piggy-bank-850607_640The value of a state pension is set by the government. Currently it is based on the amount of National Insurance contributions retirees have paid during their working life. The value of a private pension pot depends on three basic factors. Firstly, how much money has been saved into it. Secondly, how long the money has been invested. Thirdly, how well the investments have performed. In both the state-run and private schemes, you may be given the opportunity to top up your contributions. If you are in this position, it is important to think carefully about whether or not this is a good choice.
The State Pension
National Insurance contributions are paid by people in employment (above a certain earnings threshold) and are paid by the government on behalf of those in receipt of certain benefits, e.g. Job Seeker’s Allowance. Those who fall outside of these categories, e.g. people who take a gap year from employment but do not claim JSA, can sometimes choose to top up their state pension by paying contributions voluntarily. The first point to note is that you need 35 qualifying years of National Insurance contributions to claim the full new state pension. If you have fulfilled this requirement then regardless of whether or not there are “missing” years, you will still receive the maximum possible amount of state pension. There is a separate scheme which allows anyone who reaches state pension age on or before 5th April 2016 and qualify (this means they are entitled to the Basic State Pension or Additional State Pension and be either a man born before 6/4/1951 or woman born before 6/4/53) to buy up to £25 per week of extra state pension by making a lump sum payment on or before 5th April 2017. This is known as State Pension Top Up. If you have less than 35 years’ NI contributions and/or are considering making use of the State Pension Top Up scheme, then there are two key questions to ask before taking a final decision. The first is: how much faith do you have in the long-term future of the state pension? Government schemes and benefits can and do change. Governments might prefer to avoid making changes which lead to state pensioners being worse off, but in theory at least, it is a possibility. The second is: what else could you do with the money? In other words, could you get a better return on investment elsewhere?
Private Pensions
Private pensions come in two basic forms – workplace pensions and personal pensions. Under current laws, all qualifying employees must be enrolled into a workplace pension unless they actively choose to opt out. Both the employee and the employer make contributions into the employee’s pension fund (plus the contributions are eligible for tax relief), these contributions are then invested on the employee’s behalf and released to them when they are due to retire. In this case the opportunity for “free money” from an employer does generally make a compelling case for making the most of any workplace pension scheme. As always you would need to ask yourself if you could make better returns elsewhere. If you do find an opportunity where you could feasibly achieve higher returns, the next question to ask would be whether it realistically offers a comparable lack of risk.
Personal pensions do not benefit from employer contributions, but the fact that tax relief is available up to a certain level of contributions, means that saving for a pension can be an attractive way of planning financially for retirement. Up until recently, this had to be balanced against the fact that the majority of a pension pot had to be used to buy an annuity. This requirement has, however, been removed as part of a drive towards “pension freedom”. The result it that people currently saving towards a pension can make the most of the “free money” offered by tax relief, while enjoying a much greater degree of flexibility regarding what they can do with the resulting funds.
Info on state pension – https://www.moneyadviceservice.org.uk/en/articles/state-pensions
Info on workplace pensions – https://www.moneyadviceservice.org.uk/en/articles/automatic-enrolment-into-a-workplace-pension
Info on personal pensions – https://www.moneyadviceservice.org.uk/en/articles/personal-pensions