Along with mortgages, pensions are among the most important financial commitments you’ll ever make in your life.

Yet millions of people don’t really understand how they work, or put off thinking about them when times are hard and money is tight.

I have to say, I really sympathise with this view. I had to study pensions and how they worked when I took my financial planning qualifications back in 1857 and I found the whole subject distinctly challenging.

The financial world has changed significantly since I did those exams. The good news is many businesses that offer advice and support around pensions have recognised how important it is to help us understand how pensions work and how to make the most out of them.

But for many people, pensions are still a bit of a mystery. So I’ve recruited pensions expert, Clare Moffat, from Royal London, to help answer some of the biggest financial urban myths around pensions. Here’s out top ten – but first, a quick refresher…

Pensions 101

There are three main types of pension:

  • The state pension. This is the pension you get from the state (or government) and is drawn from your National Insurance contributions over your lifetime.
  • Your workplace pension. This is the pension you have through your workplace. You can usually contribute extra into it and the pension provider should send you a statement every year showing you how it’s doing – even after you’ve left the business.
  • A private pension. These are pensions you set up yourself. They often come with tax benefits and are a really useful way to save for retirement – especially if you are self-employed.

There are loads of different types of private pensions, which is why taking advice before signing up to one is a must. Before you fork out cash though, have a look at the free options on the free and impartial Money Helper website

Nine pension urban myths [and an extra one for free]

Pensions are complicated and restrictive, so you’re better off sticking the money in a savings account.

There’s a lot of confusion about when you can get your hands on your pension and how much money you can withdraw without paying tax. Yet you can actually get your hands on your pension much earlier than the state pension after you turn 55 (or 57 from 2027). You can take 25% of the pension tax-free at this point.

Pensions are without a doubt one of the most tax efficient ways to save. This might seem a little dull, but think about tax relief as a top up to your pension from the government. If you’re an employee, you could also get an additional bump up to your pension in the form of employer contributions. You can find out more here – but why not just ask your HR team how this works in plain English?

It isn’t worth saving a small amount in a pension when you are young

Even if you can only pay a small amount in to a pension, it’s worth doing, thanks to the wonders of ‘compounding’.

Compounding is the process over time where the money you invest builds interest and the investment plus interest is combined in to one. You then get interest on the whole amount. Over time, the longer you invest, the more that money can potentially grow. Think of a snowball, running down a hill and growing in size. *Caveat alert!* Pensions involve investments and can go down as well as up.

If you decide not to start saving when you are young, then you will need to pay a lot more a month when you are older to match the amount you would have earned if you paid in when younger.

You can’t change your workplace pension contributions

If you are 22 or over and earn more than £10,000 a year, you will automatically be placed into your workplace pension scheme when you start a new job. Your employer must pay a minimum of 3% of your salary into your pension and you have to pay around 4%. Then the government tops this up by another 1%.

Fabulously, you can pay more than this by increasing the percentage you pay monthly or paying a lump sum into your pension.  You might think your outgoings are too tight for lump sum payments, but if you get a bonus, why not consider adding that to the pension?

Only the person who has the pension can pay into it

Nope – you can pay into someone else’s pension for them.  The person who has the pension will receive the tax relief (and can claim higher-rate tax back if they are a higher rate taxpayer).

You might think this is pretty rare, but you’d be surprised. Some people chose to pay into a pension for a spouse or partner that isn’t working, or for a child or grandchild. You can’t go mad though. The most that can be paid into a pension is £2,880 a year, which becomes £3,600 when tax relief is added.

*Free extra pension fact!* Anyone can have a pension – including under 18’s.

You have to stop working to receive your pension

You can take money out of most pensions from the age of 55 (currently) even if you are still working. But if you take more than your 25% tax-free lump sum you will pay tax on it. This sits on top of your earnings which means more tax or even entering a new tax bracket.

This is where we have to get a bit technical (sorry). If you are in a defined benefit scheme, for example, if you work in the public sector, you may get a reduced rate if you retire early to reflect the fact you will need the money for longer. A defined benefit scheme is the fabled ‘final salary pension’ – which are getting rarer nowadays as people who have them retire.

You have to take your tax-free cash in one lump sum

You don’t have to take your tax-free cash in one go. Many ‘defined contribution pension schemes’ (the most common kind) will let you take your tax-free cash in a series of payments. You don’t get four 25% tax free chunks though!

You can take money out of your pension before you’re 55

This is the question I get asked the most about pensions, especially during the cost-of-living crisis.

Normally, you have to be aged 55 or over to take money out of your personal or workplace pension and as I mentioned, this is rising to 57 in April 2028. However, there are a few specific circumstances when you could potentially take money out of your pension earlier.

If you are retiring early because of ill-health, then you might be able to take money from your pension before you’re 55.  Your pension scheme provider will talk you through the evidence you need. If you have a terminal illness and have less than a year to live, you can take your pension benefits tax-free (as long as you’re under 75). There are also some exceptions for those who are in certain occupations like police officers or in the armed forces.

You have to stop paying into pensions when you start taking money out of your pension

You can continue to pay money into a pension even if you’ve started to take money out. However, there are limits to be aware of.

If you’ve taken money out of your pension that’s taxable, either as a lump sum or as income payments, you may trigger the MPAA (money purchase annual allowance). This limits the amount that can be paid into your pension to £10,000 a year. If this has happened then your pension scheme will write to you and tell you this.

However, if you’ve taken a tax-free lump sum, a payment from a defined benefit/final salary pension), have purchased an annuity – which pays you an income for life – then these limits don’t apply.

If I start writing about drawdown pensions, we’ll be here all day, so *deep breath* if you’ve paid money in to a drawdown pension but haven’t taken anything out (except tax-free cash), they the limits should not apply either.

The state pension isn’t taxable

This one’s been in the news a bit lately. The state pension is taxable, but it’s paid to you without the tax being deducted. From April 6th, the full new State Pension is £11,541 a year, which is a little over £1,000 less than your personal allowance (the bit of your earnings that you don’t have to pay tax on). So, if you are receiving payments from another pension, such as a workplace or personal one, it’s likely you will have tax to pay. This tax will is taken from your workplace or personal pension. More here

Featured in Mirror – Martyn James

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