Let’s face it – pensions are complicated and also rather dull! But what isn’t dull, is what they enable us to do. Many people ask themselves do they need a pension. This article is to help explain what a pension is and how they can help you to live a full life, experience the world and spend times with our loved ones with some degree of financial independence and security.
Many of my readers have come from an employed job to running their own business. They have pension pots all over the place and aren’t sure what to do with them. Does this sound like you?
Many people are scared off by the word ‘Pensions’. Largely because the government do not make pensions clear and the jargon surrounding pensions is just ludicrous!
What is a Pension?
A pension is a savings pot used to grow your money. Just like an ISA (Individual Savings Account) is a savings pot or a bank account is an account for your earnings. Yet more people are happy to save into an ISA and even a current account paying 0% interest! Why? I believe it is because of a lack of understanding. So let me explain using our no jargon approach (one of our napkin values!).
Firstly, assume that the monthly savings you make go into a pot that is just CASH. Not stocks and shares but CASH. Technically you could actually invest into cash within a pension (although this would not be appropriate for longer term savings which is what we are talking about here, but you get my point). I just want you to ignore any bad rap that may be associated with a pension for a moment.
Now imagine some ‘Love Heart’ Sweets.
In this image, all of these sweets have wrappers on them but some of them are in the jar or a “Pension Wrapper.” Now imagine the jar is this tax wrapper that protects those sweets from being taken away by the tax man!
Both the sweets inside the jar and outside the jar are exactly the same sweets. They look and taste the same. The difference between them is the sweets in the “Pension wrapper” cannot be touched by the tax man. They are protected.
However the sweets that are not in the jar can be eaten by the taxman. Potentially all of them! But the sweets (i.e. the cash) are EXACTLY THE SAME.
Now the tax man can get hold of some of those sweets in the jar at a later date when you draw the benefits of your pension pot but there are many ways for many people to draw down a pension (or gobble those sweets) with paying little tax, if you seek good advice or guidance.
So why would you want to have sweets with wrappers on in a jar rather than outside the jar? Because the “pension wrapper” does several things and here are the top 5 benefits:
5 benefits of having a Pension
- It is protected from inheritance tax (I’ll talk more about this another month) – In other words that pot can build up and build up and be left to anybody you like – children, spouse, your next door neighbour Bob.
- The tax man contributes to it by way of ‘tax relief.’ In simple terms (without going into how it is paid, pre tax etc) if you are a non or basic rate taxpayer, for every 80p you add to that jar, the taxman adds 20p. If you are a higher rate tax payer its 60p and 40p. It is FREE money.
- Rules on pensions have changed. In the ‘old days’ you used to have to exchange your pot for a fixed income in retirement (known as an annuity) which would then die with you. NO MORE! For some people an annuity is still a good option (particularly if they are in excellent health, have other assets or want some peace of mind on guaranteed income for life) but you now have the OPTION. You can take whatever money you want and when you want once you reach age 55. There are lots of options available now and you can be flexible in what you need and want to take depending on your income needs, tax position and health in retirement. If you do not use it yourself, you can leave it invested for your spouse or your children. Family succession planning as its best!
- There are limits on what you can contribute into a pension but this is dependant on your individual circumstances (your earnings, residency status and other pensions you may have).
- I often get clients come to me with old pension pots they have accumulated whilst working and say to me “It’s only a small pot, surely it’s not worth doing anything with them.” I always say to them “If it were money sitting in your current account would you say the same thing?”
Don’t ignore these pots just because they are held in pensions. Those ‘sweets in wrappers” are the same sweets that are held in your current account. It is all money at the end of the day.
Your Retirement ‘Action Plan’ – 8 Top Tips
Here is an action plan for you to consider:
- Dig out those old pension statements
- Update your addresses on any old plans (It is surprising how many people forget to do this)
- If you can’t find details of your old pension, use the Gov. UK Pension Tracking Service here: https://www.gov.uk/find-pension-contact-details
- Make sure you have nominated a beneficiary on your pensions (this is normally just a form that is filled in with the pension company)
- Review your company pension schemes – With recent changes to legislation and rules, you may have the opportunity to take a cash transfer value (professional advice must be sought here).
- Do not ignore your statements when they come through your letter box. Take Action! This is money after all.
- If you do to have a pension already, start saving now! Anything from as little as £50 per month can make a huge difference with the power of Compound interest! Try using this calculator to see the impact it can have on your savings: http://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php
If I saved £50 per month for 30 years, my £50 per month assuming just 1% growth and 2% inflation would give me a pot of £27,980! Now isn’t that worth starting – and that’s not even with any tax relief added.
You do not necessarily need to talk to a Financial Adviser about your pensions, and many of them do not want to look after pots that are less than £50,000-100,000. So what do you do?
- Talk to us! As a money coach we can help you identify what you have, and what actions you could consider without the need for paying for financial advice. We can help you make your own decisions by guiding you through financial jargon that surrounds pensions. Let us help you make a good nights sleep.
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