How are pensions calculated?
23rd Apr 2024 Pensions & Retirement
3 min read
With different kinds of pension schemes available and amounts paid into them during your career, this is how pensions are calculated
If
you live and work in the UK, there are three principal ways you can create a
pension that can provide an income when you retire. These are the state
pension, the workplace pension, and the pension you set up yourself.
State pension
You
can access this regular payment from the government when you reach state
pension age. The amount you receive is calculated according to the number of "qualifying" years of National Insurance payments you have made, consisting of
contributions you have paid when working and also contributions credited to you
when you are unable to work.
"The amount is calculated by the 'qualifying' years of National Insurance payments you've made"
Currently,
state pension age in the UK is now 66 for both women and men. However, for
those born after 5 April 1960, there will be a phased increase in state pension
age to 67, and later on to 68.
Workplace pension
This
is essentially a long-term savings plan that benefits from both tax relief and
employer contributions. It is only accessible after reaching a certain age. At
present the earliest age is 55 in the UK, but set to rise to 57 in 2028.
Private pension
This
is a pension you can set up yourself either if you are ineligible for a
workplace pension, for example if you are self-employed, or if you want to
increase the retirement funds you will receive from your state and workplace
pensions. Like the workplace pension, private pensions are only accessible
after reaching a certain age, at present 55 or over in the UK, but set to rise
to 57 in 2028.
How is my workplace or private pension calculated?
Pension amounts paid in by you and your employer depend on the kind of pension scheme you have. Credit: Mikhail Nilov
The
amount you and your employer pay towards the pension depends upon the kind of
pension scheme you are enrolled in, and whether you have been automatically
enrolled in a workplace pension or you have joined one voluntarily, where you
have "opted in".
Types of pension schemes
There
are two main types of workplace/private pension schemes:
Defined contribution pension schemes
This
is a pension pot based on how much is paid in, and can be a workplace pension
arranged by your employer or a private one that you arrange yourself.
The
money put into the scheme pays for investments such as shares made by the
pension provider, and the value can rise or fall.
"The money put into the scheme pays for investments made by the pension provider"
The
amount you receive is calculated using these factors: the amount paid in, how
well the investments have performed and how you are paid, which could be a lump
sum or a series of payments. A further factor affecting the calculation is any
management fee the pension provider may take.
Defined benefit pension schemes
This
is usually a workplace pension arranged by your employer, based upon your
salary and how long you’ve worked for your employer.
The
amount you will receive depends on the rules governing your pension scheme and
you receive a certain amount annually on retirement.
Work out how much you need
Knowing how much savings you'll need for retirement will allow you to work out if you're saving enough with your pension. Credit: Cottonbro
Use
an online pension calculator commonly included on pension providers’ websites
to ascertain whether your pension pot will be sufficient for the lifestyle you
want on retirement. To do so you need to know the projected value of your
retirement savings and whether you are saving enough to satisfy your goals.
Formulas for calculating what you need
Retirement
experts have different formulas for working out what is a sufficient amount to
aim for for a comfortable retirement. One option is to build a pension pot that
equals ten times your current salary. The 70 per cent rule, where you end up
with 70 per cent of your current salary as retirement income, is another.
However,
needs change, and your lifestyle, circumstances and health may alter
significantly over time, each triggering financial implications.
"Regularly evaluate your pension savings to see if they are on track to meet the income you will need "
Talking
to the Daily Telegraph, Michelle Holgate, of wealth manager RBC Brewin Dolphin
said: “It is best to regularly evaluate your pension savings to see if they are
on track to meet the level of income you need or would like in retirement. Many
people assume they need an income similar to their current income, however this
could be more or less throughout your retirement years for many reasons.”
You should
always speak to an independent financial adviser for additional guidance.
Unbiased can connect you with a local financial adviser that is regulated by the Financial Conduct Authority (FCA)
today.
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