In the past two years there have been more changes to the pensions industry than any other field of personal finance.
The world of pensions and savings is now dramatically different from that which existed five years ago with new pension schemes and ‘pension freedoms’ existing today.
As soon as you start your working life, you should start saving for your pension, which is simply the funds you need to accumulate to see you through your retirement.
A private pension that is not provided by the state is different from other forms of savings because it is more lightly taxed and in most instances the overall ‘pot’ is invested in order to make it grow.
If the pension is managed effectively, every £1 you allocate to it should grow in value as time goes by.
Types of pension
Private pension schemes fall into two categories, defined contribution schemes and defined benefit schemes.
A defined contribution scheme is one which is based on contributions and is often referred to as a personal pension or a ‘stakeholder’ pension.
These pension pots can either be set up individually by the saver or can be a workplace pension set up by employers.
Because the schemes add value based on the amount invested and also on how well the investments actually do, the overall value of a personal pension can go up and down.
A defined benefit scheme is much rarer these days than defined contribution schemes and is often referred to as a ‘final salary’ pension.
This pension is not based on contributions, but its value is based around the size of your earnings on retirement and the number of years that you have worked for. Under a final salary pension, the first 25 per cent of the lump sum is tax exempt.
For years, the only real choice for retirees without a final salary pension was to purchase an annuity pension, an insurance policy that guaranteed a fixed income for life.
Annuities were often expensive and often guaranteed a fairly low monthly pay out. Since March 2014, the government’s pensions reforms made the purchase of annuities non compulsory on nearly all pensions.
As of 7th April 2015, retirees were finally able to draw down the whole of their pensions when they reach the age of 55, though they will be taxed at 25 percent on the amount withdrawn.
A minority of pensioners will withdraw the entire lump sum, but it is probably more likely that most will access chunks of their overall pot to pay off mortgages.
They might invest in their children’s or grandchildren’s educations, or a second home abroad or purchase new pension investment opportunities.
Each major draw down involves a payment to the tax man so many might still opt to purchase annuity policies yet.
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