstein money). You can read more about it in our glossary.
Basically, when your money is in a pension it works for you by generating money from investments. If it makes money one year, there is more money the next year to make even more investments, and so on.
The main thing to understand about Einstein Money is the younger & sooner you start saving, the more you are likely to get over your lifetime. For example if you put £100 in your pension at age 40 and take it out at 60, it might have ‘compounded’ to be worth £265. But if you put it in age 20 it might be worth £704!*
*This is an illustrative example assuming an assumed annual growth rate of 5%. Einstein Money is not guaranteed, but is a reasonable estimate of the effect of compound investment returns on the amount you put aside in a pension over a long period of time, using a widely used growth assumption.
I’ve heard pensions have performed badly – aren’t there better ways to save than in a pension?
What you’ve heard stems from a bit of a misunderstanding about what a pension is. A pension doesn’t perform badly, because a pension is just a ‘wrapper’ for an investment product (this is explained well in this blog by Martin Lewis from Money Saving Expert).
This ‘wrapper’ effectively means a set of rules set by the government for how you can pay in and and how you can take money out of a pension in order to get Tax Relief (the main rule being you can’t take money out until you’re 55).
A pension is a tax efficient way of saving that isn’t in itself risky. The risk (and chance of losing money) comes from the investment choice inside the Pension.
Any form of investing involves risk, you need to take risk to make money. One of the beauties of pension saving though is how long your money stays invested, which actually reduces your risk of losing money overall (see our risk FAQ for more info) and is how might end up making so much Einstein Money over the long term.
Can I lose my money?
If you put your money into a pension, usually it is then invested. Investment, and as with any investment, involves some risk, and the value of your pension might go up as well as down, and you could get back less than you put in.
In Penfolds case, once your money is sent to us, it is part of your pension, and is held in your name in a special client money account, so it is separate to any of Penfold’s money. To be extra safe, we use a third party to manage these accounts, who are also regulated by the FCA. Their job is to hold your money and invest it in the plan you have chosen. Those plans are managed by some of the world’s largest money managers.
The Penfold Pension is operated and administered by Gaudi Regulated Services Limited, who are authorised and regulated by the Financial Conduct Authority. If something happened to Penfold, your pension would still exist, and Gaudi would get in touch to explain how you manage it in the future if somehow there was no Penfold online portal. You could move your money to a different pension provider for no charge.
Penfold is also FSCS protected, so if something happened to Penfold, Gaudi and BlackRock, your money is guaranteed by the government up to £85,000.
What about the Lifetime ISA?
If you’re employed, a pension is almost always better than a Lifetime ISA, because you’ll get money from your employer into your pension, which you don’t with a Lifetime ISA. If you’re self-employed and a higher rate taxpayer, then a pension might be best again, because your tax relief will be higher than the government’s contribution to a Lifetime ISA.
If you’re a basic rate self-employed taxpayer, then it’s not as black and white, and a lifetime ISA is just a different way of saving for retirement. Penfold currently only offers a pension product, not a lifetime ISA.
A pension can be accessed at 55 (vs 60 for a Lifetime ISA), and is excluded from inheritance tax, any calculations of benefits, and a pension can’t be taken to pay creditors in case of a bankruptcy – none of this is true for Lifetime ISA’s. On the other hand, a Lifetime ISA can also be used for a deposit for your first house, subject to various criteria.
You can have both a pension and a Lifetime ISA, although not many financial institutions provide Lifetime ISA’s.
How do I claim back tax on my pension?
If you’re a basic rate taxpayer, Penfold does this for you and adds the tax straight into your pension. If you’re a higher rate taxpayer, Penfold will claim the basic rate tax but you have to apply for the higher rate tax relief yourself on your tax return, although we can help.
If you have a limited company, the payment you make into your pension is ‘gross’ or before tax, so there is no further tax to claim back. This is because you have not had to pay any income tax on that money before it goes into your bank account, so there is no tax relief to be added.
However, you may then get further tax relief on your company’s tax bill because pension contributions are tax deductible. Your accountant will need to calculate this when they do your year-end accounts, but if your company is paying corporation tax you should save 19% of every pension contribution off your company’s tax bill. We will be launching a feature soon to help you work out how much tax you could be saving, but in the meantime please get in touch.
Are there limits to what I can put in a pension?
No, but there are limits on how much tax relief you can get.
There is a minimum amount everyone is entitled to, no matter what they earn. If you earn less than £12,500, you can pay in £2,880 into a pension and get £720 added by the government.
Beyond that, you can only claim tax relief up to the total amount of tax you paid that year. E.G If you pay £5,000 in tax, you wouldn’t be eligible for more than £5,000 in tax relief. Regardless of your earnings, there is an annual limit on contributions that are eligible for tax relief – currently £40,000.
Over the course of your lifetime, you can only earn tax relief on a total of, £1,055,000. Although this number usually increases slightly each year to account for inflation.
Money paid by someone else, such as your employer, counts towards those allowances.
This is the concept of automatically being enrolled into a pension scheme through your workplace. The government now requires all employers to automatically enrol their staff into a pension scheme and if you don’t want to take part, you have to actively ‘opt-out’. If you don’t opt out, you’ll pay at least 5% of your salary into a pension scheme, and your employer will pay at least 3%.
If you’re employed, it’s almost always a good idea to take advantage of your workplace/auto-enrolment pension – we wrote a blog post on this, here
How much does a pension cost?
Most pension companies will charge an ‘Annual management fee’, usually a small % of the total amount in your pension pot. If your pension is invested well, this fee should be less than the amount your pension grows by, so even after paying your fees, you’d still have more in cash terms than you put in to your pension. Penfold charges a competitive annual management fee starting at 0.75%.
Some pension companies will also charge you each time you contribute, or for setting up your pension or moving it to another provider. Many SIPP providers will also change a minimum £ fee each year, so if you don’t have enough saved in your pension you will lose much more than the annual management fee. Penfold won’t charge you for any of this.
What happens when I retire?
Once the money is in a pension, it attracts tax relief and so can’t be withdrawn until you’re at least 55. (There are some exceptions, like if you were terminally ill). At age 55, you can take 25% of it as a tax-free lump sum (although you don’t have to).
New laws introduced in April 2015 mean that anyone who’s aged 55 or over can take their pension money however they want, whenever they want, from the age of 55 – there’s now complete freedom.
For most people, accessing pension cash at 55 will be too early, so it can just be left where it is. Yet, if you want to, you can also access all your pension cash at once – the first 25% is tax-free and the remaining 75% will be taxed as income. There are different ways of using your pension cash to generate an income for the rest of your life, either by taking out enough each year to cover your spending money that year and leaving the rest invested, or by buying a product called an annuity that essentially pays you a salary until you die. It’s usually a good idea to take specialist financial advice about what to do with your pension pot when you retire.
I’ve got loads of small pensions dotted around – what should I do?
Without knowing lots about you or the specific details of these pension pots, we can’t answer this. If they are all defined contribution pensions, with little or no exit fees, it might be a good idea to consolidate them into one place, so it is easy for you to keep track of them. You should consider other factors like the fees charged each year by the different pension providers.
Penfold provides a service where, if you provide the basic details of your other pension pots, we can help you track them down and consolidate them into your Penfold pension.