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 pension from an early age to maximise the benefits of compounding growth. Employers are legally required to enrol eligible employees in a workplace pension scheme. The legal minimum contribution to a workplace pension fund 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 remainder or 5%. The government adds 25% tax relief to personal pension contributions, so you will actually contribute 4%, with HMRC contributing the other 1%. For every £100 personal contribution you make to your pension, the government will contribute £25 in tax relief. There are limits and restrictions on pension tax relief – find out more:

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

The earliest you can withdraw funds from your 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.

Pension flexibility

Not keen on the idea of your money being tied up in a pension fund until you are 55? If you want more flexibility and control over the investment of your pension contributions, consider an ISA or a SIPP. Pension funds invest your money based on your age and risk tolerance, investing in higher risk and return assets when you are younger. As you approach retirement, the funds are moved to lower risk investments. ISAs and self-invested pensions allow you to choose from a greater range of investment options.

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 earn tax relief with a SIPP, with the government adding 25% of the amount you invest. You can withdraw 25% of your SIPP tax-free and the remaining 75% may be subject to tax. SIPPs are only accessible once you are 55 years old (57 from 2028).

ISA or individual savings account

Another option to consider is an ISA or individual savings account. With an ISA there is no tax payable when you withdraw funds, and you can access your money whenever you choose. Some stocks and shares ISAs offer investments in predefined investment funds, whilst others allow you to 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 get the 25% tax relief from the government. You can always transfer money from your ISA to a pension in the future.

Review your pensions

You should review your pensions and performance regularly to ensure that they will 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 £203.85 per week or £10,600 per year for the financial year 2023/24. 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. You contribute 8% of your salary to your pension each year, and there is a 0.5% administration fee. The amounts have been discounted to show what they would be worth in today’s money.

The illustration assumes that someone will receive the state pension and withdraw about 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 £10,600 plus 40% of £32,000 or £12,800, this provides a retirement income of £23,400. 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
• Drawing out the equivalent of 40% of the annual salary and topped up by the state pension