If you’ve got money left each month after your expenses and current level of pension contributions, wanting to contribute more can be a great idea. The more you can contribute to your pension will help ensure you can have the life during retirement that you want whilst also benefitting from the tax advantages that a pension can provide.
The aim of this post is to try and help you understand whether you should pay more into your pension, giving you a number of things to consider when making that decision.
Being able to save more for retirement is certainly an excellent decision and great you’re able to be in this position. However, understanding various things such as the impact of lifetime allowances, other savings vehicles like ISAs and what tax relief you can expect will ensure you can make more of an informed decision.
How Much Do I Need to Save For Retirement?
The answer to this question is different for everyone and will be important to understand if you should pay more into your pension. What is barely enough money to live for one person could be the thing of dreams for another, it all depends on your spending habits.
The current school of thought is to save 20 to 25 years worth of expenses, so if you think you’ll spend £15,000 per year that’s a targeted retirement pot of £300,000 to £375,000.
For a more in-depth understanding, make sure to read this post I’ve written on what size pension pot you need to retire. In this post I run through everything from an example retirement budget, to average retirement pot sizes and tax considerations.
What is a Good Percentage to Pay Into My Pension?
There is a widely used “half your age rule” that is often used when trying to work out how much money you should be putting into your pension. This rule effectively says, halve the age when you start to contribute to your pension as a percentage of your gross income.
So for example, if you start contributing to your pension at age 30, make sure to contribute at least 15%. This is a useful measure as it aligns your contributions to your level of income so should be a useful measure for everyone.
What is the Average Pension Pot in the UK By Age?
Below are the average sized pension pots by age to help give you a general idea. Also to note this is using data from the Office for National Statistics found here and doesn’t include people that are self-employed.
- 16-24: £2,000
- 25-34: £10,000
- 35-44: £36,000
- 45-54: £81,000
- 55-64: £92,000
- 65+: £68,000
As you can see the total pension values are quite low compared to the estimate of £300,000 I highlighted above.
One reason for this could be the fact that the state pension is still in place and quite high at over £9,000 per year. However, the required age to receive the state pension is currently 66 which is set to increase to 67 for people born after April 1960 and gradually rising to 68 for those born after April 1977.
With the state pension age being pushed out more and more, for the younger people below aged 44 there is definitely a risk this could be pushed out even further, or even being made means tested. Making sure to not rely on this source of income will help ensure your lifestyle in retirement isn’t in the hands of the government which could end in disappointment.
These figures are also only the average, once you move into the top 25% of pension pots for example, the 55-64 age bracket is £295,000 and they’ll also be expecting their state pensions.
Pension Lifetime Allowance
The lifetime allowance will probably not be an issue for a large proportion of people. However, it’s worth knowing about it as it is currently being used as a tool to increase tax revenue.
The current lifetime allowance is £1,073,100 and this also includes any investment gains you make on the money you invest into your pension.
If you go over the lifetime allowance the tax rate is:
- 55% if you take it as a lump sum
- 25% if you withdraw it any other way, such as through regular pension payment or cash withdrawals
This is allowance is being frozen until 2026, this when coupled with the high inflation we’ve been seeing recently means the lifetime allowance in effectively being reduced in real terms. A million pounds now will be worth a lot less in the future due to inflation, so this high figure becomes more achievable each year and could impact on your decision to invest in a pension or another investment vehicle.
Tax Relief on Contributions
When you contribute to your pension you get tax relief at your highest level of tax, so effectively are saving the tax you would have otherwise paid.
For example when a basic rate tax payer (20%) contributes £80 of their take-home pay into a pension, they would have actually earned £100, so £100 is added to their pension pot.
The more you can add into your pension instead of paying tax allows you to have a larger pension pot which can benefit more from compound growth. Just remember that you will have to pay tax on withdrawals.
Should I Pay Extra Into My Workplace Pension?
Many employers offer a pension match scheme up to a certain level. The minimum they have to offer is 3%, although they could offer 5% or more if you also contribute 5%. This is effectively getting free money as every £1 you put in your pension up to the threshold, your employer will also put in £1.
If you want to put more in your pension and aren’t contributing the maximum your employer will match, definitely start here first.
Workplace pensions may also offer better terms when compared to personal pensions (SIPPs – self-invested personal pensions). This is party due to some laws that have been introduced to cap the fees of default funds on workplace pensions to a maximum of 0.75%. Also a lot of employers, especially big companies can negotiate even lower charges.
When contributing to a workplace pension through salary sacrifice the employer also pays less national insurance contributions. Some employers may give you some or all of this benefit, allowing you to contribute more to your pension.
This is not to say to ignore personal pensions, although if you do have a workplace pension definitely investigate their charges and benefits so you can ensure you’re able to compare your options. There may also be some other benefits to a personal pension, such as more choice in your individual investments.
Is it Worth Paying a Lump Sum into My Pension?
If you’ve just received a windfall of money for whatever reason, paying this into your pension is certainly worth considering. Going above your regular pension contributions will not only help move you closer towards your retirement savings goals, you’ll also be able to benefit from tax relief.
As you move closer towards retirement, paying in a lump sum can still be a good decision. Once you start withdrawing your pension, 25% of the overall pot is tax-free, that you can either get access to right away or withdraw it over time.
This means if you were to add a lump sum into your pension close to retirement, you could get all the tax advantages and then withdraw 25% of the overall pot back out.
How Do I Pay More Into My Pension?
If you currently contribute to a workplace pension there are usually options available to change your level of contribution. This is usually done as a percentage of your salary which will probably have a default percentage, such as the 3% minimum, although you can increase this in line with your savings goals.
For investing a lump sum into your pension, this may be more difficult in a workplace pension as the systems are usually set up to work on percentages. If you do need any help here just contact your HR representative within your company and they’ll hopefully be able to advise how to proceed.
If you can go through your employer it’s a lot easier and may get additional benefits such as a employer’s national insurance through salary sacrifice, although you can also contribute more to your personal pension. Each provider will have guidance on how to contribute, however going down this route just remember that you’ll have to submit your own tax assessment so you can reclaim the tax on your earnings.
Summary – Should I Pay More Into My Pension?
Overall, the more you can save for retirement, the better you’ll be equipped financially to lead the life you want to live when you finish working. Hopefully this post has given you more factors to consider when trying to work out whether you should pay more into your pension.
If you do need any specific advice tailor to your personal circumstances, make sure to contact a professional financial advisor. They’ll be able to help with everything from calculating the expected value of your pension based on your current levels of contribution to understanding what you need to submit to reclaim tax.
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