Bestinvest by Evelyn Partners won Best Pension Platform – Small Portfolio at the YourMoney.com Investment Awards 2024 for the second year in a row.
In the first of YourMoney.com‘s special award winner spotlight series, Alice Haine, personal finance analyst at Bestinvest, shares five expert tips to help you start and maintain your own future retirement funds.
Five ways small sums can turbocharge your pension savings
Everyone knows you need a pension to provide income when you stop working, and with the state pension unlikely to be sufficient for many, a private pension is one way to provide an extra source of funds.
But trying to build up a pot big enough to fund the type of retirement you want can be stressful, particularly if finances are tight. When people have household bills to pay along with mortgage costs and other key financial commitments, prioritising saving for the future can be hard, which is why pensions can get neglected.
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Workers currently have an annual allowance of up to £60,000 to contribute towards a pension or 100% of their annual earnings, whichever is lower, while non-earning pension savers have a gross annual allowance of £3,600.
Auto-enrolment has turned the majority of employees, young and old, into regular savers, which is a good job as most people don’t have big lump sums to invest. Here’s how saving little and often can make a huge difference to pension savings over time, along with some other tricks.
1) Saving little and often can deliver big returns thanks to the magic of compounding
Saving little and often, typically every month, is not only more affordable as investors can choose to direct a fixed sum from their monthly income into a pension, but it is also an effective way to manage any short-term turbulence in the financial markets and help a pension last significantly longer.
This is because money invested in the stock markets tends to benefit from compound returns over time. This is where the returns are earned on returns, leading to snowballing gains. If the pension saver also chooses to reinvest any income from their investments, rather than leave it in cash, then the overall value of that pension pot can accelerate even faster.
Someone who invests £80 per month into a medium-risk portfolio, or £960 over the course of the year, and receives 5% growth on that holding would end the year with £980. The following year, as well as attracting returns on the original £1,200 invested, they would also have the same effect applied on the return of £20.
Continuing with the same contributions and return rate in the second year would see the pot grow to £2,007, delivering a total return on the £1,920 invested of £87. Consistent saving over time will see that return multiply very fast, with the total return on £9,600 invested over 10 years jumping to £2,547.
2) Add in tax relief on pension contributions and the return gets even bigger
Pension saving has an even bigger advantage over regular investing because contributions attract tax relief from the Government. A basic-rate taxpayer receives 20% in tax relief (which actually has the effect of bumping up a contribution by 25%), while higher- and additional-rate taxpayers can claim an additional 20% and 25% tax relief through their Self-Assessment tax return, taking their total tax relief to 40% and 45% respectively.
If that same monthly investment of £80 over 10 years was invested into a pension rather than an Individual Savings Account (ISA) or regular investment account, a basic rate taxpayer would receive a top-up of £20 in tax relief every month, taking the total monthly contribution to £100 and in turn delivering an even bigger return.
On a 10-year contribution of £12,000, the same portfolio and the same 5% growth rate would jump to £15,184, bumping up the return to £3,184. Stick to that plan for 30 years and the portfolio could be worth £77,052 from a total contribution of £36,000.
3) Higher-rate and additional-rate taxpayers have an extra advantage
Remember, pension savers who are higher-rate or additional-rate taxpayers receive a further 20% and 25% off their tax bill respectively to spend as they wish, which they must claim back through a Self-Assessment tax return.
While they could choose to spend any rebate they receive on general living costs, or use the relief to offset against a tax bill for other income, they could also choose to invest it back into their pension, turbocharging its growth even more, or consider topping up an ISA.
Retirement income can come from many sources, such as property and ISA savings, and state and private pension pots, but when you consider the high savings amount needed to achieve a fairly conservative lifestyle, directing as much as you can towards retirement savings is crucial.
Remember, while money held within a pension grows free of tax on income and capital growth, it is likely to be taxed on the way out. Income tax may become payable on withdrawals during retirement where an individual’s retirement income – including state and private pensions – exceeds their annual tax-free Personal Allowance, which is currently £12,570 for those earning under £100,000.
ISAs, on the other hand, might not offer upfront tax relief but no tax is payable on any income or capital withdrawn from an ISA. Access to an ISA is also much more flexible and can work alongside a pension by offering a stop gap for someone wanting to delay accessing their pension until a later date.
4) Taking full advantage of your workplace pension is a must
Thanks to auto-enrolment, which started being phased in from October 2012, millions more people are now automatically contributing to a workplace pension today than a decade ago. Opting out of this valuable scheme is costly as you would effectively miss out on free cash as the employer must pay in a minimum of 3% of your salary, as stipulated by the Government’s auto-enrolment rules. This takes the total contribution to 8% once you factor in the employee’s 5% contribution.
The benefits of a workplace Defined Contribution (DC) pension scheme include the ease of tax reliefs being applied automatically, plus the fact many companies pay more than 3% with some matching higher employee contributions to a set level – so it’s highly beneficial for savers to take advantage of this offer.
Workplace schemes where workers pay into their pot out of gross salary are especially advantageous as they provide relief from National Insurance as well – providing an added boost to pension savings.
5) Don’t miss out on salary sacrifice schemes
Workers who fear a pay rise or bonus will tip their income into a higher tax band should check if their employer offers ‘salary sacrifice’ options. Some employers will let their staff reduce their salary or bonus payments in lieu of increased pension contributions.
As well as a reduction in income tax, both employee and employer will also pay lower National Insurance contributions (NICs), which once again makes pension saving more tax efficient. Those close to the £50,270 earnings threshold where the higher 40% tax rate kicks in could dip under it by using salary sacrifice pension contributions.
Salary sacrifice can also be useful for those nearing the threshold for the 45% additional rate of tax at £125,140, as well as those earning above £100,000 who have a unique tax challenge.
For every £2 of taxable income above £100,000, they lose £1 of the personal allowance of £12,570. Combine the loss of the personal allowance with the 40% income tax rate and those earning between £100,000 and £125,140 under the current rules are effectively paying an eye-watering 60% income tax on that proportion of their income.
One point of note, however, is that while salary sacrifice can give your pension a healthy boost, agreeing to a lower salary could impact your ability to access credit, such as a mortgage, as you will have a lower income to play with.
Plus, employee benefits such as life cover and holiday, sickness and maternity pay may also be affected so ask your employer for a personalised calculation of how the scheme will affect your take-home pay and benefits.
Alice Haine is personal finance analyst at Bestinvest
Bestinvest is an award-winning, digital investment platform and coaching service. It offers access to thousands of funds, investment trusts, ETFs and shares via an Individual Savings Account (ISA), a Junior ISA (JISA) for children, a Self-Invested Personal Pension (SIPP) and General Investment Account (GIA).
Related: The winners of the YourMoney.com Investment Awards 2024
