Contributing to a pension

Do you think you are too young to worry about pensions? Surely, contributing to a pension is something for the future? The reality is you need to be contributing to a personal pension from an early age to maximise the benefits of compounding growth.

Workplace pension

Employers are legally required to enrol eligible employees in a workplace pension scheme. The legal minimum contribution to a workplace pension is 8% of your qualifying earnings between £6,240 and £50,270. Employers must contribute a minimum of 3% of your salary with you contributing the remaining 5%. The government adds 20% tax relief to personal pension contributions. This means of the 5% contribution, you will pay 4% and HMRC contributes 1%. For every £80 net personal contribution you make to your pension, the government adds £20 of tax relief. This is 20% of the gross total contribution of £100 or 25% of the net contribution of £80. There are limits and restrictions on pension tax relief – find out more:

Withdrawing your pension

The earliest you can start withdrawing from your personal pension is 55 years of age (rising to 57 from April 2028). You can withdraw 25% of your pension tax-free. The remaining 75% may be taxable based on your personal circumstances. There are several options for accessing your pension, which your pension provider will explain in more detail as you approach retirement.

Currently pensions do not form part of your estate for inheritance tax purposes. However, from April 2027, the law is changing and private pensions will fall within an individual’s estate for inheritance tax.

When choosing a pension, always check the fees, as this can have a significant impact on the final pension value.

Pension flexibility

Workplace pension funds usually offer limited investment options, investing your money based on your age and risk tolerance. Your contributions are usually invested in higher risk assets with better returns when you are younger. As you approach retirement, the funds are moved to lower risk investments. ISAs and SIPPS let you choose from a broader range of investment options. If you aren’t keen on your money being tied up until you are 57 and would like more investment flexibility, consider investing using an ISA.

SIPPs or self-invested personal pension

A SIPP or self-invested personal pension is essentially a DIY fund. A SIPP provides more choice and investment flexibility, allowing you to invest in stock market funds, individual shares, bonds etc. You still receive 20% government tax relief with a SIPP. You can withdraw 25% of your SIPP tax-free while the remaining 75% may be subject to tax. You can only access the funds in SIPPs from 55 years of age (57 from 2028).

ISA or individual savings account

Another option to consider is an ISA or individual savings account. With an ISA, no tax is payable when you withdraw funds, and you can access your money whenever you want. Some stocks and shares ISAs offer investments in predefined funds, whilst others let you choose individual shares and funds. Currently, individuals can invest £20,000 per year in an ISA. As an ISA is a savings account rather than a pension plan, you do NOT receive 20% tax relief from the government.

Review your pensions

You should review your the performance of your pensions regularly to ensure they are on track to provide the level of income you need in retirement. You may need to increase the contributions or consider other options that will generate additional income for your retirement.

New state pension

The new state pension in the UK is £221.20 per week or £11,502 per year for the financial year 2024/25. Not going to stretch very far, is it? That’s why it is so important to save independently for your pension.

Men born on or after 6 April 1951 and women born on or after 6 April 1953 are eligible for the new state pension. You can claim once you reach the state pension age, which is currently 68 for people born after 6 April 1978.

Pension investment growth

The table below shows how much you could have in your pension pot after 48 years, depending on your pension investment growth. The numbers are based on an annual salary of £32,000, with a pay rise of 2% each year. It assumes contributions of 8% of your salary to your pension each year, and an administration fee of 0.5%. The amounts are discounted to show their equivalent in today’s money.

The illustration assumes that someone receives the state pension and withdraws around 40% of their annual salary equivalent in retirement. Experts agree that people need about 2/3rds of their salary in retirement. In this example, 2/3rds of £32,000 is £21,333. Together with the state pension of £11,502 plus 40% of £32,000 or £12,800, this provides a retirement income of £24,300. The last column shows how long the pension pots will last, based on withdrawing 40% of the salary equivalent every year.

Indicative value of pension pots at various investment return percentages. These figures should not be relied on for financial planning purposes.

Assumptions:

• 8% contributions on an annual salary of £32,000, with 2% annual pay increases
• Pension fees of 0.50%
• 48 years of contributions
• Withdrawing the equivalent of 40% of the annual salary with the remainder topped up by the state pension