THE INS AND OUTS OF PENSION SAVING

In last year's spring budget (2023), the Chancellor totally lifted the lid on pension saving. Not only was the annual contribution limit increased to ￡60,000, but to everyone’s surprise, the lifetime cap on your pension value was scrapped. But with so many pressures on people’s budgets, it’s understandable that you might put off long-term savings. Especially if, as is the case with pensions, you cannot access the money until you are in your late 50s. But when you get to retirement, you can be sure there will be the same cost of living challenges, so can you afford not to save for the future?

The great attraction of pensions compared to other forms of saving is the instant boost you get from tax relief. Effectively, you are paying yourself ahead of the taxman. Also, the money grows tax-free until retirement. Because of the magic of compound returns, and the long-term nature of pensions, relatively modest amounts paid in regularly over a long term can build up to a significant sum.

Most savers get an immediate uplift of 25% on the amount they put in, but for some, it could be double or even triple the contribution. It depends on your employment status, how much you earn, and the generosity of your employer.

If you are self-employed and pay ￡100 per month into a pension, tax relief claimed by the pension provider adds ￡25. If you are a higher-rate taxpayer, you can claim an additional ￡25 through your tax return, so your total contribution of ￡125 has only cost you ￡75.

Most employed people are now offered a ‘workplace pension’ by their company, with the company obliged to pay in at least 3% of your earnings (within a given range), provided you pay at least 5%, giving a total of 8%. However, part of your payment is tax relief, so as a basic rate taxpayer you pay 4%, end up with 8% and you have doubled your money. That’s the basic level – it’s common for companies to match the contribution made by the employee.

Salary sacrifice

If you are not already making your company pension contribution by ‘salary sacrifice’, then it’s definitely worth asking your employer about it. In exchange for reducing your salary, your company pays the difference into your pension on top of the company contribution they are already required to pay.

The numbers work out the same as for an ordinary workplace pension contribution, but you get a bonus because, with a lower salary, you pay lower National Insurance Contributions. Your company also saves employer’s National Insurance (now over 15% of your salary). If they are feeling generous, they could top up your pension by some or all of the amount they save!

Let’s look at a higher rate taxpayer taking advantage of a company contribution matching their own, using salary sacrifice, and sacrificing a gross amount of ￡500 a month (￡6,000 a year). The reduction in their net income each year would be around ￡3,400, while the total paid into the pension would be about ￡12,900, including the National Insurance Contributions the company has saved (you’ll have to trust me on the maths). The value of the pension is almost 3.8 times the cost to the individual.

Note that one drawback of salary sacrifice is that a lower salary can reduce the amount you can borrow on a mortgage.

Whatever the arrangements and the minimum contributions might be, you can always choose to pay more, with the limit on contributions from all sources being equal to your gross earnings or ￡60,000 if lower.

Running your own business

What if you run your own limited company? Well, you could have a great deal of flexibility in how you shape your salary, dividends and pension.

Provided you can justify it in terms of the performance of the business, the company can pay directly into your pension fund, with the annual limit being ￡60,000, less any contributions from other sources. Unlike for personal contributions, you are not limited to your amount of salary you receive. If you are already taking salary and dividends up to the top of the basic rate income tax threshold, pension savings can be a very effective way of dealing with a surplus of cash in your business.

I would always recommend discussing your plans with an accountant before proceeding.

Whatever your situation, there’s a good case for getting your pension savings up and running. And remember, the sooner you start, the better the outcome is likely to be. Even children can have a pension, so if perhaps their parents or grandparents have some spare change and want to give them a good start, then a monthly sum into a pension is worth considering. The maximum that can be paid is ￡2,880 a year (￡240 a month), but they still get the tax relief boost, bringing that up to ￡3,600 a year. What’s more, they can’t waste the money on high living, at least not until their retirement!

If you would like to explore how you can make the most of your savings, one of our team of experienced Financial Planners is on hand for a no obligation initial chat.

This article is intended for information only, and does not constitute advice.? All information is based on our understanding of current law and practice, which may be subject to change in the future. Past performance in not an indication of future performance. Any investments you make and any income, can go down as well as up – you might not get back the full amount invested. Wise Investments Limited is authorised and regulated by the Financial Conduct Authority, FCA no. 230553.