Interactive Investor

Are pensions worth it?


When you finally stop working and retire, you’re going to need a new income stream. That means you’ll want a pot of cash so you can start paying yourself.

There are numerous ways to invest and save for the future, but for the vast majority of people the best way to do that is with a pension.

Find out why a pension is worth it with our guide.

What are the main types of pension?

There are three main types of pension that you might use to generate your income in retirement: the state pension, workplace pensions and personal pensions.

The State Pension: Everyone is entitled to the full state pension if they’ve paid 35 years of National Insurance – either via contributions from earnings or credits for claiming certain benefits. If you’ve paid more than 10 years’ contributions but less than 35, you’ll get a proportional amount.

Workplace pensions: The easiest way to save up for retirement is with a workplace pension. All employers now have to offer staff access to a pension and pay contributions on their behalf too. Payments into workplace pensions are deducted from your salary.

Personal pensions: This is a scheme that you set up and pay into yourself. You might arrange or personal pension with a life insurance company or set up a low-cost self-invested personal pension (SIPP) with an online platform.

Both workplace pensions and personal pensions can be described as private pensions. This distinguishes them from the state pension.

Why you need a private pension for a comfortable retirement

Although the state pension provides the bedrock of most pensioners’ incomes, it’s unlikely to be enough to maintain the lifestyle you had while you were working. Even with a whopping 10.1% increase, it will still only pay £10,600 in the 2023/24 tax year.

To live more comfortably when you retire it’s worth saving in a private pension. 

Private pensions are designed specifically for retirement saving, with benefits that other savings products can’t offer.

What are the benefits of private pensions? 

There are number of reasons why it’s worth paying into a pension.

  • You get tax relief on contributions: This is the big one. The government tops up your pension contributions at a rate that is equivalent to the highest rate of income tax you pay. In black and white that means it only costs a basic rate taxpayer £80 to pay £100 into their pension. For higher rate taxpayers, it only costs £60 invest the same amount. Over the decades tax relief on contributions makes a massive difference to your eventual retirement income.
  • Tax-free growth: Although your pension income may be subject to tax, it will grow in a tax-free environment. When you die your pension can also be passed on free of inheritance tax.
  • Your employer will pay into your pension too: If you are saving into a workplace pension you’ll also get the benefit of employer contributions. Auto-enrolment rules stipulate that this is 3% of your qualifying earnings, but may well be more than that. In some cases they may even match what you pay in. This means it's always worth paying into a work pension if you’ve access to one.
  • Access is restricted: You cannot access your pension until you are 55 at the earliest (rising to 57 in 2028). You might not think of this as a benefit initially, but making your savings impossible to touch, will pay dividends when you retire. Not only does it remove the temptation to dip into your savings and run your fund down before you need it, it also allows you to capitalise on compound returns. This is where your returns start earning returns, a process that adds real momentum to your investment growth and boosts your returns over time.
  • You can spend your pension as you wish: If you are saving in a defined contribution scheme (the majority of schemes in the private sector), you’ll get to decide how to turn your pension pot into a retirement income. By moving into flexi-access drawdown you can have total flexibility as to how you take income and lump sums out of your pension. You can even take whole pensions as cash – although you do need to be aware of how it will be taxed.

Are pensions worth it if I’m self-employed?

The attraction of pensions isn’t quite so great for the self-employed. That’s because you don’t have the perk of an employer topping up your pot. 

That said, self-employed people will still need to retire at some point and so it’s still a good idea to pay into a pension, especially if you don’t have business that you can sell on or keep a stake in.

Although there are no employer contributions, the benefits of tax-relief, tax-free growth and compounded returns mean it’s still worth the self-employed paying into pensions.

How much should I pay into a pension?

It’s up to you how much you pay into a personal pension. If you’re in a workplace pension, the minimum contribution is 8% - 5% from you and 3% from your employer. However, it’s important to stress this is just a minimum – it hasn’t been set at a rate that guarantees a comfortable income in retirement.

There are various formulas that can give you a steer towards how much you should be saving. One is to take the age you start saving at and divide that by two. So if you start saving at age 30, you pay 15% of your income into your pension. If you leave it until 40, you’ll need to pay 20%.

However targets can be very off putting, particularly if you simply cannot afford to pay the amount you need. For that reason, it’s good advice simply to pay in as much as you can afford. Think of it as paying your future self, you’ll thank yourself for it when you retire.

If you aren’t sure how to work out what you can afford, it’s a good idea to write a budget. This can help you highlight areas where you might be overspending and help you free up some cash for your pension. It can also help you balance out your retirement savings against shorter and sometimes more pressing financial goals.

Pension myths

ISAs are a better way to save for retirement

ISAs are fantastic in so far as they shelter your savings from tax and, unlike pension income, your money won’t be subject to tax when you take it out.

However, neither of those benefits can rival tax relief on the way in.  From a growth perspective, the value of that top up on the eventual value of your pension, will far outweigh the benefits of tax-free withdrawals when you retire.

It’s also worth bearing in mind that if you’re a higher rate taxpayer now, you’ll likely pay less tax when you retire.

That all said, it can be helpful to have some ISA money earmarked for retirement. You can use ISA money, for example, to increase your overall income, but keep your taxable pension income below a higher tax threshold.

My property is my pension

If you own your own home, you’ll likely have built up a significant amount of equity in it, with house prices rocketing in recent years.
However, to access that money you’ll need to sell your home and downsize. This often isn’t straightforward. By the time you reach retirement age you may not want to leave the family home, or be able to find a new one that still suits your needs.

It’s more straightforward if you have a rental property. But that’s not an easy investment either. Running a profitable rental takes a lot of graft and the increasingly onerous taxes being levied on landlords is making it harder for novices, especially, to make money.

I’ll get the state pension, why should I pay into another pension?

Even if you get the full state pension – worth roughly £204 a week or £10,600 a year from April 2023 – it may not be enough to live on and you may need to make substantial cutbacks when you retire. 

Saving into a private pension will top up your retirement income and will not have any impact on the amount of state pension you’re able to claim.

Retirement seems a long way off – it’s too soon to start saving

The younger you are when you start saving for retirement the better. The later you leave it, the more money you’ll have to stump overall. Starting early will give your money more time in the stock market and let you really harness the powers of compound returns.

I’m too old to start saving for a pension

Ok, so it is better to start a pension while you’re young, but don’t let advancing years put you off. You can pay into a pension right up to the age of 75. 

While time might not be on your side as a late starter, your savings will still get an instant boost from tax relief before you even start to consider investment returns.

Pensions are too complicated

Pensions have never had the best PR. There’s jargon aplenty and the rules keep changing. But, at their core they aren’t as complicated as you might think. Think of them as a long-term investment account, that gets topped up by the government.

You don’t have to become an investment expert either. Workplace pensions and many personal pensions will offer access to default funds, while online platforms can give you lots of guidance and easy start fund recommendations to get your pension saving started.

I’ve no plans to retire so I don’t need a pension

As much as we might like to think we can go on forever, life has a habit of catching us off guard. While pipe and slippers might hold no appeal whatsoever now, there’s a reasonable chance that your views will change. You may also encounter health problems that could make working into old age challenging. It’s still worth paying into a private pension, even if only to help you in your final years and give you some added peace of mind.

How can Pension Wise help?

If you have a defined contribution pension scheme and are 50 or over, then you can access free, impartial guidance on your pension options by booking a face to face or telephone appointment with Pension Wise, a service from MoneyHelper

If you are under 50, you can still access free, impartial help and information about your pensions from MoneyHelper

Please remember, 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 advisor before making any decisions. Pension and tax rules depend on your circumstances and may change in future.