How to build up your workplace pension
The first step you need to take is arguably the easiest. 'Make sure you're actually in your employer's pension scheme,' says Richard Parkin, head of retirement at Fidelity Worldwide Investment.
'Auto-enrolment has made it harder not to be in a pension, as you actively have to opt out of your employer's scheme, but we still see people who aren't taking advantage of their company pension.'
Alarmingly, it's the 40-somethings who appear to be the most adept at ducking out of their pension planning. Research by Fidelity found that while only 8 per cent of employees in their 30s weren't in a pension, this figure rose to 18 per cent for the over-40s.
But being in your employer's scheme means you're not the only one contributing towards your retirement fund.
As well as tax relief from the government, your employer also has to pay in a minimum contribution, with the more generous employers paying in more than this.
Being in your employer's scheme is in itself a big plus, but it's also important to understand how much you need to put away. Robert Cochran, retirement expert at Scottish Widows, warns there's a risk of complacency as a result of the minimum contribution levels.
'The minimum total contribution now is 2 per cent, but even when this rises to 8 per cent it won't be enough to provide a decent level of income in retirement,' he says.
'We use a figure of 12 per cent as the target rate: if you can pay in this amount from age 30 to 64, you'll be in a much better position when you reach retirement.'
MATCH YOUR CONTRIBUTIONS
Although hitting this 12 per cent target can seem difficult, there are a number of ways to make it a little easier. For starters, it makes sense to take full advantage of any contributions your employer will pay in.
'Many employers will match any pension contributions you make, usually up to a set level,' says Parkin. 'Employers don't always promote this option, but it's free money, so make sure you take it if you can.'
As an example, if you've been auto-enrolled at 3 per cent but your employer will match contributions up to 5 per cent, then consider boosting your contribution rate up to 5 per cent.
Thanks to your employer's contribution, this takes the amount you're paying into your pension scheme up from 6 per cent of salary to 10 per cent, but only costs you an extra 2 per cent of your salary.
SACRIFICE YOUR SALARY
While giving up income may seem foolhardy, it can be an effective way to boost your pension pot. 'If your employer allows you to use salary sacrifice, it can be a particularly tax-efficient way to pay into your pension,' says Gary Smith, assistant director of financial planning at Tilney Bestinvest.
'Depending on how you approach it and how generous your employer is, this could boost your pension contributions by almost a third.'
The workings can be complex, but the benefits of this approach could include an increase in your monthly income or an uplift of up to 32.6 per cent in your pension contributions.
Although it's a great way to fast-forward your pension savings, there are some potential disadvantages associated with salary sacrifice.
As HM Revenue & Customs expect the arrangement to be on a permanent basis rather than something you dip in and out of, it may affect your ability to borrow, as potential loans and mortgages will be based on your reduced salary.
Similarly it can affect the amount you'd receive on any benefits that are linked to your salary.
ADJUST YOUR ATTITUDE
You could also consider changing your attitude to your pension savings. In the past, putting money into a pension wasn't always that appealing, especially as the only way you could get your hands on it again was to convert it into an annuity or go into income drawdown.
But, from April 2015, changes in the way you can access your pension pot make it a much more attractive savings vehicle.
'Pension freedoms mean that as soon as you reach age 55 you can take money out of your defined contribution pension,' explains Jonathan Watts-Lay, director at workplace financial education specialists Wealth at Work.
'This makes a pension much more like a medium-term savings plan, with the benefit of tax relief on contributions.'
The tax position means a pension stacks up well against the more traditional tax-efficient home for medium-term savings, the Isa.
Hugh Jory, partner at employee benefits adviser Secondsight, adds: 'It does depend on your tax position, but unless you're a basic-rate taxpayer when you make the contribution and a higher-rate taxpayer when you withdraw the money, you would be better off with a pension.'
As an example, if you paid £1,000 into a pension, tax relief would top this up to £1,250. Assuming no growth, if you withdrew it, you'd receive 25 per cent of it tax-free - equivalent to £312.50 - and pay tax on the remaining £937.50.
If you're a basic-rate taxpayer, this would mean a tax bill of £187.50, leaving you with £1,062.50 - £62.50 more than if you'd tucked the £1,000 away in an Isa.
BUDGET TO BOOST
While the new pension freedoms can give you more incentive to save into your employer's scheme, Watts-Lay says affordability may still be an issue. 'We spend a lot of time talking to employees about affordability,' he adds. 'Often we will direct them to other employee benefits that offer a means to make money.'
In particular he highlights some of the discount schemes that are often part of an employer's voluntary benefits package. These include, for example, money off high street stores and supermarkets.
