How do pensions work? 5 things I wish I'd understood sooner

For many years, I’ve had a nagging sense of anxiety about pensions.

Pensions are important but can feel complicated. Over time, I’ve tried to understand the basics. I’m not a pensions expert (please talk to a qualified financial adviser for that), but here are four things I’ve learned (and a bonus thing that is less about pensions) that have helped make the topic of pensions feel a little less mysterious.

1. Your workplace pension is really valuable

For many employees, the workplace pension is the starting point.

With a defined contribution pension, you and your employer can pay money into your pension, which is then invested. The amount you eventually have depends on how much is contributed and how those investments perform.

Some employers will match additional contributions, while salary sacrifice arrangements can also have tax and National Insurance advantages. The important thing, I think, is simply to understand what your employer offers and make sure you understand the benefits available to you.

2. Pension contributions can be tax efficient

One of the key things to note, is that putting money into a pension isn’t quite the same as simply putting money into a savings account.

Pension contributions can benefit from tax relief, subject to the rules that apply to you and your circumstances. For some people, particularly higher-rate taxpayers, this can make pension saving a particularly tax-efficient way of putting money aside for the future.

It’s worth understanding how your own workplace scheme operates rather than simply assuming that a £100 pension contribution costs you £100 from your take-home pay.

3. Your pension isn’t just a pot of cash sitting there

Perhaps the most important thing to understand is what happens to the money once it goes into your pension.

For a defined contribution pension, the money is generally invested. The intention is that, over the years, investment growth helps the pension pot become larger.

That means your pension isn’t simply a savings pot that you build up and then spend down. Even after retirement, the money can remain invested while you take an income from it. That’s how most pensions work. Rather than drawing your pot to zero, they are designed to last for the entirety of your retirement.

As with any investment, there are, of course, risks. Investments can fall as well as rise, and how long your money lasts depends on a number of factors. But understanding that the money can continue to work while you’re drawing an income was an important part of making sense of pensions for me.

It would also be worthwhile to speak with your financial advisor about ethical investments and how your pension can work for good.

4. You don’t necessarily have to take the whole pension at once

When I first thought about pensions, I imagined reaching retirement, taking the money out and then gradually spending the pot.

The reality is more flexible.

There are different ways of taking an income from a defined contribution pension. Depending on the circumstances and the rules in force, up to 25% of a pension can generally be taken tax-free, subject to the relevant allowances and limits, with the remainder potentially providing taxable income. 

The State Pension can also form part of someone’s retirement income.

So perhaps the better question isn’t simply, “How big will my pension pot be?” but “What  might my different sources of retirement income provide?” 

5. Jesus tells us not to worry   

I’ve saved the best, and most important bit, for last. Jesus tells us not to worry. For me, pensions become more than just a financial question but one about where our security, safety, and comfort is.

Our security isn’t found in the size of our pension pot, but in Jesus.

That doesn’t mean we shouldn’t plan. Scripture has plenty to say about wisdom, responsibility, and providing for those entrusted to our care. I think there is a healthy tension here. Trusting Jesus for our future while also seeking to steward wisely what He has given us today.

I’m not a financial adviser, and this isn’t financial advice. These are simply some things I’ve learned along the way, which I share with the aim of making pensions feel a little less mysterious. Pensions and tax are subject to rules that can change, and everyone’s circumstances are different. If you have questions about your own pension or retirement plans, you should consider speaking to a suitably qualified financial adviser. What you shouldn’t do, is to worry.

For me, understanding the basics and the need to view my pension in light of my faith in the God who provides, was a good place to start.

Kingdom Bank does not provide financial advice. Please seek independent financial advice when structuring your finances.