Should I pay my excess income in to my pension or savings?

Saving for your future sounds like such a simple and sensible goal. However, in reality, there are a lot of things to consider beforehand. Some of the questions we ask ourselves are; Will I need access to my money regularly? How far in the future am I planning for? Will my circumstances change over time? What do I need to pay for along the way? Amongst many others.

It can be difficult to see past your immediate spending needs, especially during the current cost of living crisis. However, rather than thinking of it as an extra cost to consider or another thing to worry yourself with, think of it as an investment into your future, as it’ll be here sooner than you think!

After careful consideration, once you’ve identified how much you can afford to put away each month, no matter how big or small, it is important to find the right balance between saving for your short-term and your longer term needs. So, what options are available to you?

Savings, Investments and Pensions

Deposit based savings, Individual Saving Accounts (ISAs), Pensions and other types of investments can each be great for trying to build up a reserve pot, but they all vary in terms of what they offer and can help you achieve different goals.

Deposit based savings give you a secure place to put money aside for your short and medium-term goals. Saving for a house deposit or towards a holiday, for example.

For your longer-term goals, investing can be a great way to help your money grow. Pension plans are long-term investments and are a tax-efficient solution to save and invest money for your later years, such as when you decide to reduce your working hours or decide to cease employment altogether and retire.

Remember that the value of pension plans and other investments can go down as well as up and you may get less back than was paid in.

The pros and cons of Deposit Based Savings and ISAs

If you’re looking to save to build up your emergency fund or saving for larger items of expenditure, then putting your excess income in a bank or building society or even a cash or a stocks and shares ISA will allow you the quick access you need.

These accounts are quick and simple to set up, however, the interest rates are generally quite low and as the cost of living is rapidly increasing at the moment, the money you invest in Cash ISAs or your bank/building society could end up losing value over time.

Stocks and Shares ISAs offer the best of both worlds by allowing quick access should you need to make a withdrawal, whilst also being invested in funds that could help your money grow. The benefits of ISAs are:-

• ISAs have tax advantages as you are not subject to any capital gains or income tax when you withdraw any of your funds.

• ISAs do not need to be included on your Tax Return.

• You can also switch funds within an ISA without triggering any tax charges.

• There is no penalty applied for withdrawing any funds from your account.

• You can invest up to £20,000 in the current tax year into an ISA. You can invest this into stocks and shares, cash or a combination of the two up to a total of £20,000.

Pros and cons of saving in your Pension Plan

The money paid into a pension plan is invested, much like a stocks and shares ISA and will have the chance to grow and it is hoped (but not guaranteed!) that it will beat the rate of inflation.

When you have a pension plan in place, especially if you have one through your employment, it’s easy to stay in the habit of saving as payments usually come straight from your salary, so you don’t really notice it missing. When you’re in a workplace pension scheme, your employer is contributing a percentage of your earnings towards this. Some employers will pay more than the minimum required and others will pay more into your pension pot if you do the same.

Most people are entitled to claim tax relief on the personal pension payments they make based on the level of income tax they pay. Tax relief is what makes pension plans one of the most tax efficient ways to save for your retirement. Tax Relief means most individuals will get 20% tax relief from the UK Government on their personal pension payments, so as an example, if you invest £100, the pension provider will claim tax relief on your behalf, increasing your £100 investment to £125. If you are a higher rate tax payer you will also benefit from a higher level of tax saving.

If your employer is making payments to the pension scheme on your behalf, you’ll need to double check with your employer how tax relief works for you. However, more often than not, as an employer contribution, you will not be entitled to tax relief.

There are, however, limits to the amount you can save into your pension plan without paying any additional tax. The current rules state that you can pay 100% of your salary, or £3,600 a year into your pension plan, whichever is higher, to still receive tax relief. There’s also the annual allowance to consider, which is currently £60,000. If you pay more than the annual allowance into your pension plan in any one tax year, you will have to pay tax on this.

One of the most important things to consider with a pension plan is that you are not able to withdraw your pension money until the age of 55 at the earliest. In 2021, the Government confirmed that this will rise to age 57 from 2028, and it may change again in the future. So, bear this in mind when you begin saving and consider your saving goals.

So, is it better to pay into a pension plan or savings?

Ultimately, the decision is all yours and depending on your priorities and goals over the coming years, you may invest in a number of the available avenues as discussed above. Your goals will change over time, but rest assured, there is an investment solution suitable for your needs depending where you are in life and whether you are saving for the short term or the long term.