Last Updated on 17 March 2023 by Dan
Hello everyone! Today I’d like to write about how you can potentially get free money – now there’s an offer you don’t get every day! However owing to the tax benefits and contributions from employers, that’s exactly what a pension can do for you.
There can be significant benefits in paying more than the stated minimum into a pension, although these won’t crystallise until the long term when you’re required. It’s a case of “the earlier the better”.
Note for Scottish readers: In this article tax savings we make reference to are using figures based on tax values in England, Ireland and Wales. Whilst the same principle will apply for Scottish readers, note you have slight different tax bands to those stated here.
As ever – our normal note that we take care with what we write on this site but it is not official “financial advice” and whatever investments and savings you enter need to be right for your circumstances. We always suggest doing your own further research. If you’re in doubt about anything, it’s worth consulting a regulated and reputable financial advisor who can provide tailored advice built for you.
Unbiased is a resource that can help you match with an advisor who matches your needs.
What does a pension do?
Let’s start with the basics. A pension is a pot of money which is designed to cover you after you’ve stopped working in your retirement. The Government offers significant tax relief on these contributions, as it’s obviously beneficial to them that you can fund yourself in that period of your life rather than rely on state support.
Most people these days have a contributory pension, where both you and your employer pay a proportion of your salary into a fund over your career. That money is then invested over the life of the pension so you also benefit from investment growth as well as the pure money.
Some people (generally older workers) may also have a final salary pension, where the company you worked for will continue to pay you a guaranteed annual income based on your final or average salary.
This article will mainly be talking about a contributory pension from here on in.
Why do I need to contribute to a pension?
The short version is that you’ll need to rely on your pension savings in later life once you retire.
Many people significantly underestimate the amount of money they’re going to need for retirement. There’s a few reasons why people underplan for retirement:
- State benefits and the state pension are much lower than people think it is – there actually isn’t that much Government support for day to day life once retired.
- The cost of care in the later stages of retirement is increasingly expensive.
- It’s quite human in terms of how we think to over focus on present day needs/wants and under-prepare for the future.
Unfortunately not planning out your retirement needs does have consequences – pensioner poverty is becoming more of an issue and many people find themselves working longer out of need for finance than they otherwise would have done.
How does an auto-enrolment pension work?
To try and help reduce the effect of people not saving enough for their pension, the government introduced auto enrolment – basically that by default both you and your employer put some money into your pension.
The amount both you and your employer are obliged to pay by default under auto-enrolment 3% of your earnings is contributed by your employer, and 5% of your earnings is contributed by yourself. These amounts are usually taken directly out of your paycheck to put into your pension.
You can read about those contributions at the Government’s Money Helper website here
You are auto-enrolled into these schemes and the above minimum, but you can opt-out of pension auto enrollment which brings us onto the next question….
Is opting out of pension auto enrollment a good idea?
Opting-out is never something I would recommend unless you desperately need the cash now. The benefit of those tax savings really does add up significantly over time, and you will feel the benefits later in life. Think of it as an investment in your future, literally.
If you have questions on if you’re presently enrolled on your pension scheme, your company HR department is usually a good place to start.
Should I voluntary pay in more to my pension than the auto-enrolment amount?
Ideally yes if you can afford to. There are three main reasons to do this:
- Very simply, the auto enrollment amount may not alone cover the lifestyle you’d like in retirement.
- Any further contributions to your pension are subject to tax relief.
- Your employer may pay in more if you do.
We’ve got more details on those last two potential pension benefits below.
What tax relief do I gain with a pension?
The main tax benefit you get from paying into a pension (unless you’re a very high earner) comes from the fact you won’t pay income tax on those contributions – so if you’re a basic rate taxpayer you can get an additional 20% on any contributions you make, and a higher rate taxpayer can get 40%. When you turn this into a proportion of salary, that can make a real difference to your financial health.
As we’re investing that money (see here for why investment works over time) the effect of that additional money going into our pension becomes also becomes a rolling effect – we don’t just get the benefit of that additional 20%/40% at that moment in time, but also further gains from having that to invest.
