Should I stick with my pension or start saving?

27 March 2012

Q

I am 30 years old and have been paying into my work pension for nine years. I currently contribute £60 a month and my employer matches that amount.However, a colleague states that she opted out of the pension and instead pays £60 per month into a savings account. She thinks this is a better idea as the value of her savings cannot fall, whereas pension investments can, therefore she has guaranteed funds when she retires. Should I follow her lead? I also have a mortgage that currently costs £620 per month and wondered if rather than investing in my work’s pension or savings, I would be better off paying an extra £60 per month off my mortgage? The current interest rate is 4.79% and there is 35 years left on my mortgage term.
From
DM/County Durham

A

You made the right decision to join your employer’s occupational pension scheme nine years ago. In retirement, a significant sum of money will be required in order to replace your income when you stop working. To build up this sum you will need to commit to saving over the long term, so the sooner you start saving the better.

A pension offers significant benefits over a standard savings account. The most important benefit in using the pension organised by your employer is that it currently matches your contributions.

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This means that £120 each month is being invested at a cost to you of only £60. In addition, pension contributions benefit from tax relief with HM Revenue & Customs (HMRC) refunding the income tax you’ve paid on your contribution straight into your pension.

If you are a basic-rate taxpayer, HMRC will top up each of your pension contributions by 20%. So, in order to match the same amount being paid into your pension with alternative forms of saving you would need to be saving £150 a month.

When it comes to growth your colleague is right, cash is safer than pension investments as the face value of cash can’t fall. However, cash can’t match the growth rates available from other assets. It is likely that your pension is invested in a range of assets, including bonds and shares. These are proven to provide a significantly greater return than cash over the long term.

Interest rates are at an historic low, with most saving accounts failing to provide growth that counteracts the erosion of inflation. It is likely that interest rates will remain low for many years to come, so cash-based savings are unlikely to grow fast enough to keep up with the rising cost of living.

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I would suggest that your colleague has made a serious error in opting out of your employer’s pension scheme if she is intending to save for retirement.

As for overpaying your mortgage, I think saving for your retirement should be your bigger priority. It would appear that the amount you are investing in your pension is extremely modest and is only likely to provide a very low income at retirement.

As a guide, you should be aiming to invest 10% of your salary into your pension before the age of 30, rising to a minimum of 15% of your salary when you move into your 30s. My advice would be to increase your regular monthly saving commitment by reviewing your monthly budget.

If funds allow, increase your pension saving and only then make overpayments against your mortgage in order to reduce the debt and the cost of interest over the long term.