There are three main types of pension, state, personal and occupational pensions. All three of which provide three unique ways of providing financial security for the future. There follows an explanation of all three of these pensions some of their advantages, and what you have to do in order to be eligible for them.
The state pension
What is the basic state pension?
The state pension is calculated based on the amount of National Insurance contributions you’ve paid throughout the years. It currently stands at £95.25 a week for a single person and £152.30 weekly for a couple.
In order to qualify for a State Pension you must first have a National Insurance number. You will have one sent to you automatically if you are a UK citizen, but you will need to apply for a number if you are a foreign national. Once you have a number, you will be required to make National Insurance contributions.
The basic State pension is available from the age of 60 for women and 65 for men. To qualify for a state pension you must have sufficient qualifying years. That is, where you have sufficient income to pay National Insurance Contributions (NICs), or are treated as having paid or being credited with NICs. At the moment and on average, men need 44 qualifying years and women need 39, in order to be eligible. This however is said to change on 6th April 2010, where only 30 qualifying years will be needed in order for one to be eligible. If someone has been unable to claim this amount of qualifying years because of long term obligations as a parent or carer, then the amount of qualifying years needed could also decreased by that date.
State pension deferrals
To get the most out of your state pension, you can put off claiming it when you reach retirement age. If you put off claiming your State Pension for at least five weeks you can earn an increase to your State Pension of 1 per cent for every five weeks you put off claiming. (This is equivalent to about 10.4 per cent extra for every year you put off claiming). If you don’t claim your State Pension for at least 12 consecutive months, which must all have fallen after 5 April 2005, you can choose to receive a one-off lump sum payment and your State Pension paid at the normal rate. The lump sum payment, when you claim it, will be based on the amount of normal weekly State Pension you would have received, plus interest added each week and compounded.
The additional State Pension
In addition to the basic State Pension, the government has an additional pension benefit This is a top-up to the basic pension. Your entitlement to the additional state Pension or ‘second state pension’ is based on how much you earn each year, and where these earnings fall on the government’s earnings scale.
The calculation is based on how much you earned and for how many years you had made National Insurance contributions. Your earnings are also considered, and also takes into account time taken out of work for legitimate reasons. The additional state pension scheme helps both those in employment and those unable to work either because they are currently incapable or because they are currently caring for others. Those who fall into these categories are given the chance to earn an extra benefit on top of their basic State Pension without being required to contribute anything.
You can currently build up the additional state pension if, you earn above a certain amount, typically 4-5 thousand pounds throughout the tax year, care for one or more children under 6 and claim for child benefit, you are a carer throughout the tax year for someone who is ill or disabled or you are unable to work throughout the tax year because of long term illnesses and disability are entitled to benefits as a result, throughout the tax year, and have been earning for at least one tenth of your working life.
In addition to the State Pension system, there are a range of non-state pension savings schemes which offer you the chance to save for, and invest in, your future. Some employers offer their workers an occupational pension scheme, and may even make contributions on their behalf. If you are self-employed or your employer does not offer an appropriate scheme, you can invest in a private pension at most banks, building societies and financial institutions.To maintain a personal pension, you will need to pay either regular doses of money, typically every month, or lump sums, which will then be invested by your pension provider.
A stakeholder pension is a flexible type of personal pension, which works in much the same way as money purchase pensions. This is as you have the liberty to put as much money into your ‘pension pot’. The managers of the stakeholder pension scheme invest the pension fund on your behalf. The value of your pension fund will be based on how much you have contributed and how well the fund’s investments have performed. It is best to make regular payments if you can, but you can stop payments for a while if you need to without it costing you anything.
Where can you get a stakeholder pension?
You get a stakeholder pension from financial services companies such as insurance companies, banks, investment companies and building societies. Other organisations such as trade unions may also offer stakeholder pensions to their members.
The legal requirements of a stakeholder pension.
