Building a savings pot to provide income when you retire
Investing regularly from as young an age as possible, while taking advantage of various tax incentives, is the logical way to achieve this.
There are two common ways to build on the foundation that the State Pension provides so as to increase your retirement income:
Investing in a workplace or personal pension, often with help in the form of contributions from your employer, and Investing in ISAs
Available tax benefits
Pensions which offer tax relief on contributions and on a quarter of the money you withdraw are the more usual choice for retirement savings. Most new workplace pensions are ‘money purchase schemes’, also known as ‘defined contribution (DC) schemes’. Personal pensions work in a similar way. Tax benefits are available in return for restrictions on when you can withdraw money.
Different pension products
While there are a number of different pension products, the underlying concept is similar: you invest into one or a series of funds, which aim to increase the value of your savings over time. Your money may be invested in a range of assets including shares, bonds and property.
Every employee in the UK over the age of 22 who earns over £9,440 per year (2013/14) is being automatically enrolled into a pension scheme by their employer unless they actively opt out.
Both employer and employee are obliged to make contributions on earnings. These contributions will ultimately be:
- Employer 3%
- Employee 4%
- Government (tax relief) 1%
When you retire, you are entitled to take 25% of your total pension pot as a tax-free lump sum.
The rest of your pension will be used to provide a regular income, which will be taxed as income. There are two ways to do this. The first is to buy an annuity from a life insurance company. This is an agreement between you and the annuity provider about how your pension pot will be paid. The amount of income you get depends on the total sum in your pension, your age and other factors.
There are many types of annuities available. It is wise to shop around and seek financial advice before making a decision.
You can also take an income directly from your pension pot, commonly known as ‘income drawdown’.
There are two types of drawdown available:
Flexible drawdown: This is available if you can prove you have a sustainable annual income of £20,000 or over. It allows you to take as much or as little income from your pension as you choose.
Capped drawdown: This is available to anyone, but the income you can take is limited to the amount that would have been available from an annuity.
Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of and reliefs from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future.