Pension plans are one of the best ways to save for the long term. For starters, you get pension tax relief on your contributions. This means that you get a top up from the government, so it effectively costs you less to save more.
In addition to that, your pension contributions are typically invested for the long term in a portfolio of stocks and shares. Anything you pay into your plan has the potential to grow and benefit from compounding. Growth within a pension plan is tax free.
If you had a workplace pension, your employer would have to contribute to your pension too. Your employer may opt to match your pension contributions. This top up to your pension is effectively a pay rise of sorts and worth having.
Is it worth increasing my pension contributions?
The answer to this is generally yes, especially if affordable. This may not be a priority for you if you’re younger, say in your twenties or early thirties. Increasing your contributions at a younger age would however have a greater impact on the end result than if you were older.
Increasing regular contributions is more common than paying in a lump sum. Your employer may also match your contributions if you increased them via your workplace pension – but do check with them as most employers have limits.
The other thing to check is that you don’t over contribute as there are annual limits to how much you may contribute to a pension in a tax year. This is known as the pension annual allowance.
Paying a lump sum into your pension
Investing a lump sum into your pension would potentially have the greater impact. This is because the entire sum invested would be set to work immediately. Conversely, a regular contribution would have to be fed into the market over a much longer period.
Investing at regular intervals as opposed to all at once would however reduce the impact if the market fell. Whilst investing at regular intervals may be the lower risk option, markets tend to recover in the long term.
Either way, just make sure the amount you’re paying in doesn’t take you over your annual allowance, which is currently set at £40,000 per year, but might be less if you’re a higher earner or have already started taking money out of pensions savings.
Which is best?
This all depends on your personal circumstances. If you found yourself with a sudden windfall such as an inheritance, a work bonus or tax refund, paying it into your pension plan would help you get closer to achieving your retirement savings goals.
Putting a work bonus into your pension could also mean that you saved on tax and national insurance deductions, meaning you’d get to keep more of it in the long run. This boost together with the lump sum invested would be set to work immediately. Find out how this works in the Standard Life article on bonus sacrifice.
Ultimately, the best option would be the one you could stick with. Both options would allow you to grow your pension pot in a tax efficient manner. A canny combination of both options could be the best way forward. If, however you’re paralysed with indecision, or need help determining how much you’d need to contribute, speak to an independent financial adviser.
Thank you to Standard Life for providing links to: article on bonus sacrifice and the pension annual allowance.