How do Workplace Pensions work?
Pensions are simple. You put aside a part of your salary every month, with the ultimate aim of building a pot of money big enough to see you through retirement.
You build this pot over decades, investing with the aim to grow your money, with the growth then compounded into further gains. Eventually, through continued contributions and investment growth, you aim to have a pot big enough to pay you something similar to a salary in a retirement. You’ll also benefit from tax relief. Once retired you’ll then be able to use the value of your pension to provide yourself with an income.
Remember, you could be retired for decades. It is essential to think carefully about how you will afford the cost of your lifestyle and expenses after you retire. Pensions are one of the solutions.
A simple auto enrolment workplace pension works by your employer establishing a pension on your behalf. The employer pays a minimum 2% and the employee makes this up to the minimum 5% overall contribution with a 3% employee contribution. You will get tax relief on your contribution, meaning your contribution is actually 2.4% net. This means a minimum total contribution of 5% on annual earnings between £6,032 and £46,350.
From April 2019, the employer pays a minimum 3% and the employee makes this up to the minimum 8% overall contribution with a 5% employee contribution. You will get tax relief on your contribution, meaning your contribution is actually 4% net. This means a minimum total contribution of 8% on annual earnings between £6,136 and £50,000.
Consider if you could contribute anymore from your disposable income? The more you contribute now, the more your money could be worth later.
Once your money is invested in a Pension, it will aim for growth in whatever type of funds you are invested in. For example, some Pensions may be invested in the FTSE 100 index of the UK’s 100 biggest companies. Think about how the FTSE 100 has grown over thirty years, your investment will aim to grow in a similar way, rising in line with economic growth.
You can’t access your Pension until 55 at the earliest, which is a good thing, as the longer you contribute, the more time you have to invest and grow your money. It is going to take time to build a pot big enough to last the decades you’ll be in retirement. Our Savings Gap research shows that an income of £23,000 is needed annually in retirement to live comfortably. Based on actual savings behaviour however, people in the UK are on course to receive an income of just £6,000 per year from their retirement fund. Contributing to a Pension, as much as you can afford, for as long as you can, is a remedy to help address any Savings Gap.
Other types of Pension include Defined Benefit, where a worker pays in a certain amount each month and their employer pays a set proportion of their final salary based on how long they’ve been employed. There’s also Personal Pensions, designed to benefit from the same tax relief mentioned in the workplace pensions. And don’t forget there is the State Pension, although at the current rate of £164.35 per week, this is unlikely to provide enough money to continue the lifestyle you’ve become accustomed to.
You can learn more about auto enrolment and Pensions on the True Potential Investor YouTube channel