Why should I save into a pension?

For some of us, retirement feels a far off, distant goal. So saving money into a pension that won’t be accessible until later in life can feel a bit of a sacrifice, even if it does offer key tax benefits.

No matter how far off it may seem, we are all likely to reach retirement age and paying into a pension is a great way to prepare for it. Whether that is through a workplace pension or personal pension, understanding how they work and how they can benefit you could really help in the long run.

A pension is a financial safety net for when you retire with the aim of allowing you to enjoy the fruits of your labour without financial stress. In the UK, there are several pension options:

• Workplace pensions. These are comprised of contributions from both you and your employer.

• Personal pensions. You set these up yourself and make your own contributions.

• The state pension. This is provided by the government as a foundation for your retirement income.

What are the benefits?

A pension fund will invest your money in a range of assets, usually a mixture of equities (shares) and bonds. Any gains you make from these investments are tax free when held within a pension. That can be particularly beneficial given the fall in the annual capital gains tax allowance to £3,000 from April 2024. This has lowered the amount of investment gains you can make without paying any tax.

Crucially, you don’t generally have to pay income tax on contributions you make into private pensions.

Personal pensions

A personal pension is like a savings pot for your retirement. You put money into it, and it has the potential to grow over time thanks to investments. When you retire, you can start taking money out of this pot. It’s flexible, so you can choose how much you want to save and when you want to start using it, as long as you’re at least 55 years old.

Furthermore, income tax relief is available on personal pensions through a government top-up at the 20 percent basic rate of income tax.

So, for every £8 you contribute, the government will top it up to £10. This means that if you invest £1,000 in your pension pot, the government will add an extra £250. As a result, you get an effective 25 percent uplift to whatever pension contributions you make.

You can still benefit from this top up even if you don’t pay taxes. So non-working people, children and retirees can all benefit. But there’s an annual limit of £2,880 (or £3,600 with the government top-up) for non-working people.

If you’re paying a higher tax rate, such as 40 percent or 45 percent, the government gives you a top-up on your pension contributions. It’s a way to balance things out. You get tax relief that makes up the difference between the basic tax rate of 20 percent and your higher tax rate. So, you end up getting more back in tax relief the more tax you pay. It’s a helpful boost from the government to encourage saving for retirement.

Workplace pensions

A workplace pension is a savings plan for your retirement that your employer helps you with. A bit of your pay goes into the pension each month, your employer adds some too, and you get tax perks from the government. It’s all set up for you, so saving for the future is easy and automatic

Pension contributions made to workplace pensions are automatically deducted from your monthly salary and so are not liable for income tax. This applies to any level of tax you pay, whether it is the basic, higher or additional rates. This means that the tax savings can be substantial if you’re taxed at the 40 percent or 45 percent rates.

The savings from both workplace and personal pensions can be even greater if they enable you to bring your salary below £100,000. Amounts you earn between £100,001 and £125,140 are effectively taxed at a 60 percent rate, as you lose your tax-free personal allowance on these earnings.

Workplace pensions can also make use of salary sacrifice. With this arrangement, you agree to give up some of your salary in exchange for your employer paying more into your pension. This reduces your salary and your employer’s national insurance costs. Some employers then pass on the national insurance savings to your pension contributions, which can improve your overall financial situation.

Pensions can also play an important role in protecting against the impact of inheritance tax. When you die, you can pass your pension on to your beneficiaries, which can be anyone you choose, usually without paying inheritance tax.

Never too early to start

Contributing to a pension is a crucial part of financial planning, and it’s never too early to start. The earlier you begin saving in a pension, the more you could benefit from the magic of compounding, where the reinvested returns from your investments themselves generate returns.

But remember, life’s other big moments matter too. Whether it’s buying your first home or planning for your children’s education, these are important financial goals. So, while it’s good to save for the future, make sure you’re also setting aside enough for the big steps you’ll take along the way. It’s all about finding that sweet spot between saving for tomorrow and living for today, and having a financial plan in place can really help with this.

At Schroders Personal Wealth one of our key principles is to have regular reviews with an adviser. An adviser can view your circumstances holistically and help create a financial plan to meet your personal goals. Key to this is helping ensure you’re making appropriate pension arrangements for your retirement.

Source:

(1) The Guardian (www.theguardian.com), ‘UK state pension age will soon need to rise to 71, say experts’, 5 February 2024.