HomeMoneyPensions & Retirement

How are pensions calculated?

How are pensions calculated?
With different kinds of pension schemes available and amounts paid into them during your career, this is how pensions are calculated 
If you live and work in the UK, there are three principal ways you can create a pension that can provide an income when you retire. These are the state pension, the workplace pension, and the pension you set up yourself.

State pension

You can access this regular payment from the government when you reach state pension age. The amount you receive is calculated according to the number of "qualifying" years of National Insurance payments you have made, consisting of contributions you have paid when working and also contributions credited to you when you are unable to work.
"The amount is calculated by the 'qualifying' years of National Insurance payments you've made"
Currently, state pension age in the UK is now 66 for both women and men. However, for those born after 5 April 1960, there will be a phased increase in state pension age to 67, and later on to 68.

Workplace pension

This is essentially a long-term savings plan that benefits from both tax relief and employer contributions. It is only accessible after reaching a certain age. At present the earliest age is 55 in the UK, but set to rise to 57 in 2028. 

Private pension

This is a pension you can set up yourself either if you are ineligible for a workplace pension, for example if you are self-employed, or if you want to increase the retirement funds you will receive from your state and workplace pensions. Like the workplace pension, private pensions are only accessible after reaching a certain age, at present 55 or over in the UK, but set to rise to 57 in 2028. 

How is my workplace or private pension calculated?

Person on laptop with calculator
The amount you and your employer pay towards the pension depends upon the kind of pension scheme you are enrolled in, and whether you have been automatically enrolled in a workplace pension or you have joined one voluntarily, where you have "opted in".

Types of pension schemes

There are two main types of workplace/private pension schemes:

Defined contribution pension schemes

This is a pension pot based on how much is paid in, and can be a workplace pension arranged by your employer or a private one that you arrange yourself.
The money put into the scheme pays for investments such as shares made by the pension provider, and the value can rise or fall.
"The money put into the scheme pays for investments made by the pension provider"
The amount you receive is calculated using these factors: the amount paid in, how well the investments have performed and how you are paid, which could be a lump sum or a series of payments. A further factor affecting the calculation is any management fee the pension provider may take.

Defined benefit pension schemes

This is usually a workplace pension arranged by your employer, based upon your salary and how long you’ve worked for your employer.
The amount you will receive depends on the rules governing your pension scheme and you receive a certain amount annually on retirement.

Work out how much you need

Money in piggybank
Use an online pension calculator commonly included on pension providers’ websites to ascertain whether your pension pot will be sufficient for the lifestyle you want on retirement. To do so you need to know the projected value of your retirement savings and whether you are saving enough to satisfy your goals.

Formulas for calculating what you need

Retirement experts have different formulas for working out what is a sufficient amount to aim for for a comfortable retirement. One option is to build a pension pot that equals ten times your current salary. The 70 per cent rule, where you end up with 70 per cent of your current salary as retirement income, is another.
However, needs change, and your lifestyle, circumstances and health may alter significantly over time, each triggering  financial implications. 
"Regularly evaluate your pension savings to see if they are on track to meet the income you will need "
Talking to the Daily Telegraph, Michelle Holgate, of wealth manager RBC Brewin Dolphin said: “It is best to regularly evaluate your pension savings to see if they are on track to meet the level of income you need or would like in retirement. Many people assume they need an income similar to their current income, however this could be more or less throughout your retirement years for many reasons.”
You should always speak to an independent financial adviser for additional guidance. Unbiased can connect you with a local financial adviser that is regulated by the Financial Conduct Authority (FCA) today.  
800x300 (1)
Banner: Olly
Keep up with the top stories from Reader's Digest by subscribing to our weekly newsletter