The key to successful retirement planning is understanding the options available and finding one that works for you. Whether you're an employee or a self-employed individual, having a pension plan is a secure way to ensure you will have a steady stream of income during your retirement years.
Retirement planning can be a complicated and intimidating process, however, setting up a pension is one of the best ways to financially secure your future. This guide will provide step-by-step instructions for setting up your own pension so that you can make an exit with sufficient funds.
Types of Pension Plans
Before we dive into the process of setting up a pension, let's first look at the different types of pension plans available. Depending on your financial health, there are several types of pension plans to consider, and 4 of them are listed below;
1. Defined Benefit Pensions
A defined benefit pension plan is a qualified retirement plan that pays out a fixed sum of money at retirement. It's typically offered by an employer and contributions are made by both the employee and the company.
The amount you receive upon retirement is based on factors like your salary and years of service, which makes it easy to determine how much you will get once you retire.
- The amount of money you receive is not based on stock market fluctuations, so it's more secure than other types of pensions.
- You are guaranteed a certain level of income when you retire.
- If your employer offers this type of pension plan, they often make contributions as well which can magnify the amount of money you receive.
- You cannot access your funds until retirement age, so if you need your funds earlier, this may not be the best option.
- If you switch employers, you may lose any contributions that have been made by your previous employer.
- Less flexible drawdown options
2. Defined Contribution Pensions
A defined contribution pension is another type of qualified retirement plan, but the payments you receive depend on the amount of money that you and your employer have contributed over time.
You are also responsible for managing your own investments, so it's important to understand how the investments you choose work before investing in a defined contribution plan.
- Higher contribution limits
- More control over the investments you make
- Your employer would match some of your contributions, which can help increase the amount you receive upon retirement.
- The rate of return on your investments is not guaranteed and depends on the performance of the asset you invest in.
- The amount of money you receive upon retirement depends on the contributions made by both you and your employer, so it can be difficult to estimate how much money you will have in retirement.
- More complex than some other types of pensions.
3. Private Pensions
A personal pension is set up by individuals with contributions from either themselves or their employers, depending on their employment situation.
The contributions are then invested in funds designed specifically for retirement growth, such as stocks and shares, bonds, and cash deposits. As these investments grow over time, so does the total value of the pension pot which can be unlocked and accessed when you reach retirement age.
There is a range of pension types available, including self-invested personal pensions (SIPPs) and stakeholder pensions.
- Higher contribution limits than other types of pensions
- Tax-deferred growth potential, meaning that your money grows without being taxed until you start taking withdrawals
- Flexible withdrawal options, so you can access your funds when you need them
- You are responsible for managing the investments in your plan, so if they perform poorly then you may not have enough money saved up when it comes time to retire.
- You may be charged high fees for managing your plan.
The Pensions Regulator (TPR) oversees workplace pension schemes in the UK. All employers must offer a pension scheme by law - but do not have to contribute if the employee earns less than £520 a month, £120 a week, or £480 over 4 weeks.
If you qualify for contributions, then your employer must agree to the terms and pay up on time; failure to do so can result in fines from TPR.
To prevent fraud, it is mandatory that any contribution your employer makes to your pension must be held in a separate account. Therefore, if your employer goes bust you are still eligible for all the money that has been put into the pension scheme.
If your pension provider is regulated by the FCA, then the FSCS provides 100% compensation if the pension provider fails. For defined benefit pensions, members are usually protected by the Pension Protection Fund which compensates up to 100% of the value if someone has reached their pension age or 90% if they haven’t.
4. Self-Invested Personal Pensions (SIPPs)
A SIPP is a type of defined contribution pension that allows you to manage your own investments. It offers the same tax advantages as other types of pensions and provides access to a wide range of investments, including stocks, bonds, mutual funds, and ETFs.
- Higher contribution limits than ISAs.
- Tax-deferred growth potential
- Ability to invest in a wider range of assets than other types of pensions
- Can only be accessed from age 55
- There is a tax on withdrawals of over 25% of your SIPP fund.
Establishing a Pension Plan
Now that we established different types of pensions, let's delve into the process of starting a pension pot.
1. Setting Up a Workplace Pension
If you are employed in the UK, you could be part of a workplace pension scheme without asking your employer. This is known as auto-enrolment and it applies if you are;
Classed as a worker
Over the age of 22 and under the State Pension age (which is 66 years old at present and scheduled to be 67 by 2028)
Earning at least £10,000 per year.
Once enrolled, payments into your plan will come from your salary automatically. The amount you contribute is typically 5% of your 'qualifying earnings'. The qualifying earnings are calculated as anything you earn in a year between the lower limit of £6,240 and an upper limit of £50,270.
For example, if you earned £50,000 a year, then your qualifying earnings would be £43,760 (£50,000 - £6,240). You would pay 5% of that figure into your pension plan.
Your employer must also pay into your plan - normally 3% of your qualifying earnings - bringing the minimum total contribution up to 8%.
