Pensions - What They Are And How They Work
What are pensions?
Pensions are long-term investment schemes intended for retirement. Most people consider retirement to be too far away to start investing now, however, the sooner you start saving into your pension the greater your income is likely to be once you retire.
Pensions also offer some tax advantages but their main purpose is to provide you with a regular income for life after you retire. Generally, you cannot access your investment money until you reach 50 years old. According to the FSA's Moneymadeclear website, the minimum age will increase to 55 years by 2010 so ask your pension provider if they will raise the minimum age any time soon and if so, to what age.
There are 3 main types of pension schemes in the UK:
- State Pension - This type of government pension is based upon the amount of National Insurance you have contributed during your working life. Men are able to draw their State pension after they reach the age of 65 and women may withdraw their pension after the age of 60
- Company Pension - An employer will set up an employee pension scheme. Also known as an Occupational Pension Scheme, it is advisable to join if your employer offers this type of pension fund as often times your employer will make contributions. Company pension schemes usually require you make regular payments based upon a portion of your salary
- Personal Pension - If you are self employed or your employer doesn't offer a pension scheme then you can take one out yourself. Many banks, building societies and insurance providers offer personal pensions and they will invest your savings on your behalf. According to HM Revenue & Customs you can begin accessing your pension at the age of 50 (until 2010 when the minimum age increases to 55)
By enticing more people to begin investing in their pension, the government offers a tax relief on the cash you invest up to a certain amount. The tax relief you qualify for will depend on whether you pay into a company or personal scheme.
Tax relief comes by way of a company pension in that your employer deducts your monthly contributions from your pay before tax is withdrawn (excluding National Insurance). Therefore, you only pay tax on your income after paying into your pension.
If you opt for a personal pension plan then the bank or pension provider will claim taxes back from the government at a basic rate of 22%. This means that for every £78 you pay into your personal pension, £22 is added for a total of £100.
There are other advantages to pensions in the form of tax relief. A pension fund, for example, is not subject to capital gains tax or investment income tax. Once you are ready to draw upon your pension you may be allowed to take up to a 25% lump sum of your investment completely tax-free (amount dependent on rules of your pension plan).
Even if you are not a tax payer, you may still want to consider paying into a pension fund. If you don't pay tax the most you are eligible to pay per year is £2,808. However, you will still receive the government contribution of 22% therefore, if you invest £2,808 per year, the government will add 22% totalling your investment to £3,600.
For more information on the understanding the basics of pensions please visit -
If you don't already pay into a pension scheme, you may want to consider investing in one now. The sooner you start saving the better off you'll be in your retirement years. If you are unsure which pension scheme is right for you, contact an Independent Financial Adviser (IFA) for help and guidance.
Published on October 26, 2007
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