Make your money work harder for you with our five simple ways to boost your pension.
Anne Molyneux, our IFA/Tax Consultant here at websters has pulled together some simple hacks which can help boost your pension pot in the long-term and make your retirement money work harder for you. Remember, the more you can put in during your younger years, the longer the power of compounding has to work its magic.
So, let’s start with understanding the compounding of investment returns.
The power of compounding
Compounding occurs when you invest regularly, over a long period, and the growth on your investments, such as dividends/interest/capital gains, is itself reinvested to generate returns. Even if you invest a small amount per month and gains are made on this small amount, you will find it can grow to a worthwhile nest egg for your future self.
For example, if you invest £1,000 pcm over 10 years you will have paid a total of £120,000 into your pension pot. Under current legislation, these contributions are made before tax is taken off. So, if you are a marginal 40% higher rate taxpayer, your future self is already £48,000 better off over that period. Looking at it another way, you have given up spending £600 per month now (after tax) to save £1,000 per month in your pension. If you are in a higher tax bracket, the amount your present self gives up every month is even smaller in relation to the amount your future self could gain through the pension investment.
Applying a constant 4% basic investment growth* over the 10 investment years gives a pot of £147,249.80 at the end of the 10-year investment period. This is the starting point for the examples below. (On this basis, a £400,000 pot would have a value of £490,832.64)
Because of compounding, your pot will grow to different amounts depending on which 10 years you use.
If you are contributing from age 45 to 55 and you leave your funds invested, with an average yearly compound return of 4% until retirement at 65, your final investment pot should grow to be worth around £217,966 by retirement.
Following this example, see the simplified table below with average growth rates of 4%, 5% and 7%.*
|Age at start and end of contribution period||Years to retirement from end of contribution period||4%||5%||7%|
When investing in any market, you should always be aware that there is a risk that at any single point in time, your investments may be worth less than you paid for them.
*this is a simplified example and does not account for sequencing risk.
The numbers in the example can be scaled up to a maximum relief contribution of £3,333 gross per month (£40,000 maximum Annual Allowance for Pension Relief without carry forward), or down to a more affordable contribution depending on your circumstances.
A £1,000 monthly contribution would cost £800 of after-tax income (take home pay) if you are a basic rate taxpayer, giving a total cost of £96,000 for the £120,000 pension input amounts over 10 years. If you are a basic rate taxpayer, please see Charlie’s example in point 4 for an idea.
If you are a higher rate taxpayer, the cost to you of the £120,000 contributions would have been £72,000 in terms of take home pay over 10 years. If you were able to contribute enough to receive the maximum relief, you would contribute £240,000 take home pay to receive pension input values of £400,000 over the 10 years. Please see Alex’s example in point 3 for an idea.
The Tapered Annual Allowance thresholds changed in 2020/21. So, from 2020/21 onwards, it is possible for Additional Rate Taxpayers to receive relief up to the full £40,000 in certain circumstances – but the minimum relief has been further restricted from £10,000 to £4,000. The maximum benefit would be £180,000 on contributions of £220,000 – giving you a total input pot of £400,000 over the 10 years.
1. Check your State Pension Years
Get your Government Gateway account set up and check your state pension record regularly.
If there are any errors or any years to purchase, you can be out of time to correct/purchase missed years if you do not act in a timely manner.
You can do this simply by using this link: https://www.gov.uk/check-state-pension
2. Alex - taxable income between £100,000 and £125,000
Anyone with taxable income between £100,000 to £125,000 could take advantage of a 60% government contribution for taxpayers.
As an example of how this works, let’s look at Alex.
Alex earns £130,000 from employment and has no other income.
Alex makes workplace pension contributions of £5,000 to which the employer adds £10,000 each year.
This uses £15,000 of the Annual Pension Allowance. As there is no Annual Allowance to carry forward, the maximum further contribution on which pension relief is allowable would be calculated as follows:
£40,000 – £15,000 = £25,000 gross, which equates to a contribution to a Relief at Source scheme of £25,000 *0.8 = £20,000. Most Self-Invested Personal Pension Schemes (SIPPS) are relief at source.
So, how do we get the other 40% back to Alex?
The pension contributions of £5,000 are taken from gross pay and leave Alex with a taxable amount of £125,000.
If Alex does nothing further, there is an addition to the pension of £15,000 and £76,040 in cash - after paying tax and National Insurance of £48,960 on the taxable £125,000. This equates to a total of £91,040 between pension and net pay.
