If you’re employed, the chances are you’re putting money into your workplace pension month in, month out. But how much do you know about your scheme and will it be enough to deliver the income you’ll need when you retire?
To mark the start of this year’s Pension Awareness Week, find out where you stand by getting the answers to these key questions.
1) What type of pension scheme do you have?
Most people are now in so-called defined contribution (DC) schemes. Here, your monthly contributions are paid into your scheme and the amount your pot is worth when you retire will depend on the amount you paid in and investment performance, less charges.
When you come to take your pension, you’ll be able to decide what to do with it and how to turn it into income. This is in contrast to defined benefit (DB) schemes, where you’ll get a guaranteed income in retirement. Examples of these include final salary and career average schemes where how much you’ll get will depend on your earnings, the generosity of the scheme and the length of time you’re in it. DB schemes are expensive to run, so they’re increasingly rare. However, they still come as standard in the public sector. So if you’re a doctor, nurse, civil servant, teacher or work in the army, for the police or fire service, you’ll likely be in one of these schemes.
2) How much are you paying in?
Pension rules set a minimum contribution of 8% of your qualifying earnings. This is made up of 5% from you and 3% from your employer. However, it’s important to note these contributions only need to be based on your “qualifying earnings” not your total earnings. Qualifying earnings is currently whatever you earn above £6,240 (though a bill to remove this threshold recently received Royal Assent which, once implemented, means pension contributions will be paid from the first pound you earn) and below £50,270, and means that someone earning £60,000, £80,000 or £100,000 wouldn’t be paying any more into their pension than someone earning £50,270.
Depending on your scheme and what you’ve agreed, you – and your employer – may be paying more into your pension. Your employer may also base your contributions on 100% of your earnings, rather than your qualifying earnings too. So, if you don’t know what you’re paying in, or the deal you’re getting from your employer, ask your HR department. Without this information, it’s impossible to make any meaningful decisions about your retirement planning and segues neatly on to our next point…
3) Am I paying enough into my pension?
The 8% of qualifying earnings figure isn’t a recommended contribution, it’s a minimum, and, even if you start saving as soon as you’re able, it’s unlikely to be enough for a comfortable retirement. There are plenty of rules of thumb to give you a steer – like 10-15% of your income, or dividing the age you start saving by two and contributing that as a percentage of your earnings. But rather than getting bogged down by percentages, it might simply be better to pay in as much as you can realistically afford.
- In your 20s or 30s? Why prioritising your pension now could make you rich
- Single? Six dos and don’ts for retirement
It’s not easy to prioritise your pension when you have so many other calls on your cash and retirement still seems a long way off, but your future self will thank you for it. According to our calculations, investing an extra £50 a month could net you a whopping £76,301 more over 40 years (assuming 5% annual growth, net of fees).
And, as a handy motivator, if you pay more into your pension, bear in mind you’ll also get more top-ups from the government (from tax relief on pension contributions) and potentially more from your employer too. Many employers will agree to match your pension contributions up to a limit, so the more you pay in, the more they will too.
4) Are you getting the correct amount of tax relief?
Tax relief on pensions contributions isn’t the easiest concept to get your head around, but the impact it has on your savings’ growth cannot be underestimated.
Effectively, tax relief means that you don’t need to pay income tax on money you pay into your pension. It’s perhaps easier to view it as a government top-up that’s linked to the rate of income tax you pay.
Basic-rate taxpayers get 20% tax relief, which means that it only costs them £80 to invest £100. Higher-rate taxpayers get 40% tax relief, so a £100 contribution costs them just £60.
However, tax relief can be applied in different ways, so if you pay the higher (or additional rate), it’s important to check you’re getting full whack.
- Relief at source: with these schemes your pension contributions are made after tax has been deducted. This means you’ll only get 20% tax relief applied automatically, so if you’re eligible for higher or additional rate tax relief back, you’ll need to claim the rest back with a self-assessment tax return.
- Net pay: here, your pension contributions are taken from your pre-tax income and you only pay tax on what’s left. This means you get the full amount of relief you’re entitled too straightaway and you need to take no further action.
If you don’t know which way your scheme operates, your HR department can shed some light.
5) Where’s my pension invested?
Most defined contribution workplace pensions offer a reasonable choice of investment funds, and you can decide exactly how your contributions are allocated. But most people (an estimated nine out of 10) invest their contributions into their scheme’s default fund. This is the pot your provider offers for those who do not want to choose their own investments, or don’t make any decisions at all around where to invest.
These funds are ‘one size fits all’ – designed for all savers, irrespective of their age, aspirations and income levels. Typically they will be invested across a range of holdings including stocks and shares, bonds (loans to businesses and governments) and property (such as retail and office space).
Investment experts can be critical of default funds, but while some are certainly better than others, they shouldn’t necessarily be regarded as a bad choice or lazy option. This is especially the case if you don’t know much about investing and wouldn’t know where to start building your own portfolio.
- Are lifestyle retirement funds right for the 100-year life?
- Pension stories: examine the saving habits and goals of investors at different life stages
The key risk with defaults is that they may be lower risk than you need, with a heavier bias towards bonds and property. This can mean your money doesn’t grow as fast as it could, especially when you’re still young and retirement is a working life away.
But it doesn’t have to be an either/or choice. If you want to boost your investment performance, you can always look to invest a portion of your contributions into a more adventurous fund (with a greater emphasis on shares) and keep the rest in the default. As your investment journey progresses, and you start learning more, you can always choose a wider range of funds.
In the first instance, you can start by checking where you money is invested and how it’s performing. This should all be detailed in your pension statement, and your provider’s website should also give you details of alternative options. Armed with this information, you are in better position to know whether you need a change of strategy.
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.