Whether your latest pension statement has put the frighteners on you or you simply have the money to spare, it goes without saying that topping up your pension is one of the best ways to improve your financial security in retirement.
However, while the decision to boost your retirement saving might be a simple one, working out what to do with your extra savings may seem anything but.
Should you pay it into your existing pension or set up an all-singing, all dancing Sipp, or is a pension even the best home for your money?
Factors such as whether you are boosting contributions on a monthly basis or have a lump sum to invest will also come into play, as will the length of time you have until you plan to retire. The type of pension scheme you are currently paying into may also influence your decision.
Beef up your workplace plan
Thankfully the decision should be a straightforward one for the vast majority of savers, according to Alistair McQueen, savings and retirement manager at Aviva. “On a like-for-like basis, your workplace pension will outperform any other savings vehicle once tax relief and your employer’s contribution have been taken into account,” he says.
Currently, savers receive tax relief on pension contributions equal to the highest level of income tax that they pay. This effectively means a basic-rate tax payer only needs to pay £80 to invest £100, a higher-rate tax payer will only need to pay £60, while those who pay the additional rate will have to stump up just £55.
For members of defined contribution schemes, how much your employer pays in will vary according to the deal you have – some employers will match your contribution up to a certain cap, others will only pay the statutory minimum. Under auto-enrolment rules, employers must pay in 1% of their staff’s qualifying earnings into their pension, but this is set to increase to 3% from April 2019.
You can talk to your employer about increasing contributions, but, if possible, it’s worth registering on your provider’s website too. Many will have tools to show the benefit of additional saving. You may be able to calculate, for example, what effect an extra £100 a month will have on your eventual pot, says Mr McQueen. You may even be able to change your contributions and review your investments online.
If you have maxed out on your employer’s contributions, there may be some argument for investing additional contributions into a personal pension or self-invested personal pension (Sipp). You may also be able to consolidate schemes from former employers into the new pot.
Should you set up a Sipp?
However, this should only be considered if you want to be more actively involved in running your pension or are frustrated by any limitations of your employer’s scheme such as online functionality or investment choice.
Kay Ingram, a director at adviser LEBC, says: “Most employers’ schemes are good value and will have discounts on charges that aren’t available to the individual.”
Jonathan Watts-Lay, a director at Wealth at Work, agrees. “With an occupational scheme, your costs will always be lower. The only argument would be if you wanted to invest in something that wasn’t available in your scheme.”
- How to pick a Sipp platform
Boosting a final salary scheme
If you are a member of a defined benefit scheme (such as final salary), the situation is a bit different. Here, you cannot simply pay more into your defined benefit plan – any further savings will need to made into an additional voluntary contribution, or AVC, plan.
These may enable you to purchase added years or bring your retirement date forward, but Gary Smith, associate director of financial planning at adviser Tilney Bestinvest, warns “it is very expensive”.
Alternatively, your AVC may be a defined contribution pot. This means its eventual value will be based on the amount of money that you pay in, plus investment performance and less any charges and will not be linked to your earnings or time in the scheme.
Confusing matters further, this pot may be linked to your main pension or it may not. Your employer will be able to let you know. If it is linked, it may make sense to take advantage of it, as when you eventually retire you can take your 25% tax free cash from this pot. This can work out better value for money than taking it from your main plan. Mrs Ingram says: “If you take it from your defined benefit plan, you are giving up a guaranteed and inflation protected income.”
If your plan isn’t linked to your main scheme – meaning you wont’ be able to tax-free cash from it – or indeed you don’tneed it for that purpose, Mr Smith says it may be worth investing in a standalone pension. This is because you will have full access to the pension freedoms – giving you improved death benefits and easier access to your money.
He explains: “If you put money into a standard pension arrangement, your loved ones would get that money as a tax-free lump sum if you died before age 75. You can also access your pension at age 55 and carry on working.”
If you don’t work in the public sector, you will also have the peace of mind that if your employer fails this money won’t be passed into the Pension Protection Fund.
Although the scheme is designed to protect workers’ pensions when companies with defined benefit schemes fail, it may not be able to fully compensate your loss. Mr Smith adds: “If you pay money into a Sipp or other pension, it’s your money.”
- Your guide to final salary pensions
Be aware of savings limits
Mr Watts-Lay says warns that because the benefits of final salary pensions can be so good, if you’ve been in your scheme for most of your working life it makes sense to check you won’t breach pension saving limits, after which you won’t be eligible for tax relief on your contributions."
Be aware of the lifetime allowance. It is now at £1 million but if you have, say, been in the civil service for a long time you could be caught out with a more modest income – you don’t have to be the chief executive.
Whether or not you are topping up a final salary or defined contribution, it also pays to think about the annual allowance for pensions. You can currently save up to 100% of your income to a maximum of £40,000 a year. Bear in mind that if you are a very high earner, you will need to consider the taper allowance, which gradually reduces the amount you can pay into a pension and still get tax relief.
