You pay into your pension every month – but did you know there’s a maximum amount each year you can put away? Or that there’s a lifetime limit?
Here’s how pension limits work – and why paying into your pension as early as possible helps you build a large retirement fund.
- Annual and lifetime pension limits
- Why paying in as early as possible is a good idea
- How to use the workplace pension scheme to boost your pension pot
- What should you do?
- Alternatives to paying into a pension
You can invest up to £40,000 per year into a pension and get tax relief from the Government on it (or up to 100% of your annual earnings, whichever is less). This means the Government pay in the tax you WOULD have paid if you’d received the cash through your salary – so it’s like extra free money into your pension.
The lifetime annual allowance is how much money you can have in all of your pension pots added together. In 2019, the lifetime allowance is £1,055,000.
You could pay more than these amounts into your pension – but you won’t get the tax relief. So, if you’ve managed to max out your limits (excellent work, by the way!), it could be worth looking at other investments such as equities ISAs for the rest of your retirement finances.
Since the introduction of auto-enrolment, more people than ever have workplace pensions. Which is great! But if you don’t qualify for one, it’s essential to set up your own private pension plan.
When times are hard and we’re living hand-to-mouth, it’s hard to envision our future – let alone save for it. However, pensions are the most tax-efficient way to save for your retirement – which means you’ll get the most return on your savings if you start as early as possible.
Even if you’re paying just £25 a month into a pension at the age of 25, you can’t access that money until you’re at least 55. That’s 30 years of compound interest at work! Your small payments quickly add up over time – and interest means the pot quickly grows.
A recent report by Royal London revealed that people retiring aged 65 need a pension pot of £260,000 for a comfortable £9,000 income a year (plus the State Pension). That’s a staggering 75% more in real terms than the £150,000 needed in 2002. Most people don’t have near that amount – so the earlier you can save, the better!
It’s never too late though: if retirement is only a few years away, don’t panic. You can increase your pension contributions as much as possible to save a bigger pot.
You’ll find more information in these great FREE financial guides:
If you’re eligible for a workplace pension, we always recommend you join the scheme. It might feel like a hard blow to contribute 5% of your pre-tax pay each month to the scheme – but wait!
Your employer has to contribute 3%, too – and the Government tops up (usually 1% for basic-rate tax payers) . So, you’re not losing 5% really – you’re GAINING 4% on your savings.
Workplace pensions also tend to be low-cost schemes, too. They’re supposed to be low-risk investments for steady (if slow) fund growth. This means the management fees are much lower than costly private pensions – saving you potentially thousands of pounds in fees over your lifetime.
Even if you’re not convinced a pension is the best way to save your money, it’s worth putting at least some of your investment money into a pension product because:
1. You get tax relief on the money you put in. You pay income tax at a lower rate on when you take out your pension. That offers huge savings for higher-rate taxpayers.
2. Your employer has to put 3% into your workplace pension. That’s extra free money you wouldn’t get with a private pension.
3. The money is taken out of your hands until you’re at least 55. If you’re the sort of person who could dip into your savings here and there it’s a very good way of saving yourself. You can’t get your mitts on it until you’re ready to retire.
4. Pension rules have been greatly improved: they’re much more flexible and, in some cases, more transparent. There are also very good products around such as stakeholder pensions and SIPPs which are generally worth having.
The tax relief you get on pensions means that if you are a basic rate taxpayer (20%) for every 80p you put in your pension the government adds in 20p and if you’re a higher rate taxpayer (40%) for every 60p you put in you get 40p added by the government. If you’re a really high earner and on the 50% tax band you get to share it 50/50 (you put in 50p and so does the government).
Also, while you’re at it, check your State Pension forecast. If you don’t qualify for the full pension, you still have time to make voluntary National Insurance contributions to boost it.
We think it’s a great idea to spread your investments and the best way to do this, once you have started to put some cash into a pension, is to put money into an ISA-wrapped investment.
You can invest up to £20,000 in an ISA this tax year (April-April). This can be split between a cash ISA and an equities ISA.
ISAs are like reverse pensions really: you don’t get tax relief on the money you put in but then you don’t get taxed on the money you take out at the end. With pensions it’s the other way around.
Also, the money you put into ISAs is much more flexible. You can take it out whenever you like and do what you like with it.
So, it’s worth having some money in a pension and some in stocks and shares-based ISAs. We explain in this ISA article why stocks and shares ISAs are the best for long-term investments.