By making some adjustments Alex can make some big changes to the overall position.
Should Alex contribute £20,000 from the £76,040 to her pension? A further 25,000 will accrue in this pot, taking the pension contribution for the year to the full £40,000. Alex will receive a tax refund of £10,000, making take home pay after tax £66,040.
(We come to this figure by taking the £76,040 earnings, less the £20,000 contribution, plus an income tax refund of £10,000.)
Alex is £15,000 better off in total with take home pay of £66,040 and the £40,000 in a pension giving a total of £106,040 versus a total of £91,040 had the contribution not been made.
However, please do note that under current legislation the funds in the tax-free pension wrapper cannot be accessed until age 55, and this is set to increase to 57 from 2028.
So, if Alex is 25 years old – maybe the extra £10,000 in cash would be helpful for a deposit or as a savings cushion. However, if Alex is 47, has sufficient ISA and other savings/has paid off the mortgage – a sensible move might be to take advantage of the favourable tax treatment of pension contributions and the tax-free growth that occurs within them while this is still available.
3. Charlie - Potential 20% back on contributions from your personal allowance
Charlie earns £28,000 from employment but has no bills to pay (for whatever reason – lucky Charlie!), and no other income.
Charlie can contribute £28,000 gross to a pension. This example will use a combination of Occupational and Self-Invested (SIPP) pensions.
Over the tax year, Charlie contributes £1,400 into a workplace pension with an employer contribution of £840 which gives a total contribution of £2,240 gross.
This means Charlie can receive relief on further gross contributions in the tax year, up to £25,760. This amount is the level of his relevant earnings – which in this case is the salary of £28,000, less the £2,240 gross pension contributions already made through the Occupational scheme.
If Charlie contributes £25,760 *.8 = £20,608 to a SIPP, the administrator will apply for relief at source that will top this up to £25,760, which when added to the occupational contributions, will give a total pension input value of £28,000 across both pension schemes.
If Charlie does not make the additional contribution, the position is £23,695.84 made up of a pension of £2,240 plus net pay of £21,455.84 (after paying Income Tax and employee National Insurance Contributions (2,820 2,324.16)). If Charlie makes the contribution, the position is £28,847.84 made up of pension £28,000 across both pensions and £847.84 in cash. (£21,455.84-£20,608 = £847.84). In total, Charlie is now £5,153 better off, but the funds are locked in pension and cannot be accessed until allowed by legislation, which is currently set at 55 years of age, and this is set to increase to 57 from 2028.
Thus, whether this is appropriate will be dependent upon Charlie’s circumstances and the amount of other liquid funds available to meet pre-retirement expenditure.
4. Understanding the benefit of employer matched contributions
If the employer matching will not take you over the annual allowance and you can afford to put in the maximum percentage that will be matched – then just why are you NOT doing this? It is free money! That really does not happen often.
5. Understanding Salary Sacrifice
If your employer offers this it is worth exploring. A portion, or a fixed amount of your salary is put straight into your pension. This means there is no National Insurance (NI)contribution on this amount from either the Employer's or the Employee's perspective. So there can be a real NI tax savings of 12% for an employee and 13.8% for the employer. In some cases, the employer even passes some of that savings on in the way of a topped up contribution if you opt for salary sacrifice.
However, be aware that using salary sacrifice will reduce the amount of taxable income that is used for credit and mortgage applications.
If you cannot contribute to a pension - what else can you do?
If you have hit the Lifetime Allowance (congratulations!) you should investigate whether there is an alternative benefit that can be offered to you.
You should not make further pension contributions if you have a protection that will not allow you to do so (unless you have taken professional advice).
If you will have to pay a tax charge on the additional contribution and/or on your own contributions, you might want to view the exercise this way. Compare:
• The additional funds after tax (net income) will wind up in my pension, growing free of tax on interest, dividends and capital gains (assuming the scheme will pay the tax bill)
• net income would I be investing in the market (after I have used my ISA allowance) that would be outside an ISA or Pension wrapper and therefor subject to income tax on interest, dividends and capital gains.
It is also important to take your cash flow needs and your age considerations. If you think you are likely to need your savings before your retirement, putting them into a pension will not meet your financial planning needs. This is where expert advice comes into its own.
Our experts at websters are available to help you make the most of your money and to help you make the right decisions to reach your goals.