Mr Watts-Lay says: “This affects people earning over £150,000 and, once you hit £210,000 a year of taxable income, you can’t invest more than £10,000 into a pension each year.”
Regular saving versus lump sums
For the majority of us who still have plenty of mileage in their pension, experts agree that the best way to invest is little and often. This allows you take advantage of pound cost averaging whereby you are able to buy more shares when prices are low and fewer when prices are high – effectively smoothing out the peaks and troughs of stock market investment.
If you invest a lump sum and markets are soaring so will your returns, but if markets fall you could quickly lose a sizeable chunk of your investment, which you may struggle to recoup if you need the money in the next few years.
But that’s not to say you should spend any windfall rather than saving it for your retirement. “Pensions are long-term investments so that should reduce the anxiety of lump sum investing,” says Mr McQueen. “But if you are less than five years away from needing your money, you may consider how singularly you look at your investment.”
Indeed, Mrs Ingram points out that just because you have a lump sum it doesn’t mean you have to invest it in one go. “The problem with lump sum investing is you have to get the timing right. But you can get your money into the pension wrapper [and benefit from tax relief], then put your money in cash and then dripfeed it into the markets to smooth out the ups and downs.” She adds: “This could be particularly important now with Brexit hanging over us.”
- How to invest in 2016: the basics
Likewise, if you receive bonuses at work this can be a very tax-effective way of topping up your workplace pension. Take the example of a £10,000 bonus – if this was paid via salary sacrifice into your pension, rather than straight to your current account, you would not pay any tax or national insurance (NI) on it. Your employer would make an NI saving of 13.8% too and its not uncommon for them to pass this saving on to you, boosting your total contribution to £11,380, according to Hargreaves Lansdown.
By contrast, if you took your bonus the conventional way, after tax and NI a higher-rate taxpayer would receive just £5,800 into their account. Don’t delay For those with more complicated circumstances – for example, higher earners who may get caught out by the lifetime or taper allowances – it will undoubtedly make sense to talk options through with an independent financial adviser.
For the rest of us, while it may seem like there are lots of options and choices to make, the important thing is just to get saving and not get too bogged down about making the ‘right’ choices.
As Mr McQueen says: “The biggest difference anyone can make to their retirement is saving more. Full stop. The mechanics of where and when you invest are secondary.”
Is a pension always the right home for your retirement savings?
Topping up your pension is always a commendable activity but before you rush to boost your retirement savings, think about your wider finances first. Patrick Connolly, a chartered financial planner at IFA Chase De Vere, says: “If you have expensive debts, pay these off before committing money elsewhere. Then, if you have no cash savings that you can access at short notice you should make sure you build up a cash buffer.”
Even if you are debt-free and have savings to hand, you may question whether a pension is the right home for your money. Cash held in Isas will remain accessible and because you can withdraw money tax free it can be a useful complement to taxable pension income and provide a way of boosting your income without increasing your tax bill. Yet while Isas are flexible, experts agree that – thanks to tax relief on contributions – pensions are better equipped to grow your savings. “You’ll never get the same rate of return anywhere else,” says Jonathan Watts-Lay, a director of Wealth at Work.
The clever way for final salary scheme members to top up their pension and take tax-free cash
A final salary scheme member is entitled to an annual pension of £30,000 without taking any tax-free cash. His scheme has a fairly typical commutation factor of 12:1 for calculating tax-free cash which means that for every £12 of tax-free cash paid for each £1 of pension income given up. So if a member was prepared to see their annual income fall to £25,000, they could take £60,000 as a tax-free cash payment.
However, if they had an additional voluntary contribution plan worth £24,000, they could use this to part-fund their tax-free cash. They would then only need to give up £3,000 of pension to generate £36,000 tax-free cash and would receive a pension of £27,000 and £60,000 tax free.
Source: Tilney Bestinvest
What will you do when you have paid off your mortgage?
Finally paying off your mortgage is a big milestone, but what will you do with all that extra money once you’ve cleared this debt?
According to research from Saga Investment Services, over 50s are typically better off by £322 a month once they’ve paid off their mortgage. Of the survey respondents, half put some into a savings account, 45% splashed out on home improvements, 40% put it towards holidays while 27% treated themselves to a new car.
Just 23% put any of their ‘mortgage pay rise’ into their pension, and of those who did just 40% of this additional income was used to top up their pot. Investing surplus income into a pension is a great way of supercharging it. This is because you get tax relief, equal to the rate of income tax that you pay, on your contributions.
As a result, Saga Investment says those homeowners who do manage to repay their mortgage before they retire could boost their pension by an average £40,000 if they redirect this income into their retirement savings (see infographic above).
This article was originally published in our sister magazine Moneywise, which ceased publication in August 2020.
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