Is there limits on the amount of tax relief I can claim on a pension?
Yes – if you’re working full time tax relief on pensions is limited to either 100% of your earnings or £60,000 of contribution in a single year (Note: It’s £40k as at March 2023, but will become from April £60k for the 23/24′ tax year following the budget)
You can put more than this into your pension in a year, you just won’t get the tax relief above this.
It’s worth noting that the £60,000 limit also includes any contributions made from your employer, as well as yourself.
Why should I check my employers pension scheme?
As you’ve seen above, your employer is already contributing some additional money into your pension pot. You also have the right to voluntarily increase the % of your salary you’re putting into your own pension.
Your company might literally give you some free money if you do. If you look through your employee handbook, or employee benefits guidance, you may find that the company will match any additional contributions up to a point.
For instance, it may illustrate that “where you make pension contributions up to 6%, the company will also match this 6% contribution”.
This really is worth checking. You have to make a small sacrifice now in terms of converting some of your take home pay into that additional pension contribution, but when every pound is matched by your company, it really is well worth it. This can make literally thousands of points worth of difference to you, and tens/possibly even hundreds of thousands if you do this early to get it invested in the long run).
How to review a pension for further gains
Now there’s a few additional things you might want to consider to really get your pensions savings going – these require a little more work but can really add up.
In the above we’re looking at how you can maximise your contributions by getting the employer and the taxman to maximise the benefit you’re getting from your pension.
With these tips we’re targeting the other end in terms of reducing the ongoing charges applied to pension that can take away some of your gains.
Review your Pension management fees
The pension itself will me managed by a pension management company, who will charge a fee for that service. It’s usually somewhere between 0.25% and 2% a year.
Now if you’re at the higher end of that, that’s quite a spread – if it’s the very maximum it’s a 1.75% gain on your money ever year that you, not your pension provider could be getting. With pensions building up over time, the amounts in there can be reasonably large so again this can make a substantial difference.
It also needs to be balanced against performance though – if you’re consistently getting market beating performance from a higher cost pension, that can still be worth it. Rare this situation occurs though.
You have the right to transfer your pension to another provider, so it may be worth seeing if you can reduce those management costs by transferring it.
To do this, you may need to call your pension provider to understand what fees they are charging. Sometimes you’ll find things can be cheaper than you expect, as your workplace will also sometimes cover some of the management fees (or your workplace will have been given a bulk buy discount with the provider).
There can also be exit fees when leaving a pension provider, although this is becoming less common. This complicates things – you’ll need to make a personal judgement on if the fee is worth paying vs. the service you’re receiving and the gain you’d make on transferring it.
Just be aware that you want to be very sure of who you’re transferring it to and do your research. If your new provider performs poorly, you’ve made that choice of provider and the responsibility sits with you. You also want to be sure your new provider is genuine and reputable – unfortunately there are a significant number of pension scams out there, and you to not want to hand over your hard-earned pension to someone else.
Consolidate your pensions
If you’ve moved around a few jobs, you’ve probably got a variety of pensions stacked up. Once you’ve done the research above, it’s generally cheaper to have your pensions in one place as you can avoid some duplication of fees. As a result, once you’ve worked out who is the cheapest provider using the advice above, you may want to think about consolidating all of your pensions with them.
An alternative is to use a service which does the hard work of tracking down old pensions and consolidating them for you. We consider PensionBee to be excellent for this – it’s a superb service that’s really useful for getting your pension in effective low cost options (and if moving it won’t save you money, they leave it where it is).
If you’re a self employed person, remember that it’s important to still save in your pension as your employer won’t be doing so for you. This also gives you the flexibility to choose your provider as you aren’t tied in to whoever your employer is using. You can find some details of the companies that offer SIPP and their costs and charges at Koody’s guide to pension providers.
Any questions?
Pensions can be simultaneously one of the more confusing aspects of personal financial management but also one of the most important to get right! So if you have any questions on any of the above please do just leave us a note in the comments below.
And that’s it!
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