The best place to start to start when explaining pensions is at the beginning.
In a sentence; a pension is a tax efficient savings plan that is used to build an income for your retirement.
There are two stages to retirement planning. Firstly the ‘accumulation’ phase is all about saving as much money as possible into your plan and investing it with the aim of it growing in size.
The second stage is the ‘income’ phase and is where you convert the savings pot into an income for life. This is done by purchasing an annuity, more on these later (or there is a useful blog article on them here).
Below is a list of the three main elements that make up a pension;
Tax Wrapper - Some financial ‘products’ use a tax wrapper which is an allowance provided by the taxman that bestows some tax advantages on the underlying investment.
Think of this as a blanket that you can drape over some of your investments in order to protect the returns from tax. Savings that are not covered by a tax blanket are taxed at 20% on any interest or 18% on any capital gain, over and above your annual allowance.
Examples of tax wrappers are Pensions and ISA's. These are identical in the tax treatment of the monies in the pension, whereby any growth is accumulated free of tax. Pensions also have an additional benefit in that they receive tax relief on any contributions made into them. This is a rebate of the income tax that you paid on the equivalent part of your salary. If you are a basic rate taxpayer you will receive 20% rebate (if you pay £80 the taxman will give you £20) or 40% if you are a higher rate taxpayer, up to certain limits).
Provider - This is the insurance company or other provider of the administrative hub for your investments. They deal with the paperwork, applications, statements, fund choices, claiming any relevant tax benefits etc. They will also set the charges of your plan.
Funds - The nitty gritty of where your money is actually invested. Investment funds are a pot of multiple investor’s money, managed by a fund management team. They will buy and sell assets in line with the brief of the fund. i.e. a UK Equity fund will invest in UK stocks and shares, a UK Fixed Interest Fund will invest in UK fixed interest securities etc.