There are very few people on track to save enough in their pension and so nearly all of us could do with saving an extra £10,000 in our retirement pots next year.
If you are on the average salary of around £35,000 and you increased your contributions to £10,000 a year while you are still in your 20s, you would have a pension pot of £1.5m by the time you retired, according to calculations by the investment platform AJ Bell for the The i Paper.
Meanwhile, if you managed to save £10,000 a year from your thirties, you would save just shy of £1m, and £440,000 if you began in your forties.
While saving this much every year is not realistic for everyone, even managing it for one year can make a big difference, no matter how far down your working career you are.
We look into how you do this in the least financially painful way possible.
How much to save to get to £10,000
Assuming you don’t have any extra help from your employer (you may be self-employed, so you don’t have employer contributions to bump this up) the good news is you don’t have to save the full £10,000 as £2,000 will come from tax relief (or £4,000 if you are a higher-rate tax payer).
If you are a basic-rate self-employed taxpayer you will just need to save £8,000, which works out as £667 extra per month. If you are a higher-rate taxpayer you will be able to claim back an extra 20 per cent tax relief from the taxman, meaning the £10,000 pension contribution will only have cost you £6,000.
If you are employed you are in a stronger position as your employer can help you save. By law, companies have to open a workplace pension for anyone from the age of 22 who earns more than £10,000 a year.
On top of this, companies have to pay a minimum of 3 per cent of someone’s qualifying earnings, while the employee will be automatically set up to pay 5 per cent. This happens unless the individual opts out of the pension schemes (and even then they can opt in again at any time).
If you earned the average salary of just over £35,000 – and you and your employer paid the minimum contributions – you would end up with a total yearly amount going into your pension of £2,300 (£1,150 that you contribute, £862 that your company contributes and £288 coming from 20 per cent tax relief).
In order to get to annual savings of £10,000 you would need to pay in an extra £7,700 over the year. This is a personal contribution of £6,160, which works out as an extra £513 per month, with the rest being made up by tax relief.
How do I pay this extra amount in my pension?
You could do this by contacting your pension company and setting up a standing order of £513 to be paid each month. You may also be able to do this on the website of your pension provider too.
When you log in to their site, there may be a drop-down menu where you can increase your percentage contributions.
Assuming you’re on the average salary and your company is paying in the minimum you would need to put in total contribution levels of 27 per cent of your earnings to reach the £10,000 level.
I can’t afford to contribute this much. What can I do?
You could see if you can negotiate with your employer so the company increases its contribution. Additionally, you can double-check you are maximising the amount they will automatically contribute.
If the employer increased their contributions to 5 per cent instead of 3, this would leave the employee only needing to pay in 25 per cent rather than 27 per cent.
“This works out as needing to pay in £479 per month in personal contributions, ” says Tom Selby, “roughly £35 a month less than if the employer contributed just 3 per cent.”
It’s sensible to check with your HR department what your employer’s maximum levels are, and what you need to do in order to reach that.
Many employers do contribute more than the minimum of 3 per cent, while some companies will match contributions up to a point.
For an idea of the difference this makes, investment management company Brewin Dolphin has provided some calculations.
These show that someone who started saving at 30, earning roughly the average wage, would end up with £81,000 more in their pension when they retire had their employer contributed 5 per cent rather than 3 per cent.
For a 40-year old it would be £48,000 more.
“You should also consider workplace pension terms when taking on a new role or negotiating salary with your existing employer,” adds Mr Selby. “There is no guarantee this will always work but there is no harm in asking the question.”
Put your bonus in your pension
“If you’re lucky enough to get a bonus, you could put some of that into your pension,” suggests Helen Morrissey of Hargreaves Lansdown.
“If you do it through bonus sacrifice then you don’t pay income tax or national insurance on the money going in. So, if you were a basic rate taxpayer and received a £1,000 bonus that you put into your pension in this way then the whole £1,000 would go in.
“If you received it as income then you would have paid income tax and national insurance on it which would have left you with around £720.”
If you get a pay rise
If your pay rise is, say, £2,000, you could ask the HR department just to increase your pension contributions by that amount, or you could put £1,000 towards your pension as it’s the easiest time to save more, and keep £1,000 for the here and now.
It makes even more financial sense to put it in your pension if your pay rise will push you into paying a higher rate on tax (which is triggered when you start earning £50,270 higher-rate threshold, above which you go from paying 20 to 40 per cent).
This way, you can reduce your earnings to below the £50,270 you will keep your income tax rate down (and not pay double in tax) and save more for your pension. That is a win-win for your monthly pay packet, and your future one.
What role does compound interest pay?
Putting in as much money as you can, as early as you can – whether you are in your twenties, thirties, forties or fifties, means it costs less to build a good-sized pension. This is down to compound interest.
Compound interest is when you save money and earn interest on the savings. As a result, you also earn interest on the interest itself. The investor Warren Buffett once likened compound interest to a snowball rolling down a hill, increasing in mass and speed as it tumbles on. It is the magic formula to growing your pension pot from something tiny to something big.
How much you need to save in total
The Pensions and Lifetime Savings Association (PLSA) says that you now need an income of £31,300 a year for a “moderate” retirement – and that assumes no housing costs. But its analysis suggests that four out of five people are not saving enough for this.
Pension maths
- Government statistics put the average pensioner’s income at £349 a week.
- The ONS estimates that having a pension worth more than £374,500 would put you in the top 10 per cent of savers. About 4.98 million people fall into this category and collectively they hold 64 per cent of all private pension wealth.
- To get a £1m pension pot by the age of 68 you would need to save £389 a month from the age of 18, according to Brewin Dolphin. If you started saving at 30, you would need to put away £755 a month. Both assume annual investment growth of 5 per cent.
- You can get tax relief up to the annual allowance which is £60,000 per tax year for most people. The annual allowance is a general limit on what can be paid into all of your pensions, per tax year, before a tax charge might apply. This includes not only money you contribute yourself, but also the tax relief paid in by government as well as anything paid in by your employer. Your allowance might be lower if your income is over £260,000 for the year.
