Best ways to top up your pension
But what is the best way of increasing your pension saving? Does it make more sense to pay more into your employer scheme or set up your own savings scheme like a Sipp? Or are pensions even the best home for this additional saving?
What will work out best for you will depend on the nature of your workplace scheme as well as the ease, convenience and control that you require in managing your investments. How much more you intend to pay should also influence your choice.
As a first step, Laith Khalaf, head of corporate research at Hargreaves Lansdown suggests looking at your employer scheme.
If you are paid a bonus - asking your employer to pay this into your pension can be particularly tax-efficient.
Take the example of a £10,000 bonus. If this was paid via a bonus sacrifice scheme straight into your pension you would not pay any tax or national insurance on it. Your employer would make an NI saving too of 13.8% and it's not uncommon for employers to pass this on to you, boosting your total contribution to £11,300, according to Hargreaves Lansdown.
However, if you took your bonus it would be subject to tax and NI – so a higher rate taxpayer would end up with just £5,800 in cash compared to £11,300 going into your pension.
Upping monthly contributions
Khalaf says that even if you just want to increase your monthly contributions, sticking with your workplace scheme should still be your first choice if it means your employer also pays in more as a result. "But if you've maxed out on your employer contributions then you have a freer rein as to where to invest."
Work scheme vs Sipp
Once you have reached the point where there is no further financial incentive to sticking with your employer's scheme, it may make sense to set up your own private pension such as a Sipp.
Some work schemes are definitely better than others. "I've seen company schemes that offer just six or seven funds," says Khalaf. And even if you do have a decent fund selection, it may still be difficult to manage or make the right fund choices. "Some fund lists read like a phone directory – you don't get the level of support that you do in the individual market."
If you want to switch funds you may have to fill out and post a form and if you can manage any of your pension online you may not find it's available when you need it. "We've even come across pension websites with opening hours!" remarks Khalaf.
So for the investor who wants to take control of their retirement saving, a Sipp – that offers access to the whole fund universe as well as shares – can have a lot of advantages over work-based schemes. It's quick and easy to check valuations, research investments and switch funds online 24/7.
You don't just have to pay your top-up contributions into your Sipp, it can also be a great way of consolidating any pensions you may have – but are no longer contributing to – with previous employers, meaning you now just have two schemes to manage.
David Macmillan, managing director of Aegon says: "We've found, on average that by the time our clients hit 60, they've got 5.5 different pots. By having all that money in one place it can help drive down the cost of investing and administration."
Is Sipp always best?
Sipps invariably offer investors the biggest choice of investments. But that doesn't necessarily make them the right choice for you, warns Patrick Connolly, IFA at Chase De Vere.
"There is often a misconception that a Sipp is the most appropriate wrapper for all investors. Charges on Sipps are typically greater than charges on a personal or stakeholder pension. There is little point in paying these extra charges if you are not intending to use the extra functionality." And while investment freedom is a great boon for experienced investors, it can be a risk for those who don't know what they are doing.
"Many Sipps are little more than personal pensions with an extended range of fund options. While investors may appreciate this extra choice, it could prove a disadvantage if they inadvertently invest in specialist funds which are higher risk than they appreciate."
For those savers that are less confident at making their own decisions and aren't receiving independent advice it may make sense just to pay more into your existing work scheme. Likewise if you are only going to be topping up your contributions by a small amount or don't have other schemes to consolidate, it may not be enough to justify the costs involved with setting up a new plan.
Topping up final salary pensions
The position is a bit different if you are a member of a final salary or defined benefit scheme. "Most defined benefits schemes will have the facility for you to pay in extra," explains Andrew Tully, technical director at MGM Advantage. However, the money won't go into your ‘defined benefit pot' rather it will go into a separate AVC (additional voluntary contributions) plan. This will be money purchase (or defined contribution), meaning the eventual value of this plan is not fixed and is dependent on both how much you pay in and how the investment performs.
In some cases the money saved into this pot will be linked to the main defined benefit scheme. This means you can take your tax-free cash from your defined contribution top-ups as Tully explains. "It leaves your defined benefit pot intact which can be quite advantageous. Commutation rates [for taking tax free cash from defined benefit schemes] can be quite ungenerous."
However if your AVC scheme is not linked (many aren't) you will have to decide whether to go with the ease and convenience of your work scheme - but potentially limited fund choice - or the freedom and flexibility of a standalone Sipp.
Are pensions the best savings vehicle?
Whatever type of scheme you have, it may also be that a pension isn't the best home for your additional savings. If you want to maintain the ability to access the money before your retirement if needs be, an Isa might make sense. Although you don't get the tax relief on contributions (as you do with a pension) your money grows tax-free and there will no tax to pay when you cash it in making it a great way for preparing for any lump sum expenditure in retirement.
Maxing out on Isas may also be a sensible option if you are lucky enough to be close to breaching either the annual or lifetime allowance - after which point pension saving ceases to be tax efficient.
Connolly says: "For most people the best approach for long-term savings is a combination of pensions and Isas. Pensions provide initial tax relief which give your savings an immediate uplift, whereas can still be tax efficient and you can access your money whenever you like. Before you invest more in your pension, make sure you've got the right balance between the two."
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
A form of money purchase defined contribution pension launched by the then Labour government in April 2001 with low charges and no-frills minimum standards. Designed to appeal to people on low and middle incomes who wanted to save for retirement but for whom existing pension arrangements were either too expensive or unsuitable, the stakeholder didn’t really take off and looks to be superceded by the National Employee Savings Trust (NEST).
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
Additional voluntary contributions
If you’re a member of an occupational pension scheme but want to increase your contributions to help boost your income in retirement, this is where AVCs come in. An AVC is a top-up pension that sits alongside your company pension and is administered by your employer. You get tax relief on your contributions and, if you move jobs, you can apply to transfer your AVC plan to your new employer or your AVC your contributions have to stop with your old employer and you will need to start a new AVC plan with your new employer. An AVC linked to a company scheme is subject to the rules of the main pension. (See Free-standing additional voluntary contribution).