'If you can get 5 per cent off your weekly grocery shopping, this saving could be redirected towards your pension,' he explains.
'It's money you didn't have before so you won't miss it, and because pension contributions attract tax relief and might even be matched by your employer, their value increases too.'
Even where this option is not available, simple budgeting strategies may be sufficient to free up spare cash for your future.
SAVE MORE TOMORROW
Another strategy worth considering is 'save more tomorrow', a behavioural economics concept developed by professors Shlomo Benartzi and Richard Thaler.
Following this idea, you elect to increase the percentage of your salary that you pay into your pension each year when you receive a pay rise.
For example, in the US where this programme is commonplace, an employee might start out paying 3 per cent of his or her salary into the pension, with this sum increasing by one percentage point each year until it reaches a cap of 10 per cent.
Parkin is a big fan of this approach. 'By tying the increase to an annual pay rise, it works on the principle that you won't miss what you never had,' he explains, adding that this can be a great way for younger people to achieve high levels of pension contributions early in their careers.
'It's not yet readily available in the UK, but with pay increases returning to the workplace I expect we'll start to see it soon.'
You could put this principle into action yourself. Although it lacks some of the appeal of a ready-made option, where inertia can actually help to keep you on track, it's worth getting into the habit of increasing the percentage you pay into your pension when you get a pay rise.
In addition to bumping up your regular contributions, you could also boost your pension savings by redirecting one-off payments to your scheme.
'The value of bonuses, inheritances, company share schemes and even existing savings and investments can all gain a valuable uplift thanks to the tax treatment on pensions,' explains Secondsight's Jory. 'Plus, once you reach age 55, you'll be able to take it out again if you need it.'
The tax relief certainly makes this approach worth considering. For example, if you received a £2,000 bonus, this would be uplifted to £2,500 if you are a basic-rate taxpayer. If you are a higher-rate taxpayer, as well as this uplift you'd be able to claim back a further £500 in your tax return.
Although the tax relief coupled with potential access at age 55 makes it more attractive to throw as much as you can at your employer's pension scheme, the maximum you can pay in this year is the greater of £40,000 or 100 per cent of your earnings.
KEEP ON TRACK
While pushing as much money as possible towards your employer's pension will certainly help your retirement fund grow, it's important to keep an eye on your progress.
Angela Seymour Jackson, managing director for workplace pensions at Aegon UK, explains: 'Review your pension at least once a year to make sure you're on course to provide the retirement income you want.
'You can also use tools such as the Money Advice Service's pension calculator to give you an overview of all your pensions, including the basic state pension, so you can see if you're on track.'
It's also important to act now, as the government's review of the tax treatment of pensions could make strategies such as salary sacrifice and redirecting lump sums much less attractive, or even impossible.
Although nothing has been decided yet, Smith says the general consensus is that, over the longer term, tax relief will not be as generous as it is now.
'I wouldn't be surprised if we saw the government introduce a 33 per cent flat rate for all taxpayers, to claw some back from higher-rate taxpayers and provide an incentive for lower earners to carry on paying into their pensions,' he says.
'But this would only be a short-term measure before cutting it back below current rates or possibly abolishing it altogether in favour of allowing us to access our pension pots tax-free.'
But, while changes to tax relief may affect some of these pension-boosting strategies, approaches such as matching and the behavioural economics idea of 'save more tomorrow' are much more resistant to the tinkerings of the politicians and will help you build a sizeable pension fund.
SALARY SACRIFICE IN ACTION
Peter Fisher earns £30,000 and pays £80 a month into his workplace pension. This is topped up to £100 with tax relief, giving him an annual gross contribution of £1,200.
He decides to sacrifice £1,200 from his salary, with his employer paying this directly into his pension. Although this gives him the same pension contribution, the tax and national insurance savings mean he receives higher net pay.
Peter decides that, as he doesn't need this additional income of £144, he will redirect it to his pension. This receives basic-rate tax relief, giving a gross contribution of £180. This takes his annual gross pension contribution to £1,380.
His employer is generous, so rather than pocketing the saving he makes in employer national insurance contributions as a result of the reduced salary (13.8 per cent of £1,200 = £165.60 a year), he redirects it to Peter's pension.
This additional boost would take his annual gross pension contribution to £1,545.60. This represents an increase in annual pension contribution of £345.60 or 32.6 per cent.
A tax-efficient way of receiving staff benefits, where an employee agrees to forego a proportion of their salary for an equivalent contribution into their pension scheme or in exchange for company car, gym membership, childcare vouchers or private medical insurance. A salary sacrifice scheme is a matter of employment law, not tax law, and is often entered by an employee who is about to move into the higher 40% tax bracket.
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 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.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
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.