Are pensions better than savings and investments?

Find out the pros and cons of pensions as opposed to regular saving and investment options.

According to the Money Advice Service in 2015,^† more than half of people in the UK either aren’t saving enough for their retirement or aren’t saving for it at all.

The harsh reality of this, it says, is that these people will either have to start saving more, retire later, or reduce their expectations of what they’ll be able to afford in retirement.

With the maximum state pension standing at just £115.95 a week for tax year 2015-16, it’s a good idea to start putting away additional money for retirement as early as you can.

But it’s not always easy to know the best way to save for your retirement - is an employer pension pot the way to go, or would you be better off saving or investing the money yourself?

Employer pension

An employer pension or workplace pension is a way of saving for your retirement that’s arranged by your employer.

You don’t need to remember to pay anything yourself, as the money is deducted straight from your wage packet each month.

Usually your employer also contributes and you’ll get tax relief from the government as well.

The government still puts tax relief into your pension pot, even if your income is too low to pay tax.

Automatic enrolment

Between 2012 and 2018 the government has rolled out a scheme that means all employers must offer a workplace pension scheme.

There are minimum amounts that the employee, employer and government must contribute to the scheme, although your employer may contribute more than the minimum.

An employer will automatically enrol its eligible workers into its scheme unless an employee actively opts out.

How is the money invested?

Your employer’s chosen pension scheme provider will decide how to invest your pension funds, but you’ll usually be offered a selection of different types of investment funds and levels of risk.

Should I use my employer pension scheme?

Because you get both contributions from your employer and tax relief from the government, workplace pensions are an effective way to save for retirement for most - not using it is akin to turning down a pay rise, although the benefits are deferred until your retirement.

However, if you’re self-employed, work abroad or you don’t meet the minimum earning requirements for your workplace pension, you might want to look at some alternatives.

You might also want to save or invest to give you more to retire on than your pension alone.

Private pensions

If you’re ineligible for a workplace pension, you might want to pay into a private pension, also known as a personal pension, instead.

You might also choose to take out a personal pension in addition to your workplace pension to boost your retirement funds or to invest differently to your workplace pension.

A personal pension is run by a pension provider, which will claim tax relief at the basic rate and add it to your pension pot.

If you’re a higher rate tax payer, you can claim the additional tax as a rebate through your tax return.

Other than not receiving employer contributions, a personal pension works in the same way as a workplace pension - it’s invested by the pension provider, usually with a few choices for you to make about type and risk of investment.

Should I use a personal pension?

If you’re self-employed, unemployed or otherwise ineligible for a workplace pension, a personal pension still offers attractive tax breaks.

If you are employed, unless there’s a compelling reason not to pay into your employer’s scheme you’re probably better off doing that so you don’t miss out on employer contributions.

Self-Invested Personal Pensions (SIPPs)

A SIPP lets you take a DIY approach to pension planning by choosing the investments yourself.

It differs from a personal pension because there’s no pension provider involved - instead you can choose to invest in anything you like.

Like a Stocks and Shares ISA, a SIPP acts like a tax-efficient ‘wrapper’ for all your investments.

You choose what shares, funds and other investments to place in your SIPP and the government automatically adds tax relief at the rate you pay tax.

For instance, if you’re a basic-rate taxpayer playing income tax at a rate of 20%, you could invest £1,000 in your SIPP and the government would add £200, increasing your gross contribution to £1,200.

What’s more, investments in your SIPP can grow free from capital gains tax and income tax.

To invest in a SIPP you should either be well-informed about investments and able to make your own decisions over how and where to invest wisely, or you might want to consider consulting an independent financial adviser.

SIPPs are often sold through investment supermarkets and managed online.

Charges and fees

Charges and fees for SIPPs can vary widely between providers, so you should think about how you’d like to invest and how often you’ll change your investments before choosing one.

There’s usually a set-up fee when you take out your SIPP and some SIPPs also have an annual management fee.

