This post is sponsored but the views expressed are those of Magical Penny
When you hear the word ‘pension’ what do you think?
For most people it’s a pretty confusing concept. One of the biggest confusions about pensions is what investments actually go into a pension, and how much does one need to have a retirement that does not mean being being cold and hungry.
Understandably with low understanding comes low levels of trust. I’ve heard countless friends and collegues tell me variations of:
“I don’t trust pensions”
“I haven’t got a clue about my pension
It’s a sad state of affairs because a pension can be a great way to save for retirement – mostly because it allows you to invest money you haven’t paid taxes on and the pension pot grows tax-free year after year. You only pay tax when you start taking out an income (generated by the pension pot when you buy what’s called an annuity).
The confusion and mistrust around pensions have not gone unnoticed:
As the video shows, there’s lots a ‘buzz words’ around pensions.
Ultimately though, there are really two types of pension – defined benefit and defined contributions. The difference is a defined benefit pension promises you a certain amount of money when you retire, whereas a defined contribution pension gives you you a certain amount of money today to use when you retire.
Defined benefit pensions are also known as final salary pensions and have become increasingly less popular as the risk to deliver an income is placed on the employer rather than the employee. This ‘risk’ has been problamatic for companies in recent years as the economic uncertainty have led some schemes into trouble running out of money in the fund to pay existing pensions.
A more empowered way to save in a pension is through a defined contribution pension:
How a defined contribution pension works
Most private companies these days offer a defined contribution pension and it’s something you should be doing, especially if they offer what’s called a ‘match’ –where the company ‘matches’ what you put into the scheme up to a certain percentage of 3%.
Let’s give an example:
Say that you earn £20,000 a year and your company offers a 3% ‘match’.
This means that whatever you put into the pension account, the company will put in the same up to 3% of your salary. Therefore to get the most money from your company you need to put in at least what the maximum match is. In this example its 3% of £20,000 = 20k*0.03 = £600.
Put £600 of your own money into the scheme and you’ve just given yourself a £600 raise and you now have £1200 in the scheme! Result! You can actually put in as much as you want, up to 100% of your salary but your company won’t put in any more money into your account than the ‘match’ amount.
As you can see it’s worthwhile but its not the whole story –you need to consider how this money is going to grow and keep up with inflation. You do this by having your pension contributions invested automatically in various investment funds.
Even if you don’t have an employer match it’s worth looking into if a personal pension of your own is good for you.
Ultimately, pensions have a bit of a bad reputation given the ever changing rules about them and the failure of some pension schemes to be transparent in what you can expect to receive when it comes to retire. However, with a defined contribution pension you can receive free money today to help fund your future and be in more control than ever.