Due to their tax advantages, pensions remain one of the most powerful tools for saving for retirement. Your pension saving strategy should be driven by your personal goals, often retirement related, and when you want to achieve them. Pension legislation and understanding how much to save make pensions a complicated area and professional financial advice is highly advisable.
Every one of us will have different requirements from our pension plan but there are some broad rules of thumb that can be applied depending on where we are in our lives and careers. Following are some pointers to help you understand the decisions you might need to be considering in each decade.
20s (and earlier)
At the start of your working journey, surplus income is likely to be at its lowest. It is therefore valuable to be in your employer’s pension scheme as you will benefit from any contributions that they are obliged to pay. All employers are required to auto-enrol any employees over the age of 22 who earn over £10,000pa into a pension. Under that age/income employees may be able to opt in.
If you earn over £6,240pa and are in the scheme, the minimum pension contribution is 8% and 3% of this must be met by your employer, but they may contribute more. Check if your employer will match higher contributions as this is the easiest way to boost to your savings.
You can receive tax relief at your highest marginal rate of tax through pension contributions meaning if you earn over the higher rate band of £50,271 (tax year 2022/2023) you could receive tax relief of 40%. This can either be done by salary sacrificing into your pension pre-tax or contributing net of tax. In the latter scenario, the pension provider will gross up the contribution by basic tax rate and then higher rate tax is reclaimed through your tax return.
Furthermore, if you earn over £100,000, you may lose some or all of your personal allowance where the first £12,570 of your income incurs no tax. Pension contributions can potentially help retain this by bringing your taxable income back down to £100,000.
Investment savings in the early years are very powerful due to cumulative returns. At 4% real return, £1,000 saved at age 30 could be worth near £4,000 at age 65, whereas £1,000 saved at age 50 would be worth nearer £2,000. Earlier in your career, can often be a time to consider higher equity exposure (and the higher risk that comes with it) because there is more time ahead of you to ride out any significant market fluctuations.
Please note, these are indicative performance figures for guidance purposes only and thus should not be relied upon as an indication of future returns.
As earnings and pension savings increase, it pays to understand the pension annual allowance and tapering rules.
Tax relief is available at up to 100% of your earnings, subject to the pension annual allowance. The standard annual allowance is £40,000 but may be tapered at a rate of £1 for every £2 that your adjusted net income is over £240,000 to a minimum of £4,000 at £312,000.
The pension lifetime allowance is currently £1,073,000 and any drawn pension over this value is taxed at 55% or 25% plus marginal rate of income. Other tax efficient vehicles, such as ISAs, may be beneficial alongside a pension when there is risk of lifetime allowance issues.
These areas are particularly complex and higher earners and those with significant pension savings would benefit from financial advice to assist with these issues.
Changing employers throughout your career may mean that by this age many workplace pensions have been accumulated. Legacy pensions can often be forgotten and may not be appropriately invested or are incurring higher costs than necessary. It could be beneficial to consolidate them, either into an existing pension or a new one. Furthermore, an income strategy is simpler to enact from one pension pot rather than many. Ideally the receiving pension would have the full range of options for drawing benefits.
Currently, pensions cannot be accessed until late 50s. As you get closer to needing to draw your pension, risk taken in investments should reduce accordingly, to protect the investments from the downside of market volatility.
When the time arrives, there are numerous ways you can draw your pension benefits, including drawdown, annuities, scheme pensions and lump sums. A financial adviser can help ascertain the most appropriate method for your circumstances, taking into account tax efficiency in relation to your other assets capable of producing income. State pension is also payable in the late 60s and gaps in your national insurance record can potentially be filled through voluntary contributions to ensure a full state pension entitlement of £9,339pa.
At age 75 there is a final test against the lifetime allowance for any undrawn pension benefits. Furthermore, if the pension-holder passes after this age, any flexible pension inherited and drawn by beneficiaries is subject to income tax at the beneficiaries highest marginal rate. Before this age, there is no income tax incurred by the beneficiaries. With forward planning, a financial adviser may be able to recommend strategies for mitigating the impact of these events.