Pension Basics
Pensions are high on the agenda at the moment, following the recent publication of the latest report from the Pensions Commission and a raft of rule changes which came into force on 6 April 2006 (known as A-Day).
However, there's a considerable amount of confusion over how pensions operate and how they'll change in future, making it very difficult for us to make financial plans for our retirement.
What is a pension?
In its simplest form, a pension is essentially an income that you receive when you retire. To build up a big enough pot of money to provide that income, someone has to do some saving. What makes one pension scheme different from another is down to how this money is saved, whom it is saved by and how the income is eventually generated.
To encourage us to save enough for our retirement, the Government provides a tax break. So, as long as a pension scheme fulfils the criteria they have set down, then the money that goes into it comes out of your pre-tax earnings.
Think of it this way: you put some money in, then the Government chips in the tax that you have paid (or would pay) on that money. There is a limit, of course, on how much you can pay in. The limit will depend on what type of pension scheme you are contributing to. In the case of some schemes, the older you are, the more you can put in.
These contributions form a pension fund, which is invested over the years until your retirement. In theory all this seems fine and dandy. In practice, life is about to take a shot across your bows. Pension rules are far more complex than they need to be and the new rules are adding to the confusion as there a number of transitional issues to deal with.
Pros and Cons
It is worth bearing in mind though that a pension is only one way of saving for your retirement. You need to balance the pros and cons and compare various options. The benefits of pensions are:
- The tax break;
- The fact that you aren't able to succumb to temptation and spend the money prior to your retirement.
Offsetting this are the two main flaws:
- The charges tend to be more complex and higher than other long-term investment schemes;
- They aren't particularly flexible, particularly in respect to how you receive your pension money once you retire.
(To read the full article, go to the Motley Fool)
Written by Fool.co.uk. Posted on 14th November.
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