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Pensions are complicated and a bit dull so it’s no surprise that people’s eyes glaze over when you start talking about them.
Countless conversations with friends, family and colleagues have revealed to me that although people want to save for retirement, they’re confused about where their money goes when they save it into a pension and that they’re worried about losing their cash.
Here’s a rundown of the top four questions I’ve been asked about pensions:
Lots of people assume that their employer is holding on to their pension cash but they don’t. If you’re a younger saver (which I’ll assume you are) then you are probably saving into a defined contribution (DC) pension scheme (I’ll explain what that means later).
This means your employer has picked a pension fund for you to save into. It could be run by an insurance company, an independent pension company, or the government-back National Employment Savings Trust (Nest).
Your savings are held in this pension and invested. You can pick where your money is invested if you want to but if you don’t make a choice – and 99% of people don’t – then you are placed in a ‘default fund’ where your money is invested for you.
The pension fund invests the money because they want it to grow. If they just left it sitting in cash then inflation (or the cost of living) will erode how much your money is worth when you retire and it wouldn’t have been worth saving it.
You can find out where your money is invested by asking your pension provider – your HR department should be able to give you details if you don’t have them. The pension will also give you a list of pension options too so you can decide to take more or less risk, invest in ethical investments, or invest in something that’s important to you.
More than once someone has asked me if they lose all their pension money if they change job. The answer is: no, definitely not!
If you move jobs your new employer will put you into their workplace pension scheme and your old pension will just sit there, invested in whatever it is currently invested in. Your old employer obviously won’t pay any more money in but you will still be able to invest the money in the old pension wherever you like.
The only problem is that this system leaves you with lots of little pots of money all over the place and in the future you may want to consolidate these pensions into one big pot (although this is a costly exercise).
The government did try and introduce a ‘pot-follows-member’ plan where your pension would jump from employer to employer building up all your pension savings into one large pot. However, like everything that cost money and it was abandoned.
The pension industry is currently working on a pensions ‘dashboard’ that would allow you to see all your pension pots from different employers in one place.
How do I get my pension when I retire?
There is some confusion around how you ‘get’ your pension because at the moment we still have two types of pension schemes in operation. ‘Defined benefit’ (DB) pensions are paid as an income for life by an employer when you retire, with the amount you receive based on a percentage of your final salary multiplied by the number of years worked.
This was a good system and it meant you knew what you were going to get. But it is also very expensive to run because people are living longer.
That’s why you probably have a ‘defined contribution’ (DC) pension. When you retire, you don’t receive an income from DC pensions, you receive a pot of money and the size of that pot of money will be based on how much you contribute and how well the stockmarket does.
At the moment you can take 25% as tax-free cash – but only from age 55 – and then you have to decide what to do with the rest.
You can take it as cash but because it’s considered income, you may have to pay a load of tax on it plus you won’t have anything else to live on in later years.
If you want to make the money last you can either put it into a drawdown policy, which means investing the money and drawing down an income each year, or you can buy an annuity. Annuities are an insurance policy against living too long – you give your pot of pension money to an insurer and they offer you an income for life.
Annuities are secure but they’re out of favour because the income they generate has fallen as interest rates have slumped.
If you’re a younger saver, all these rules could change by the time you retire. It’s unlikely we’ll be able to access our pension pots at age 55, especially as we probably won’t get our state pensions until age 70!
Do I lose my pension money if I die before retiring?
If you die before retirement your money doesn’t disappear into the ether, neither does it get swallowed up by a pension company or your employer.
You can make sure the people you care about get your pension if you aren’t lucky enough to live to a ripe old age. To do this you need to sign an ‘expression of wish’ form, which will tell the trustees of the pension – who pay out the money – who you want to benefit.
You’re allowed to leave your pension to whoever you like but you need to keep track of your old pensions and ensure that the ‘expression of wish’ forms on all your pension pots are up to date.
Understanding the ins and outs of pensions doesn’t have to be difficult. If you do a few simple things: make sure your money is invested where you want, keep track of your old pension pots, and fill out expression of wish form, it’s easy to ensure your money is working its hardest for you.
Retirement may not be for a long time but a little bit of effort now can stand you in good stead for the future.