Making the most of pensions

purse and cash
Image caption A "pension" is nothing more than a tax efficient way of saving money, says Fergus

I'm Fergus Muirhead and I'm here to answer any questions you may have about any money or consumer issues.

Please drop me a line here at with your questions.

You can also read more on money and consumer issues on my own blog.

In response to your pensions questions, I started to look at the different types of pensions and how they interact a month or so ago.

This time I'll expand on that by looking in a bit more detail at the non-state pension options, although I'll start by recapping on what the state is likely to provide.

Most people find pensions a real turn-off, partly because they get a lot of bad press and partly because we don't need them until we're older and so we tend to put off thinking about them as long as possible.

But please read on because they are important and as soon as you grasp how to make them work for you, the easier it is to plan effectively.

Also, at a simple level, a "pension" is nothing more than a tax efficient way of saving money, and proposed changes to the way in which you can use that money later in life will make them more flexible now than ever before.

State pension

The basic state pension is available to everyone who has paid enough National Insurance contributions during their working life. The definition of "enough" is long and dependent on a range of factors and is described in more detail than I can go into here on the Pension Service website at

The basic state pension is currently £107.45 for tax year 2012-13 but may be supplemented by pension credit depending on circumstances. Again, it is described in detail on the Pension Service website.

If you are unsure whether you will qualify for a full state pension then you can complete form BR19 and ask the service for an estimate of your entitlement at retirement.

If you are an employee, you may be entitled to additional benefit from the second state pension (previously known as Serps). It may be that you have chosen to "contract out" of the second state pension, in which case your National Insurance contributions that would have paid for this benefit will be diverted to your own arrangement.

If you are currently contracted out it may be worth looking at going back into the second state scheme.

Occupational pensions

There are two main types of occupational pensions, although many employers are now restricting access to the more expensive final salary scheme in favour of money purchase schemes that allow them to control cost more easily.

The usual rule is that if your employer offers access to a pension then take it!

Final salary schemes

With this type of scheme, your pension in retirement is based on the length of service you have and your final salary.

With the best of these schemes, someone with 40 years' service could expect a pension of two-thirds of their final salary.

However, you may have the option of taking some of this pension as a tax-free lump sum when you retire, thereby reducing the annual pension you will receive thereafter to around half of your final salary.

Some final salary schemes are still free - your employer will pay all of the cost of your benefits - but this is rare nowadays.

Most are funded by a mix of employer and employee contributions. Public sector schemes are a good example of this, with employees usually paying around 6% of salary and the employer paying the balance.

Most of these schemes will also provide valuable life assurance benefits, with up to four years' salary being paid out on death.

Money purchase schemes

These schemes operate in a similar way to personal pensions. You, or your employer - or a combination of both - will pay money into a pension and the final value will depend on the investment growth achieved by the money that is being invested. So there is no guarantee on the level of income you can expect to receive at retirement.

Investments are varied and carry different risk - you can leave your pension money sitting in a deposit account, you can use your entire fund to buy shares in one company or you can go out and buy a commercial property that you can then rent back to your business.

You need to take advice before deciding which type of investment is most appropriate for you. See more on personal pensions below.

Personal pensions

If you are self-employed, or don't have an occupational pension, then any money you want at retirement will have to come from your own savings, and the main savings vehicle that people use for retirement planning tends to be a personal pension. That is largely because it is a tax efficient savings scheme that allows you to put aside some of this year's income to use at some point in the future.

You put aside money every month, or every year, and that money is invested on your behalf - usually in a mix of stock market funds. But importantly, in these days of stock market volatility, it could also be in cash, fixed interest or property depending on the way your pension is set up and how much investment risk you are prepared to take.

When you get to retirement age you can either purchase an annuity (i.e. an income for life) or use the value of your fund to provide an income within certain limits. Up to 25% of the value of your fund can usually be taken as a tax-free lump sum.

Any investments you make into a personal pension are eligible for tax relief at your highest rate of tax, subject to limits. So if you are a basic rate taxpayer, each £100 will only cost you £80. This reduces to £60 if you pay tax at 40% and £50 if you are a 50% taxpayer.

However these limits, and the amount you can invest in a pension annually, are subject to change at the whim of the government.

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