How Pensions Work & How to Get The Most Out Of Your Pension

To maximise your pension you need to know how pensions work. For most people pensions are the best way to build wealth for the future. Pensions are a way for you, your employer and the government to provide money for your benefit in later life. Learning how to get the most out of your pension is very worthwhile.

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State Pension

State pension contributions are earned through working or looking after young children. When working you need to earn more than the lower earnings limit which is currently £6,240. State pension requires minimum 10 years contribution and 35 years to get the maximum payout which will be £221.20 per week or £11,502 per year from April 2024. Pensions grow in line with the triple lock of the higher of - wages growth, consumer price inflation or 2.5%. If you are missing contributing years you can purchase them for around £800. It is best to wait until you are near state pension age before buying additional years.

Workplace pension
Defined Benefit Pension

For workplace pensions there are two types, defined benefit where the benefit is a promise of a guaranteed future income one day when you retire it's a known or defined benefit now the amount of that income will be based on your earnings the length of time that you're with that employer and in the scheme. Some are calculated on a final salary basis others are calculated on a career average basis. Most private sector employers have shut their defined benefit pensions, but if you worked for a large company in the 1990s or earlier you might have one. You can use the government’s Pensions Tracing Service to track down all your old pensions.

Defined Contribution Pension
Defined contribution pensions are where you build up a pot of money by investing from your salary over the years until you retire. How much you get out of the end is unknown; it's the amount of contribution that is known or defined as you go along. How much the pension fund grows to is also a function of how the investments inside the pension perform over time. So you need to keep a close eye on how your money is invested. In the uk it's mandatory for employers to provide a pension of some kind, most likely a dc a defined contribution plan you will be automatically enrolled in the scheme but you can opt out.

You get free money with pensions in the form of tax relief. So if you don’t like paying tax, consider topping up your pension with an additional voluntary contribution. With pensions you are trading off only being able to access your money at a later date with tax concessions.

When you could contribute £100 to your pension via salary sacrifice the equivalent after-tax payment is:
£80 - Basic rate taxpayer
£60 - Higher rate taxpayer
£55 - Additional rate taxpayer
£40 - Higher rate taxpayer contributing income between £100,000 to £125,140 (the loss of the personal allowance)

If your income is £60,000 or higher, then £48,000 is the maximum amount you’re allowed to contribute into your pension each year - as you'll also be receiving a £12,000 tax top-up. If you are under 75, aren’t employed or earn under £3,600 annually then the most you can pay into a pension is £2,880 (or £3,600 with the tax relief applied).

You can backdate unused allowance for up to 3 years. Backdating pension contributions is relatively straightforward, as long as you have had a pension open for the entire period. But you still won't be able to go above the other annual limit - 100% of your earnings for the year. For example, if you earn £50,000 a year, that is the maximum you'll be able to add to your pension and still get tax relief - even if you haven't used up your allowance in the years prior. If you trigger the Money Purchase Annual Allowance the maximum amount that can be paid into your pension is £10,000 a year. The MPAA only applies to contributions to defined contribution pensions and not defined benefit pension schemes. The MPAA is triggered if you take income from a defined contribution pension. But it is not triggered if you only take a tax-free cash lump sum from your defined contribution pension. The MPAA is not triggered if you are under 75 and start to receive a state pension or a defined benefit pension.

Pensions are taxed as income when you take money from them. But there is no national insurance to pay and no capital gains tax. Pensions grow tax-free too so as you roll up wealth for the future there's no tax being taken off any dividend or interest payments received.

Chapters
00:00 Introduction
00:33 State Pension
01:35 Defined Benefit Pension
04:04 Defined Contribution Pension
05:51 Self Invested Personal Pension
08:41 UFPLS vs Flexi Access Drawdown
09:53 Retirement Calculator