Should I get a pension?

You might think of pensions as a bit dull, not to mention complicated. However, for most people they are the best way to save for retirement. 

The good news is, if you’re working, you probably already have a pension through work.

So called auto-enrolment rules now mean all employers must offer a workplace pension to staff. You don’t need to sign up to join the scheme, instead your employer will set it up for you - if you don’t want to participate you will need to opt out.

How does auto-enrolment work?

Auto-enrolment is the hassle-free route to retirement saving. Your employer will sign you up to your workplace pension automatically and contributions will be deducted from your salary. 

Contributions are a minimum of 5% from your qualifying earnings (everything you earn between £6,240 and £50,270) but your employer will top that up with a further 3%, giving you a total 8% contribution. Part of your contribution will also be funded by tax relief from the government.

Your workplace pension will normally give you a choice of investment funds, however if you don’t want to make a choice - or you don’t tell your pension provider where you want your money to go - it will be paid into a default fund.

If you don’t want to pay into the pension you will need to tell your employer and opt out.

So I don’t need to worry about my pension then?

Auto enrolment is a fantastic initiative that has got millions of workers saving for their retirement since it was launched in 2012. 

However minimum contributions are low and may not be enough to give you a comfortable standard of living in retirement. 

To really make the most of your workplace scheme it pays to invest as much in as you can afford and engage with your retirement savings.

To do this, it’s important to have a good understanding of how pensions work and their pros and cons.

Pros of a pension

Tax relief

When you pay into a pension you will usually qualify for tax relief on your contributions. This can give your retirement savings a fantastic boost, but according to the People’s Pension 35% of savers are totally unaware of it. 

If you pay into a workplace pension, your monthly pension contributions are often deducted from your gross (pre-tax) wage - meaning you don't pay any income tax or National Insurance on the money.

If you pay into a personal pension then you can claim the tax relief back from the government - as the money you pay in is from your net (post-tax) salary.

For a basic rate tax-payer this effectively means it only costs you £80 to pay £100 into your pension. Higher rate taxpayers only have to pay £60 to invest the same amount.

Compound returns

Another significant benefit of paying into a pension is the compound returns that your fund will earn over the course of your working life.

Over the course of your working life which could be up to 30-50 years, the benefit of this compound re-investment can be quite substantial.

Your choice of income 

When you come to the end of your working life you have the option of purchasing an annuity to guarantee you an income throughout your retired life. 

Alternatively, you can take a more flexible approach. For example, investing your money and drawing an income from it or taking cash lump sums.

Thanks to the introduction of the pension freedoms in 2015 it’s up to you what you do with your pension savings once you reach age 55. 

You can also choose to mix and match these options according to your needs.

Employer-matched contributions

Your employer will need to pay 3% of your qualifying earnings into your pension, meaning you’re get valuable free cash from your bosses. However, many employers will match your contributions to a certain level as a part of your salary package. This could double the funding of your pension and is an easy way to boost the final value of your pension fund.

Cons of a pension

Access

Most pensions lock away your savings until you reach a certain age, usually 55 or higher.

While this means that you can't be tempted to spend your retirement savings on a  luxury holiday it is a frustration for many savers.

Investment risk

As your pension is invested into various stocks and shares there is a varying degree of risk associated with each of these investments.

This means that your pension could decrease in value if things go badly and that you actually lose money in the short term on your investment.

Most pensions employ an investment strategy called life-styling so that your money is gradually moved from high to low risk as you move closer to retirement age.

The amount of control you have over the level of risk will depend on the sort of pension you have.

You are more likely to be able to specify the level of risk if you hold a personal pension. Although company pensions offer you some choices, most savers will be in a default fund. 

However, it is worth remembering that a pension is a long term investment. There may be short-term dips over the course of your working life, but you will normally benefit from investing in the stock market.

What are the alternatives?

If you are unsure if paying into a pension is your best option there are some alternative ways to save for retirement that you might want to consider - although some of them are more realistic than others!

1. Invest in property

Building a property portfolio while you're working that will then support you when you retire is one alternative to investing in a pension.

There are two main approaches you can take:

The first is to gradually move up the property ladder, then downsize to a smaller property when you retire leaving you with a lump sum to live off.

However, there are some drawbacks to this plan, we’re all used to rising prices, but they can fall too. You may also love your family home and not want to move into something smaller when the time comes. 

Even if you are happy to move you might find that downsizing into a suitable home doesn’t release the amount of capital you’ll need. You may also struggle to find an appropriate home to live in.

The second type of property investment is to build up a buy-to let portfolio. This is where you buy one or more properties to rent out. 

There are however again a number of risks to this plan, firstly it assumes that you will always be able to find a suitable tenant who pays the rent on time. 

Secondly, It's not a hassle free investment. Maintaining and managing the property can be expensive and time consuming. As you get older you may need to pay someone to do it for you, or sell up. 

Thirdly, buy to let investments are heavily taxed, meaning HMRC could take a serious chunk out of your retirement savings.

Both strategies also come with concentration risk, because you are essentially putting all your eggs in one basket. If the property market crashes, you’ll have no protection.

For more information our guide How to invest in property provides a comprehensive breakdown of the essential information.

2. Use your ISAs

Since 6th April 2017 everyone can save up to £20,000 a year tax free into ISAs. This can be split between stocks and shares or cash ISAs.

Many view ISA savings as a viable pension alternative and there are definitely some benefits.

Firstly, anything you save into an ISA will be easier to access than if you saved into a pension. This means that if you need to access the money in an emergency you can.

Secondly, when you take money out of your ISA it will not be subject to income or capital gains tax.

However, most advisers would argue it’s better to use a pension - tax relief on pension contributions over the years will normally outweigh the benefits of not paying tax on ISA withdrawals.

These options can work brilliantly in combination. ISAs can be a great way to increase your retirement income, without boosting the amount of income tax you’ll need to pay.

You could also consider a Lifetime ISA if you are aged between 18 and 40. You can pay in up to £4,000 each year to age 50 and the government will give you a 25% bonus (to a maximum of £1,000 each year). The money can be used to either buy your first property or fund your retirement.

Any money you pay into a Lifetime ISA counts towards your overall ISA allowance.

3. Work

For many people working in retirement is simply not an option.

However, with many of us spending longer in retirement and employability laws becoming more accommodating, working into retirement can be a great way of supplementing your retirement income. 

This doesn’t have to mean working to the bone. It’s more about making employment work for you, whether that’s by reducing your hours, starting a new part time job or even setting up your own business venture.

4. State pension

Perhaps not strictly an alternative to a pension, as you pay into it already through your National Insurance contributions, but the value of your state pension is definitely worth taking into consideration.

Currently the new state pension pays £179.60 a week if you have 35 years’ worth of national insurance contributions. 

Find out more about how much you’ll get with our guide to the new state pension.

Unsure what's the best option?

Pensions for many of us are a daunting prospect, but there are experts who can assess your individual situation and advise you on your options.

It's also worth remembering that there is no reason that you can't combine all of the above methods to spread your bets, rather than relying on one method to fund your retirement.

If you are considering starting a pension, the earlier you start saving the better, as you will get even greater benefit from the compounding returns. Read our step by step guide: How to get a pension for more information on getting started.

If you want some advice regarding your pension or retirement options then speaking to an Independent Financial Adviser or IFA can help.