If you earn between £6,240 and £10K annually then you won't be eligible for auto-enrolment - but your employer would have to open a pension plan for you if you ask.
Finally, if your annual income is less than £6,240, your employer will open a plan for you if you ask. However, they won't be required to make any contributions. If you fall in this category, you may want to consider additional ways of saving for your retirement, one of which is a personal pension plan.
2. Setting Up a Personal Pension Plan
A personal pension is an essential savings plan that can be used to supplement state or workplace pensions or as a stand-alone retirement income option for individuals who are self-employed.
With close to 7 million people in the UK now relying on personal pension plans, it has become even more essential to understand what they are and how they work.
There are many reasons to consider setting up a personal pension plan. For those who do not have access to other employer or state-provided pensions, it is an invaluable option for building retirement savings and planning for the future.
Personal pensions can be used to top up existing pensions, allowing individuals greater control over how they manage their finances in later life.
A Step-By-Step Guide
Step 1 - Choose Your Pension Type
Decide which type of personal pension best suits your needs. Stakeholder pensions tend to have low minimum payments but offer fewer investment options compared to SIPPs. Determine if you want the flexibility of a SIPP or the lower-cost option of a stakeholder pension.
Step 2 - Research Providers
Once you have identified the right kind of pension that works for you, research different pension providers to compare their costs, investment options, and transferability terms. It's important to choose a provider that fits with your retirement goals.
Step 3 - Open an Account & Start Making Contributions
Once you have selected a provider, open an account with them and make sure all paperwork is completed accurately and sent off promptly. You will often need to provide proof of identity and personal information.
Regular contributions are an important part of any pension plan, so make sure you commit to making payments on a regular basis. Many providers offer the ability to set up automatic payments for those who wish to do so.
When it comes to planning for retirement, there is no one-size-fits-all approach. The best age to start a pension plan will depend on individual circumstances such as your retirement age and income.
The state pension age is 66 years, though most people over 55 in the UK do not have a pension plan. However, the earlier you start investing in a pension plan, the better off you will be in retirement.
Starting a pension early offers many advantages. One of the main benefits is that your contributions have more time to grow through compound interest – meaning your savings will increase at an accelerated rate. This means that larger sums can be accumulated with smaller contributions, allowing you to build up a larger pension fund.
On the other hand, if you start saving late in life, you will need to make higher contributions to get the same benefits as earlier investors. Even if you are not able to contribute as much as someone who started earlier, it is still important to have a plan for retirement and start contributing as soon as possible.
It’s never too late to begin saving for your future – even small contributions can help supplement your state pension and ensure that you have enough money for retirement.
The Bottom Line
A pension plan can be a great way to save for retirement, and the earlier you start, the greater potential you have for your savings to grow. Whether you choose a workplace or personal pension, it is important to consider other factors such as debt repayment and your financial goals first before considering pensions.
The rules around workplace pensions are complex so before making any decisions it's best to seek advice from an expert financial advisor or seek out the appropriate regulation.
FAQs
What is the best age to start a pension?
Do all UK citizens get a pension?
Should I get a personal or workplace pension?
What should I invest my pension into?
Should you pay off debt or fund your pension?
Additional Resources
- If you have held different jobs from multiple employers, this thought might have crossed your mind how many pension pots do I have now? How do I combine them? The term pension consolidation is just that – it’s the process of combining, or consolidating, all your pensions into a pot that rules them all.
Are you looking for ways to minimise the tax burden on your pension? Understanding the intricacies of pension taxation is essential for optimising your retirement income.- When you leave an employer, any benefits that have been accrued in your pension will not be lost, as the fund actually belongs to you. This means that even though you are no longer working with that particular company, you will remain a member of their pension scheme and your money will stay invested as it was prior to leaving.
- Your child might be decades away from retiring – but helping them build their pension early on will help them have a sizable pot once they reach retirement age. With the ability to deposit up to £3,600 per year without paying income or capital gains tax, a junior SIPP account is an excellent way to do so.
- Regardless of your current financial situation and how young you are, building a substantial pension pot is essential. People work throughout most of their lives, and their retirement is the only time they can kick back, relax, and enjoy the benefits of their hard work.
- What is (hopefully) one of the cheeriest of occasions, retiring abroad, can and often is soiled by an endless amount of paperwork and one big question: whatever will happen to my pension? It seems daunting, but once you understand the process, you'll see it's not rocket science. Here, we explain how it works.
- It's generally possible to transfer your pension to another provider and this could be a great way to save more money and get the most out of your pot. In this guide, we'll look at how you can transfer your pension, your eligibility to do so, and any other factors to consider before taking the plunge.
- Are you looking for a flexible and controllable way to invest your pension savings? If so, you might want to consider a self-invested personal pension (SIPP). Unlike traditional pension plans, SIPPs give you the freedom to manage your investments in a hands-on manner and invest in a variety of assets, including stocks, bonds, and mutual funds.
