Interactive Investor

Pension myths: how misconceptions could be hurting your retirement

Rachel Lacey dispels five common pension myths and offers tips on how to make the most of your retirement savings.

8th February 2024 14:39

Rachel Lacey from interactive investor

From confusion around tax relief to the generosity of your employer’s workplace pension, there are number of misconceptions about retirement saving that could have a huge impact on your financial security in later life.

To make sure you don’t get caught out, we’re here to shatter some of the most notorious pension myths and help you keep your retirement savings on the right track.

1) It’s too late to make a difference

How many investments give you an instant return?

Basic-rate tax relief will top up every penny you pay into your pension by 20% before you even consider stock market returns. Higher and additional rate taxpayers will get 40% or 45% tax relief respectively.

As such it only costs basic-rate taxpayers £80 to invest £100, while higher-rate tax payers only need to pay £60 and additional rate taxpayers just £55 to invest the same amount.

This unrivalled top-up means your pension will always be an astute investment, even if your retirement feels like it’s only just around the corner.

Each year you can pay in 100% of your earnings (up to £60,000) into your pension, but if you have the capital to spare, you might, in some circumstances, be able to pay in more.

Carry forward rules enable you to use any unused pension allowance from the previous three tax years. Importantly though, if you are carrying forward, you still cannot pay in more than you earned in a tax year.

2) I don’t need to worry about my pension just yet…

OK, while we have just said it’s never too late to make a difference, it’s also never too early.

Time is every investor’s best friend. The power of compounding means the more time you give your contributions to grow, the less overall you need to save.

Take an investment that earns an average 5% a year. To get a nest egg worth £500,000 our imaginary investor would need to save £338 a month over 40 years to reach that goal, paying in a total of £162,240.

However, if our investor only had 20 years to save the same amount, they would need to put away £1,233 each month at a total cost of £295,920.

It’s a simplistic calculation but it highlights the benefit of time on your investments.

Even if you can’t afford to pay much into your pension while you are young and have other financial commitments, it still makes sense to pay in as much as you can, rather than parking it as a problem to tackle a few pay rises down the line when you have more income to spare.

3) I’ve got a workplace pension, I’ll be fine

Auto-enrolment rules require all employers to offer eligible staff a workplace pension and pay into it on their behalf. But they don’t require them to fund holidays, meals out or any other plans you might have for your retirement.

The minimum amount that needs to be paid into your pension is currently 8% of your qualifying earnings (5% from you and 3% from your employer) but that’s all it is, a minimum.

It’s not a recommendation or a guarantee of a comfortable retirement.

Complicating matters further is the fact that it’s only based on your qualifying earnings. In the current tax year, these are your earnings between £6,240 and £50,270 – meaning the maximum amount that this 8% contributions needs to be based on is just £44,030.

As such, many people, particularly higher earners with an income above £50,270, may not have as much going into their pension as they might expect.

Many employers are, thankfully, more generous – basing contributions on all your earnings or perhaps paying in more than the minimum amount. They might match your contributions too.

But it’s important you know exactly what your employer pays before you make any assumptions around whether you are paying enough into your pension.

Talk to your HR department if you have any questions about your workplace pension.

4) Tax relief will be applied automatically

Although basic-rate tax relief will be applied automatically, irrespective of the type of pension you have, some higher and additional rate taxpayers will need to do a bit of legwork to get the full relief they are entitled to.

It all comes down to whether your pension runs on a “relief at source” or “net pay” basis.

If it’s a relief at source scheme, pension contributions will be taken from taxed income and your pension provider will claim tax relief from HMRC on your behalf. However, you will only get 20% tax relief applied, which means that if you pay higher or additional rate tax, you will need to claim the additional 20% or 25% you’re eligible for back by completing a tax return.

All personal pensions, including self-invested personal pensions (SIPPs), that you set up yourself will run in this way, as will some workplace pensions.

With a net pay arrangement, your pension contributions are paid before tax is deducted and then your remaining salary is taxed accordingly. This approach means you get the right amount of tax relief automatically and do need to take any further action.

Many workplace pensions will now work in this way, but if you are a higher-rate taxpayer, it’s important you know how yours operates, otherwise you could be missing out on valuable tax relief. Contact your HR department if you aren’t sure.

It's easy to declare your pension contributions on your tax return – look for the tax reliefs section. The important thing is that you declare the total value of your contribution – including basic-rate tax relief (20%). So, if you paid in £800 and got £200 in tax relief, you would enter a total contribution of £1,000 on to the form.

If you aren’t sure how much you have paid in over the course of the year, check your pension account online or go through your bank statements. Don’t forget to include any lump sum or one-off contributions you might have made in addition to monthly payments.

5) I can’t get tax relief if I don’t pay tax

Even if you don’t work or pay income tax, it is still possible to pay into a pension and get tax relief on your contributions. The allowance, is lower than it is for taxpayers, but it’s still worth taking advantage of, if you can access the money.

Each year non-taxpayers can pay up to £2,880 into a pension, which will be topped up to £3,600 once basic-rate tax relief has been applied.

Non-taxpayers can pay into a pension themselves or somebody else can make contributions on their behalf. This can be helpful for couples where one doesn’t work as it means both of them can have some pension savings in their name.

If you have the cash to spare, you can even start a pension for a child, using the same allowance – a particularly tax-efficient move that could mean children or grandchildren have healthy retirement savings before they’ve even left school.

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.

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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.