The central purpose of most investments is to grow savings over time. Throughout the course of an investor’s life they may build up their initial “pot” through a diverse portfolio of different assets. A key element of every saving plan should be at least one pension product; while these savings keep your money safely tucked away for the future, they can also be a great way to earn tax-free income for later in life. In addition to the state pension, most earners will also pay into a private pension plan to boost their retirement income, enabling them to live more comfortably once they’re no longer earning.
When deciding which forms of pension to invest in their are several important aspects to consider; in this article, we’ll highlight some of the areas where savers should focus their attention, and how a well thought-out pension plan can make all the difference between a healthy retirement pot and a slim savings fund. Many pensions products involve investment in the stock market, or in bonds, and many pension plans which can gain value can also lose it, should their investments fail. Before committing to any pension, savers should consult an expert financial advisor who will be able to determine what the precise risks and benefits are to each pension product.
Pensions have many benefits as a form of investment, and though they require money to be locked away long-term they do come with several incentives. Chief among these is the ability to earn tax-free; most pensions are exempt from taxation, and can be used to accrue earnings over the years. This is exceptionally attractive for savers who are confident in the stock market, and who are willing to place their money in more volatile funds - the potential to make substantial earnings without paying any tax is a strong incentive. While a pension may be susceptible to income tax when it’s actually paid out, there are still substantial tax reliefs in place which make earnings from a pension significantly easier to keep hold of than an individual’s other income. Therefore, a pension should always be part of a saver’s overall investment strategy, since it provides a highly valuable source of non-taxed income.
In addition to providing a tax-free wrapper for investment, pensions are also a highly flexible asset. In comparison to many other savings products and investments, a pension plan may be split and reallocated numerous time to take advantage of new deals, which enables pension holders to keep up with the market. This flexibility is crucial, and is a good argument for investing in pensions rather than property; a buy-to-let home, for instance, will cost a good deal more to purchase in the first place, and is a very difficult asset to liquidate.
The UK State Pension is the default savings product which all UK citizens are entitled to receive. The amount which pensioners receive is determined by the amount of National Insurance they pay throughout their life, and can reach a maximum of £122 per week once the pension holder reaches retirement age. This is not a lot to live on, though, and many individuals turn to private pension plans in order to top up their later-in-life income. There are two main forms of private pension; the workplace pension, and the personal & stakeholder pension.
As of 2018, every UK workplace will be required to enrol their staff in a workplace pension scheme. These pension schemes are contributed to directly from employees salaries, and are deducted from each payslip - the amount of contribution they make is determined as a percentage of their salary, so they more they earn, the more they’ll pay.
In many cases, employee contributions are matched by a contribution from the employer and in some cases by tax relief as well. This means that an employee’s pension contributions often end up significantly increasing in size from the amount they put in - as an example, an employee might put in £50 each month. Their employer might then match that with £40 of their own money, and a £10 tax relief payment, resulting in an overall contribution of £100. Because it’s such an easy way to grow savings, and allows employees to double their money, a workplace pension scheme is a highly valuable part of any savings plan.
Some savers might not have the option of contributing to a workplace pension (such as the self-employed), or may wish to open up an additional pension plan as well as their state and workplace pensions. A variety of pension products are available for savers who wish to gain access to a more flexible, adaptable form of pension fund, and there are two main flavours of pension on offer: savers can contribute to a large pension fund controlled by a fund manager, or pick and choose their own investments.
Stakeholder pensions allow savers to contribute to a large fund, along with many other investors. Their money will then be invested in the stock market, and (hopefully) grown over the years. Once past the age of 55, pension holders can then access their money just as with a regular pension, and there are many options which savers can take advantage of to maximise their earning potential.
Self-invested personal pensions (SIPPs) are a highly flexible investment vehicle which allows savers to select specific funds to invest in. This enables savers who are confident and experienced with the stock market to put their own savings to work, rather than relying on a central fund manager. Although the money in a SIPP will still not be available until the pension holder reaches the age of 55, the fact that earnings are tax-free on pensions means that a SIPP can be a powerful component of any long-term savings portfolio.
One final form of pension plan that bears mention is the Lifetime ISA (or LISA). These ISAs enable savers to contribute throughout their life to building up a fund, which pays out a 25% bonus once the saver reaches 60 years old (or purchases a first home). While a LISA is not as flexible as a private pension nor as rewarding as a workplace pension, it does provide a useful form of pension plan for those without access to other options.
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