We need to talk about pensions: five things employees need to know
These are key questions that employees need to know the answers to if they are to be fully prepared and able to retire at the time of their choosing. To help with this challenge, Nigel Peaple, director policy & advocacy at the Pensions and Lifetime Savings Association (PLSA), outlines five simple things employees should know about pensions to make planning for the future that bit easier.
1. A full state pension is worth £9,339 per year
The state pension is a regular payment from the government most people can claim when they reach state pension age.
Most people in the UK who work, or undertake caring responsibilities, will be eligible for a state pension if they have worked and paid National Insurance contributions or been a carer for at least 10 years.
If they have done so for 35 years, they will receive a full state pension, currently worth around £9,339 per year. This can be drawn at that level from when a person is between 66 and 68 years of age, depending on their date of birth.
2. Most people are now automatically enrolled in a workplace pension
The government also helps people make extra pension savings on top of their state pension by ensuring most workers are automatically enrolled into a workplace pension.
There are two types of workplace pension: those based on the contributions made plus returns from investing the fund (defined contribution pensions) and those linked to salary (defined benefit pensions).
The value of a defined contribution pension depends on the level of contributions both from the individual employee and the employer. For many people the contributions equate to around 8% of a band of their pre-tax earnings, of which at least 3% comes from the employer, though there are more generous schemes and employees can choose to contribute more.
The value of a defined benefit pension is based on salary, very often with a view to providing half or two-thirds of salary after a full working life.
There is also some support from the government through tax measures, in particular, when employees draw their pension 25% of the sum is free of tax.
3. There are tools to help employees assess how much to save and how much money they will need in retirement
For many people, the best way to have an adequate income in retirement is to save gradually over the whole of their working life and save what they can afford. However, depending on their financial circumstances, some may prefer to save less when they are younger and more when they are older, especially if they expect to receive an inheritance before they retire.
Based on in-depth research with the British public, the PLSA has produced its Retirement Living Standards to help savers picture their future life in retirement at three different levels of expenditure: minimum, moderate and comfortable. These look at all aspects of day-to-day costs such as weekly food shopping, the cost of transport, going out and holidays.
Roughly speaking, a single person will need about £10k a year to achieve the minimum living standard, £20k a year for moderate, and £30k a year for comfortable. Like 5-a-day, this can be briefly summarised as 10k-20k-30k. For couples, it's 15k-30k-45k. These expenditure levels do not include mortgage or rent payments as most retirees do not have to pay them. However, if you think you will need to pay them, you can add on the relevant figure.
Someone on average earnings with a full state pension and the minimum level of automatic enrolment pension saving is likely to achieve a lifestyle between the minimum and moderate levels.
We have estimated that if a couple is each eligible for a full state pension their income will exceed the minimum level. If each make regular contributions of £200 per month for their whole working life, their workplace pension and state pension should enable them to reach the moderate level. For someone on average full-time earnings (£30,000 per year) to save at £200 per month is equivalent to 8% of salary.
More information can be found at www.retirementlivingstandards.org.uk. In addition a helpful Pension Calculator to find their likely income in retirement is available on the MoneyHelper website.
4. You have choices to make about drawing your pension
When savers get to retirement, they can choose how they draw their workplace pension savings. For example, those with a defined contribution scheme can select a product that pays a fixed amount every month (an annuity), take a more flexible option where they can vary what they draw but the amount is not guaranteed (drawdown) or take cash as a lump sum. Savers can also choose a mixture of these approaches.
According to the Financial Conduct Authority’s 2020 Financial Lives Report – in the previous four years before the report – almost a quarter (23%) of all adults who had drawn a defined contribution pension had taken an annuity, while over half (55%) had taken a partial amount from their pot as cash while over a fifth (21%) had emptied their entire pension pots as cash.
If an employee has a defined benefit pension, they can choose to take their whole pension as a regular income, often upgraded in-line with inflation, or after taking financial advice – for pots over £30k – they can choose to transfer their pension to a defined contribution pension.
5. Information and advice is available
There is a lot to take in, but savers need not be confused. To help navigate the numerous options there is free guidance and information available from the government-backed MoneyHelper and Pensions Wise services.
For those looking for a more personalised review of their options, savers can also visit an independent financial adviser who will delve deeper to help them decide the best route to enjoying a comfortable retirement. In addition, many employers offer financial wellbeing benefits that can help employees navigate their retirement planning.
The author is Nigel Peaple, director policy & advocacy at PLSA.
This article is provided by the Pensions and Lifetime Savings Association.
An employer’s guide to talking about workplace pensions
The PLSA has also published new guidance to help pension schemes and employers support savers’ financial wellbeing by starting a conversation about their workplace pension.
Launched to coincide with Pensions Awareness Day, An Employer’s Guide to Talking About Workplace Pensions is designed to encourage employers to educate their workforce about how their pension scheme works, how they can make the most of employer contributions, and how they can make good decisions to set them up for a more secure future.