What is a pension?
Firstly, it’s important to know that when we talk about pensions, we mean your pension plan. This is the way in which you invest for retirement rather than the income you get. Basically, a pension is a long term investment that helps you save for your retirement.
Payments into your pension are collected together and invested to build up a pot of money known as your pension fund. When the time comes to retire, it is the money built up in the plan that will be used to provide you with a regular income.
As the government is keen to encourage us all to put money away for our retirement, they’ve made pension plans tax efficient and you can benefit from basic rate tax relief on your payments. This means that, currently, for every £80 you pay in, the government will add a further £20 to your pension fund, and, if you pay income tax at more than the basic rate, you may be able to reclaim further tax relief when you complete your tax return (which does not get added to your pension fund).
Many employers will also make a payment into your pension fund. They’ll contribute money to your pension on top of paying your salary. If you work for a company or small business, you should talk to your manager or Human Resources department to find out what you may be entitled to. It may not be immediately obvious, so it’s always worth asking the question.
With the government and possibly your employer adding to your pension fund every time you pay money in, you’re effectively getting extra money added for free.
When you retire, the money built up in your pension fund is used to buy an annuity or another product which provides you with an income in your retirement. Your pension income will be taxed as earned income.
The money in your pension plan is invested with the aim of growth and the final sum is used to buy an income when you retire. However, you need to be aware that tax rules may change in the future, and the value of your investment can go down as well as up and the value of the pension fund may be worth less than has been invested.