You’ll usually have to pay a dealing charge when you buy and sell investments and there may be exit and transfer charges for moving providers or moving finds from another pension into your SIPP.

Finally, when you want to start drawdowns on your SIPP there’ll be a charge and then there may be annual ongoing charges for this too.

Should I use a SIPP?

If you want total control over choosing and managing your pension investment a SIPP may be for you.

However, due to the often complex nature of the fees and allowances, you might want to seek independent financial advice first.

You also won’t benefit from employer contributions in your SIPP, so you might want to consider a workplace pension first if one is available to you.

Pension contribution limits

Although you can hold as many pensions as you want - for example you could have a workplace pension and a personal pension - there are limits on how much you can put in them each year.

For the tax year 2014-15 this was 100% of your earnings before tax up to a limit of £40,000.

Non-earners can contribute up to £3,600 a year to their pension in 2015-16 and still get basic-rate tax relief - effectively this means they can pay in £2,880 and the government adds £720.

As well as the annual allowance, there’s a limit on the total amount you can save over your lifetime into your pension, which was £1.25m in 2015.

Alternatives to pensions

You might want to consider saving for your retirement outside a pension scheme; this can be done instead of a pension, or in addition to one.

Bear in mind, however, that if you choose to do this you’ll miss out on pension contributions from the taxman and, potentially, your employer.

The big advantage of saving or investing outside a pension is that you’ll be able to use the money earlier if you want to, whereas pensions can usually only be taken from the age of 55.

You could also withdraw a lump sum - while this is now allowed with pensions, any amount above 25% of your total pension in a tax year will be taxed.

Investments

You might consider investing money for your retirement.

Investment might offer better returns than savings, but remember that the value of your investment could go down as well as up.

You could consider investing up to your annual ISA allowance in a Stocks and Shares ISA to protect it from capital gains tax - although, unlike with a SIPP, you’ll still have to pay some tax on any dividend income.

Savings

It’s sensible to have some savings in addition to your pension for the reasons outlined above - namely, flexibility on when and how much you draw down.

If you only have savings, however, you’ll miss out on the tax breaks you get with a pension, as well as employer contributions you’re likely to get with a workplace pension.

Using your Cash ISA allowance will let your savings earn interest tax free, but this is unlikely to come close to the tax relief you’d receive on a pension.

Nevertheless, having savings and investments in addition to a pension will give you the best of both worlds - tax relief and employer contributions that may come with a pension, with the savings or investments letting you access lump sums without paying tax on them whenever you like.

Lifetime ISA

Lifetime ISAs are available for people aged between 18 and 40 from 6 April, 2017. They can be used to save towards your first home or for your retirement.

If you use them to save for retirement, you'll receive 25% of your savings as a government bonus, paid on up to £4,000 of savings a year.

You can save more than £4,000 a year in a Lifetime ISA, up to your annual ISA limit, but you'll only receive the bonus on the first £4,000.

You can keep adding to the Lifetime ISA and receiving the bonus up to the age of 50, but you can't withdraw the funds and get the bonus until you're 60 (unless you use it to buy your first home).

If you choose to access the money early, you'll lose the bonus and any interest from the bonus, and may have to pay a 5% penalty on the funds withdrawn.

Property

Some people see property as a sensible investment for retirement, either instead of, or in addition to, a pension.

Indeed, if you pay off a buy-to-let mortgage while you’re earning, you could retire and use the rent from the property as an income.

You could also sell the property to provide a lump sum.

However, if you do sell there may be capital gains tax to pay and the rental income will also be taxable. There’s also the expense and hassle of running and repairing a rental property.

Many people won’t want to manage rental properties during their retirement and choosing a property manager will take care of some aspects and rent collection.

However, even with a management company you’re likely to still need to find landlord insurance, make decisions and pay out for the running of the rental property.

Another thing to consider may be investing through property crowdfunding, but remember that this also brings risks.

By Derri Dunn

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