Step 41: An Introduction to Pensions

Pension… a word dreaded by many, not just because they might not like the idea of being old, or – on the contrary – are worried it’ll be way too long before they can finally retire. Many simply don’t have a clue what their pension might look like and fear that they might never be able to retire properly, due to a (nearly) empty pension pot or the absence of a decent pension plan altogether.

Or maybe you just hate the idea of talking about pensions as it sounds like the most BORING topic in the world to you.

Be that as it is, ignoring your pension is not going to do you any good and considering the many changes that pensions are going through at the moment in many countries, it is wise to learn more about them and especially to understand your own pension projection better and to put together your own pension plan. So you are going to take the bull by the horns here and set up or review your current pension scheme. It might be tough, unpleasant or tedious at first, but once the bulk of the work has been done, you can sit back with a comfortable feeling, knowing you might still be a long way away from where you want to be, or from your retirement in general, but that you’ve put in a plan to get you back on track or closer to your end goal.

So let’s start with some of the pension basics. Pension options can vary widely from one country to the next, from industry to industry and between different employers. We’ll begin by looking at a general overview of what pensions really are before moving on to the actual pension schemes and their own advantages and disadvantages.

What are pensions

Pensions are in essence a fund into which the state, an organizations and/ or an employee pay money, in order to finance retirement. This allows people to stop working when they are older, whilst still being able to have access to a monthly income or a lump sum of money saved over the years. Many countries have pensions as a compulsory part of an employee’s benefits that must be paid monthly, whereas in other countries this might not be the case, leaving those who don’t sort out a pension early on in life in danger of financial insecurity and problems later on in life. Even those who do have a pension plan, often don’t realize how much (or little) they will get when they actually get to retirement age. Others might find themselves with a pension gap: this can happen to those who didn’t work during several years or people who are self-employed but didn’t set up a pension plan. We will look at all of this in the subsequent steps on pensions, so if you fear that any of this might be the case for you, or you are worried about your pension in general, make sure to read on

Types of pensions

We can generally divide pension schemes into three main categories, although each category might have different options within their structure to further look in to. Most countries offer (some of) the following three types of pension schemes,:

• State pension – a pension paid by the state when somebody reaches state pension age. It is normally financed by the employee and /or employer during the employee’s active working life through monthly taxes taken out of the employee’s wage and sometimes by the employer’s compulsory social security contributions. Employees generally build up a state pension in the country / countries they live and work in, providing they have worked for a certain minimum amount of years. The monthly pay is normally the same for everybody, regardless of how much the employee previously earned.
• Workplace pensions – pensions provided by an employer, union or work sector. Other names include occupational, company or employment pensions. Participating in a workplace pension is often voluntarily and not all companies offer this option. In some cases employers also make contributions to this scheme for their employees. This pension would be in addition to the employee’s state pension.
• Personal pension – you can also set up your own private pension scheme via banks, insurance companies or pension plan companies. These are completely separate from any work related schemes, but are a good alternative if you don’t have access to a workplace pension or if you have reached the maximum contribution on it.

All of the above pensions are considered to be income when you start drawing your pension, meaning you’ll be liable to income tax.

Step 41 – An Introduction to Pensions – in detail

We will be looking at each type of pension in detail in the next few steps, but for now we’ll start with an easy exercise to get an idea of what your pension situation is like.

• Check whether you are entitled to a state pension, and if so how much the current state pension is per week or month.
• Check whether you are enrolled in a workplace pension and if not whether your company offers any type of workplace pension. Request pension details and an overview of your contributions if applicable.
• If you have a personal pension plan outside of your employer’s scheme, find details of payments, your status and specifications.

The information that you’ve collected here will help you in the next three steps when we look at each type of pension in detail, before moving on to putting together your own pension plan in step 45. But before being able to determine on a plan of action, you first need to know what the current pension schemes are that you are enrolled in or that you might be entitled to.

So whether you fear(ed) pensions because they sound complicated, boring or scary, remember that by taking one step at the time you can achieve anything. Even something as fearsome as pensions..

Read more about my 100 steps mission to financial independence or simply decide to take control today and join us on our step-by-step quest on how to make your finances work for you, starting with step 1.