The minimum requirements for any stakeholders pension to be viable, include firstly the limits on annual management charges. These limitations mean that managers can charge fees of up to one and a half per cent of your pension fund each year for the first 10 years you hold the product, and thereafter up to one per cent. Other requirements include, being able to switch to any other pension provider without the pension provider you leave charging you. Moreover, you legally stop re-start or change your payments whenever you want. However, as a safeguard it is strongly advisable that the scheme is run by trustees, or by an authorised stakeholder manager, whose responsibility will be to make sure that the scheme meets the various legal requirements
Tax relief in personal pension schemes
For each pound you contribute to your scheme, the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot.
If you’re on the higher tax rate of 40 per cent, you’ll still get 40 per cent tax relief for any money you put into your pension. But the way that the money is given back to you is different. This is as the first 20 per cent is claimed back from HMRC by your pension scheme in the same way as for a lower rate taxpayer .It’s then up to you to claim back the other 20 per cent when you fill in your annual tax return or by claiming by telephone or letter to your Tax Office
Is a personal pension right for you?
Most of the people who invest in this kind of pension scheme, are either those who are self employed, people who don’t have a company pension scheme offered to them and generally people who have money to save in such an investment. If for instance you’re an employee, you can opt out of the additional State Pension and instead put the National Insurance payments which would have gone towards it into a personal pension, including a stakeholder pension. But such a decision would require careful planning, and financial advice before execution.
Company pensions are set up by employers to provide pensions for their employees on retirement. Company pension schemes vary from company to company. Your scheme is likely to fall into one of two general types – a ‘salary related’ or ‘money purchase’ scheme. In a salary-related scheme the amount you get is based on your salary and the number of years you’ve been in the scheme. With a money purchase scheme the amount you get is based on how much has been paid into the scheme and how well the money has been invested.
Company pension schemes, like personal pension and stakeholder pension schemes, require you to make regular contributions. These contributions are calculated as a percentage of your salary, however you may boost your benefits by making additional voluntary contributions (AVC’S). An advantage of this kind of pension scheme is that you get tax relief on the money you put into your pension pot. That means that you pay less tax on the money you put in.
If you stop working for the employer running the scheme, you will still be a member (known as a deferred member) of the scheme. If it is a salary-related scheme, your benefits will be revalued on a regular basis to ensure they keep pace with inflation. If it is a money purchase scheme your fund will continue to be invested and you will continue to receive yearly statements and forecasts on how it’s performing.
So what kind of pension is right for you?
The main decision to be made here is whether you would rather invest in a private pension scheme, e.g. an occupational or personal pension scheme, or claim for a state pension. Looking at some of the advantages and disadvantages, one of the most distinctive advantages in investing in personal pensions are the profit motives the private sector operates on. In theory, this would mean a secured investment, however this does not take into consideration the ever fluctuating state of the economy. To look at this from an economic viewpoint private pensions enable the government to lower taxes. Arguably lower income tax may increase incentives to work. Lower corporation tax may then increase incentives for business investment in the UK, which means a healthier British economy. On the other hand, the government has made a commitment to people in work that they will receive a state pension. The government can’t turn round and tell people nearing retirement age that they are not going to honour these commitment. This again ultimately means a secured investment – free from the ‘fluxuation risk’ of an otherwise invested personal pension. Taking this point further, the financial crisis highlights the fact that private finance firms can go bankrupt. If people invest in a private scheme, that scheme may go bankrupt and people will be left with nothing for retirement. This has already happened with some private pension schemes. Therefore, there is an expectation the government will step in and rescue those pensioners who have seen their private scheme fail. The point is you can’t rely on the free market to guarantee pensions.
It would seem therefore, that a state pension is a safer investment. However the benefits of a personal or ‘private’ pension could very well outweigh the risks of having such a pension. This would however, depend entirely on your personal circumstances. So an important thing to remember, is when planning ahead not only must you invest in a secure pension plan, but you must also invest in the correct kind of pension plan