Look after the Big One

What is the most valuable thing you are likely to own in your lifetime? No, not a house. Have another guess.  It is actually …… drum roll…… are you ready?………. YOUR PENSION! 

I know – surprise right?  Most 30 something year olds get thrown into a pension by their employers and escaping it takes some serious effort, so most just stay in for the ride. These pensions are called workplace pensions and your employer is compelled to pay into them.

How to double your money

The good news is that the employer contributes 3% of your earnings, you pay 4% and the taxman throws in 1% which adds up to 8%. Not a bad deal.  For each hundred quid of earnings, you pay £40 and £80 turns up in your pension pot. Not many places you can double your money that easily.

Not only is it a good deal going in, but all the investment returns whether it is interest, dividend, rent or capital growth, is tax free. Now that may not sound like a big deal to you, but let me give you a simple example that will knock your sox off. 

Investment TypeAmount InvestedGrowth rateValue after 30 yearsAfter tax on gain at basic rate (10%)After tax on gain at high rate (20%)
Unit Trust£10,0006%£57,435£51,692£45,848
Pension Fund£10,0006%£57,435£57,435£57,435

So a high rate taxpayer lost over £11,500 in tax compared to the pension. 

Now we know pensions are great going in, they are great for tax free growth and the cherry on the cake …… you can have a quarter of the fund you build, back completely tax free.  I am telling you there is nothing better than pensions when it comes to saving tax. 

So what are the down sides?  I guess the biggest is that you can’t access any of the money before age 55 (this is going up to 58 soon). There are also limits on how much you can squirrel away because there are limits to the taxman’s generosity. You can pay in all of your earnings up to £40,000 a year, and there is a lifetime limit to the size of the pension pot you can have without them wanting some of the tax relief back – currently it’s £1.073 million. 

So how big might my pension actually be? 

In our case study of Too Nice Tara and Savvy Sarah we compare two women who make different financial choices during their lifetime. These ladies went to school together, married at the same time and had the same size families and health experience, but end up £1 million apart by retirement age. Read the details here, but this is what their pension pots looked like:

Case StudyPension Fund @ age 67
Savvy SarahSarah joined her employers workplace pension and exploited her employers offer to match her contributions up to 10% of earnings£713,405
Too Nice TaraTara joined the same workplace pension at the minimum 5% contribution level which was matched by her employer and she had a shorter career that her friend.£118,344
Difference£595,061
The assumptions used in this case study are 5.5% per annum growth on the pension fund and contributions based on the women’s earnings during their careers.  Please refer to the case study for greater detail. 

In the case study it also points out that in reality Sarah is likely to have been advised to invest her pension fund differently to the default option that is designed to be middle of the road because of the very long term nature of the investment. This could easily have added an extra 0.5% per year investment growth and that would have put ……….. wait for it………… an extra £90,000 in her pension pot. Small differences add up to big sums over the term of an investment.

So here is your housekeeping checklist for looking after The Big One 

  • Make sure you start your pension as soon as you can – the first £1 earns you the most because it is invested for the longest period. Get on with it! 
  • Exploit any employer contributions to maximum advantage. Often an employer will match your contributions up to a certain level – don’t leave free money on the table! 
  • Choose the right fund – here at Women’s Wealth we believe this is the single most valuable thing we do for most of our clients. Many have let the scheme default to a middle of the road fund rather than making an active choice about how their pension is invested. THIS IS AN EXPENSIVE MISTAKE in many circumstances.  If you don’t know how to choose a fund then get advice because the advice is likely to be a fraction of the cost of the mistake – please don’t neglect the biggest single asset you are ever likely to own in your lifetime. You deserve better. 
  • If you have periods of low or no earnings then you can still pay into a pension and get the tax bonus – even if you are a non-tax payer – Yeh money for nothing! 

https://www.gov.uk/employers-workplace-pensions-rules

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