It can be hard enough making ends meet every month, let alone worrying about the future, but it’s vital to think about how you’ll cope financially when you stop work.
Every pound you can save for the future will make a difference, but it’s not always easy to know where the best home is for your savings – and whether you should pay into a pension or more readily accessible savings accounts.
Savings pros and cons
Since the Bank of England slashed the base rate to 0.5% in March 2009, savings rates have fallen dramatically, so it’s really hard to find decent returns. Only a small number of savings accounts can keep pace with inflation, or the cost of living, which means the purchasing power of your cash is being eroded as time goes by.
The best way to fight back against low savings rates is to make the most of your annual individual savings account (ISA) allowance, as returns from these accounts are free of tax. You can invest your full £15,240 allowance in cash into an ISA this tax year (2016/17), or you can split your allowance in any division you like between cash and stocks and shares, or peer-to-peer loans through the new innovative finance ISA, or you can put it into stocks and shares or an innovative finance ISA alone.
If you don’t want to take any risks with your money, then your best bet is to stick with a cash ISA. However, bear in mind that if you are investing over the long term, historically shares have tended to provide better returns than savings accounts.
Pensions pros and cons
The big advantage of a pension is that you get tax relief on any contributions you make, so your investment is given an immediate boost. If you are basic rate taxpayer, you save 20p in tax for every pound you make in pension contributions, rising to 40p in tax for every pound you contribute if you are a higher rate taxpayer. If you are an additional rate taxpayer, you save 45p in tax for every pound you pay into your pension.
In the current tax year, everyone is allowed to shelter up to £40,000 or 100% of their earnings – whichever is less – from tax by making pension contributions in the current tax year. Unlike ISAs, you can also carry forward any unused annual allowance from the three tax years preceding this one.
If your employer offers a workplace pension, you should join it as they will usually make contributions on your behalf in addition to any payments you make into the scheme. Some will even match or better your contributions, providing a big boost to your pension pot.
In the current tax year everyone is allowed to shelter up to £40,000 or 100pc of their earnings – whichever is less – from tax by making pension contributions
All employers will have to provide workers with a workplace pension scheme by law over the next few years, under the government’s auto-enrolment scheme. Under this scheme, you will automatically be enrolled in your employer’s pension scheme if you haven’t joined already.
Whereas you can get your hands on any savings held in cash ISAs whenever you want, you can’t currently draw retirement benefits from your pension until you reach the age of 55, so pensions aren’t as flexible as savings accounts.
However, thanks to a rule change in April 2015, once you reach 55 when you can take out as much money from your pension as you want at any time without being hit by huge tax charges you can take 25% of your pension as a tax-free lump sum and any withdrawals after that will be taxed at your personal rate. Previously, any withdrawals after your tax-free lump sum would have been taxed at 55%.
Because you can access as much cash in your pension pot as you want to, you will no longer have to buy an annuity. An annuity is a contract you buy from an insurance company that guarantees to pay you an income until you die, in return for you handing over your pension savings to them.
If you do still opt for an annuity, remember you do not have to buy from the same firm that provided your pension fund, as much better annuity rates may be available elsewhere. You will also be offered independent advice.
You can find out more about from our article, Pension changes explained.
…but you can’t start saving soon enough
Wherever you choose to save for your future, the more you can afford to put away now, the more comfortable your retirement will be.
You don’t have to decide on one particular route and stick to that for your lifetime. Often choosing a combination of savings accounts and pensions can provide you with both flexibility and access to tax relief on your pension contributions.
Always seek professional independent financial advice if you need help deciding which investments are right for you.