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Education

An Introduction to Pensions

BACK TO BASICS: A quick look at the different kinds of pensions available to savers and investors in the UK

Alanna Petroff 19 September, 2012 | 7:00AM
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Video Transcript:

On-Screen: An Introduction to Pensions with Alanna Petroff. Let’s start with the question… “Do you have a pension?”

Unidentified Speaker: I have a pension but I have no idea how it works.

Unidentified Speaker: I will probably set one up maybe next year. I'm just basically saving all my money at the moment. So, I'm using my money now rather than thinking about the future.

Unidentified Speaker: Yes, I do have a pension and, yeah, I have a vague idea of how it works.

Unidentified Speaker: Well it’s generally money that goes into a fund and is then invested, or several funds, you can kind of pick and choose which one you want... in order to give you a return later in life when you are retired.

Alanna Petroff: We all know what pensions are and we know that we should be putting money away into our pensions but from there, after the basics, it gets a little bit complicated. Plus within the UK, the government is always changing the rules. So, I'm going to take this opportunity to explain all of the pensions environment to you in less than five minutes.

To start there are three main pension groups: State Pensions, Work Pensions and Personal Pensions.

Everyone in this market contributes to a pension whether they know it or not. They're contributing through their national insurance contributions to the state pension. And then when you hit retirement age the state will pay you just over £100 per week. Now £100 per week sounds nice, but that’s probably not going to cut it in retirement, and that's why financial advisors say that you should open a work pension.

On-Screen: Work

Petroff: Let's say you're working in an office perhaps like the one behind me. The odds are pretty good that your employer will offer you a work pension. In many cases employers will have this scheme where they do matching contributions. Let's say you contribute 3% of your salary, your employer will also contribute 3% of your salary. So, that is getting a 3% raise without haggling with your boss. Amazing.

Now moving on, the government also wants to encourage people to contribute to their pensions, whether they be work or personal. So, in both cases, for whichever pension you're going for, they're going to give you your tax money back on the contributions that you make. So, this is how it works.

If you're a basic rate taxpayer and your company has a pension matching contribution scheme, you can tell your employer to put £100 from your pay cheque into your pension. That's considered your net contribution, which comes out of your pocket.

Then using a funny little bit of tax math, the government will give you your tax money back on that contribution, which works out to £25, so the £100 and £25 together is called your gross contribution.

Next, depending on how your work pension is set up, your employer will probably match that gross contribution, giving you another £125. So, from just £100 out of your pocket, you get £250. And if you're a higher rate taxpayer you'll get even more. That sounds like pretty good deal.

If you're contributing into a pension, it's important to know that you're also going to be paying fees. You're going to paying fees to the pension provider. In the case of having a work pension, those fees are generally lower compared to, let's say, a personal pension where the fees tend to be a little bit higher. So, that's segues nicely into talking about personal pension plans. 

On-Screen: Personal

Petroff: There are many different kinds of personal pension plans. You might have heard of the Self-Invested Pension Plan, also known as a SIPP. Now within SIPPs, you can invest in a wide variety of different assets. For example, you can invest in property and you wouldn't be able to do that through a work pension. But you might face higher fees. And also, with a SIPP, you're not going to be getting those nice contributions from your employer.

So, if you're looking at personal pension plans, the main thing that you're going to have to look at is flexibility and variety in terms of the assets that you can buy into, also fees, and you're going to want to be comfortable with your own investment knowledge because you're going to be doing this own your own.

On-Screen: One last thing…

Petroff: We've now covered state pensions, work pensions and personal pension plans. But there is one last thing that you're going to want to consider. It's fine to be making contributions into a pension plan, but you want to know where you should invest. You have to do some research. You can't just leave your money in cash, it's not going to be growing and you do want to see your money grow. Plus, you don't necessarily want to take that default fund that your work offers you because it might not be tailored specifically to your needs. So, you want to be doing your due diligence and research to find a pension plan and the investments that are just right for you.

On-Screen: Visit Morningstar.co.uk for more information

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.

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