FOOL SCHOOL
Pensions: Introduction

May 20, 2002

A pension is 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 once again about to take a shot across your bows. There are some complications along the way.

It is often said that most of us don't put enough into our pensions. That's only part of the truth. What is really meant by this is that most people don't invest enough for their retirement. A pension is only one way of investing for your retirement. Like all investment decisions 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.

We're going to take a look at the state pension, occupational pensions and personal pensions (such as the Stakeholder Pension and SIPPS). Confused? Thought you might be. Don't worry. All will become clear in the next few weeks as we work our way through the various different types.

More: Pension Centre