With the cost-of-living crisis in full swing, Rachel Lacey examines how to make your investments work harder and boost your pension wealth without paying a penny more.
We all know that we should probably be saving a bit more for retirement. However, with inflation expected to hit double figures and costs across the board continuing to rise, few of us are able to squeeze any more money out of our personal budgets to increase our pension contributions.
The good news though is that by giving your pension a bit of TLC, it is possible to increase your pot without paying a penny more into it.
The changes might not make a difference straightaway, but over time could make a significant improvement to your financial security in retirement.
Make your investments work harder
When did you last review where your pension contributions are going? If you still have a lengthy investment horizon (10 to 15 years or more) you can afford to take some calculated risk with your fund choices. At this stage you want the vast majority of your pension saving to be invested in equities – so consider replacing multi-asset funds that spread their holdings across equities, fixed interest and cash with pure equity funds.
You might also want to ditch anything with ‘cautious’ in the title. With time on your side, you want to be focused on growing your pot – the time for a more defensive approach comes once you are in or near retirement.
Get some growth investing ideas with ii’s Super 60 handpicked range of funds.
Review your pension charges
Your pension provider or SIPP platform will charge you a fee for running your pension, the more you pay, the lower your returns.
On paper, these fees might not look much, but over time they can rack up and put a serious drag on your pension’s investment growth.
If you have an older-style personal pension, or a dormant work pension that you’re no longer paying into, you may well be paying more fees than you need. By transferring your pensions into a low-cost SIPP, you could make a serious saving.
Most pensions charge a percentage-based fee and anything north of 0.75% to 1% is now considered expensive. Some providers charge a flat fee, irrespective of your portfolio’s size; as such, this option becomes increasingly attractive the more your pot grows.
Research from analysts The Lang Cat show that by transferring a £150,000 older-style pension with a fee of 0.75% into a low-cost SIPP with flat fees, you could save in the region of £20,000 over a 20-year period (assumes ongoing contributions of £200 a month).
Look at your fund charges
You don’t just pay a fee to your pension provider or platform, you’ll also pay fees to cover the running costs of collective investments such as funds or investment trusts.
Actively managed funds tend to be the most expensive. While you’ll likely be happy to pay a bit more for stellar performance, you might not relish shelling out for a fund with average, or worse performance.
Passive, or tracker funds do not have a manager who chooses what to buy and when to sell. Instead, they simply aim to replicate the performance of their designated index, the FTSE 100, for example.
These funds won’t beat the index, but if you’ve been paying handsomely for an active manager who didn’t meet the mark, they could prove a cheaper way of getting similar returns.
There are also costs for buying new funds, so once you’ve found investments that you’re happy with, stick with them and leave them to do their work. Constantly switching in and out of funds can be expensive and puts another drag on your returns. Only ditch funds that have under-performed consistently rather than those that may just have had a bad quarter.
Claim tax relief
When you pay into a pension you are entitled to tax relief on your contributions that is equivalent to the rate of income tax you pay. This means it only costs a basic-rate taxpayer £80 to invest £100, while higher-rate taxpayers only need to pay £60 to invest the same amount.
However, it’s often only basic-rate tax that is applied automatically. Depending on your scheme, higher and additional rate taxpayers may need to claim their extra relief back via a self-assessment tax return.
This only applies if you are paying into your own personal pension or you’re in a workplace scheme set up on a ‘relief at source’ basis.
If you’re in a workplace scheme that runs on a ‘net pay’ basis, you won’t have to do this because your contributions will have been made from your salary, before tax was deducted.
Take advantage of salary sacrifice
If you’re a member of a workplace scheme, it may be worth asking your employer about making your pension contribution via salary sacrifice. Here you agree to a salary reduction and your employer pays that money, along with its own contribution, into your pension.
As your salary is lower, the amount of national insurance both you and your employer pay is reduced. This means that, strangely, your take-home pay could actually go up as a result.
Even better, some employers will also pass their NI saving on to your pension – giving your retirement savings an additional boost.
It’s important to think carefully about setting up a salary sacrifice arrangement however, particularly if you have a lower income. This is because reducing your salary can have an impact on the amount you are able to borrow for a mortgage and your entitlement to benefits including statutory maternity pay and statutory sick pay.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.
Important information – SIPPs are aimed at people happy to make their own investment decisions. Investment value can go up or down and you could get back less than you invest. You can normally only access the money from age 55 (57 from 2028). We recommend seeking advice from a suitably qualified financial adviser before making any decisions. Pension and tax rules depend on your circumstances and may change in future.