Pensions Explained: A Millennial’s Guide to Saving For Retirement

With so many living costs to take into account when you’re in your twenties, finding spare cash to squirrel away for retirement can understandably fall to the bottom of our to-do lists. However, considering a comfortable retirement is said to cost upwards of £15,000 a year, it makes sense to start saving as early as possible.

If you’re new to the world of pensions, fear not. In this post I’m going to explain the very basics to help you get started:

What is a pension?

To put it simply, a pension is a pot of cash that you pay into in order to save for retirement. Depending on the type of pension you select, your employer and the government may also contribute and help you save more money.
You have two primary options when it comes to selecting a pension. The first is a workplace pension and involves contributions from your employer. The second is a private pension that you’ll have to research and set up yourself.

Update: Following the UK Budget Announcement 2016, you also have the Lifetime ISA which you can learn more about in my guide The Lifetime ISA Explained.

Are pensions worth it?

When you pay money into a pension, you’ll benefit from tax relief. This means that some of the tax you paid on your income will be returned to you. The amount returned will all depend on the amount you place in your pension. The tax relief you receive will usually be placed straight into your pension pot.

For example: If you’re a standard rate tax payer, you’ll pay 20% tax on your income each month. This means that for every £100 you earn, the Government will usually take £20. However, when you pay some of your earnings into a pension, you’ll get some of that tax you paid back.

So if you pay £80 into your pension pot, the Government will place £20 into your pension pot too. You may have noticed that £20 isn’t 20% of £80. This is because the Government will give you tax relief on the money you earned before tax was deducted.

How much will my employer pay into my pension?

The amount your employer will pay into your pension will all depend on the pension provider they select and the terms offered by this pension provider. Some employers offer extremely generous pensions, while others offer the bare minimum.

How much should I put into a pension?

Different people recommend saving different amounts. However, some experts suggest saving as much as 15% of your income towards retirement! Of course, this isn’t possible for most people, so it’s simply a case of saving as much as you can afford as early as possible.

I can’t emphasise enough how important it is to start saving for retirement as early as you can. Even if you just put £20 into your account each month, by starting early, you give your money the opportunity to grow with the help of interest. To learn more about this, take a look at this blog post I wrote recently that explains the amazing power of compound interest.

What is auto-enrolment?

In a bid to encourage people to start saving for retirement early, the Government recently introduced the auto-enrolment scheme. Auto-enrolment forces all employers to automatically enrol workers on a pension scheme. The scheme is in stages, with larger companies being forced to implement these pension changes earlier than smaller companies. By 2018 all businesses must have auto-enrolled workers on a pension scheme.

Employees can opt-out of the scheme if they’d rather delay saving for retirement, but if you’re not going to miss a small percentage of your cash being deducted from your wages each month, it could be worth giving it a go. You’ll benefit from tax relief and ‘free’ money from your employer, after all.

What’s the easiest way to get a pension?

If you’d like to start saving for retirement but you aren’t too bothered about the terms and you don’t want to faff about with loads of research, auto-enrolment could work in your favour as you’ll automatically be enrolled onto a workplace pension. All you’ll need to do is go along with your company’s offering.

If, however, you decide to opt for your own pension, you’ll need to do plenty of research to find the best deals. You also won’t benefit from contributions from your employer.

Should I pay into a pension if I’m in debt?

It’s widely recommended that people start saving for retirement as early as possible. However, if you’re in debt, it could be worth paying this off first to avoid your debts spiralling out of control. It could also be worth speaking to a debt charity for more information and guidance.

After all, unlike easy access savings accounts, you can’t dip into your pension and withdraw money whenever you like. Once the money is in there, you won’t be able to access it until you’re at least 55. So if you were to suddenly need money for an unexpected expense, you wouldn’t be able to withdraw anything from your pension.

If the only debt you have is student debt, it’s probably worth paying into a pension providing your finances are otherwise secure.

Do I get all my money when I retire?

Last year the government announced new rules they called ‘Pension Freedom’. Designed to give people the freedom to use their pensions as they please, this allows anyone aged 55 and over to take their whole pension savings as a lump sum if they wish.

Unfortunately, although you’ll benefit from tax relief while contributing to your pension, once you come to retire and withdraw your money, you may have to pay tax on it as if it was income. Usually, the first 25% you withdraw is tax-free, but you’ll pay tax on the rest.

What is an annuity?

When you gain access to your pension, you have several options. You could dip into it whenever you please, you could withdraw it all and put it in a high interest savings account, you could invest in property, or you could opt for an annuity. An annuity involves selling your pension pot to an insurance company. The insurance company will give you a regular income for the rest of your life. That’s certainly not to say it will be a generous income, however. It all depends how much you’ve saved and how long the annuity provider expects you to live.

An annuity can either work in your favour or against you. Since your annuity provider will keep what’s in your pot when you die, you’re taking a bit of a gamble. After all, if you die just a handful of years after selling your pension pot to an insurance company, you can’t take the remaining money with you and your family won’t get it either.

On the other hand, if you live long past your life expectancy, the annuity provider will have to keep paying you a regular income even after the money you gave them has run out. Also, since an annuity gives you a guaranteed income for the remainer of your life, you can rest assured that you’ll always have a reliable source of income.

What happens if I die before retirement?

It’s not nice to think about, but it’s important to find out about how your money will be passed on if you were to die. Whether you die before or during retirement, it’s often possible for any leftover money in your pension pot to be passed on to relatives. However, the rules surrounding this are complicated and all depend on the type of pension you’ve saved. For more information, take a look at this guide from the Money Advice Service.

Can pensions be risky?

Technically, a pension itself shouldn’t be considered risky. As Martin Lewis explains: “A pension is simply a tax-free wrapper to save money for retirement. Their bad rep comes from investments that don’t pay off or high charges.

“Pension saving is a tax-efficient option that isn’t implicitly risky. The risk comes from the investment choice. Safer investments, such as putting your money in cash rather than exposing it to the risks of the stock market, are available.”

Is a pension the only way to save for retirement?

A pension is certainly not the only way to save for retirement. Some people choose to save in an ordinary savings account, invest in the stock market, or purchase property with the intention of letting it out. You could even purchase NS&I Premium Bonds and hope that you win. It’s all about finding the option that is right for you, most profitable, and most importantly, one you can afford.

The future is uncertain and it’s difficult to know how our own circumstances could change in the years to come. It’s also hard to predict how the rules surrounding pensions, tax and savings could change too. As a result, some people recommend placing your eggs in several baskets (if you can afford to) and diversifying your retirement savings as much as possible.

Have you started to save for retirement? Or can you simply not afford to yet? I’d love to hear your thoughts in the comments below.