We are continually being told that planning for our retirement is essential. However, only by deciding yourself that a particular pension is worthwhile will you wholly commit to pension planning. To help you make the right decision, here are some advantages and disadvantages of a standard pension.
1. Compound Interest
One of the main advantages of putting money into a pension is that it benefits from compound interest growth. You will accrue interest on the savings you make, and over time this interest will itself accrue compound interest.
So, the sooner you get started saving for your pension, the more chance your pension has for compound growth. For example, during the second year of your investment, you’ll receive interest on the initial sum invested. You’ll receive interest on the initial sum plus the interest from the first year in year two, and so on. This compound growth continues for the life of your investment.
1. Tax Relief
Perhaps the most significant advantage of a pension is that your contributions receive tax relief. For workplace pensions, your contributions are taken from your salary before tax is deducted. So, you only pay tax on the amount of salary remaining after you’ve paid your pension contributions.
If you are paying into a private pension, you’ll have already paid Income Tax on your earnings before making pension contributions. However, you can claim the tax you paid on these contributions from the government. If you pay tax at the basic rate, you can claim 20%. So for every £80 you pay, £100 will go into your pension. For higher rate taxpayers, you will need to claim the tax through an annual tax return to HMRC.
Savings from pension investments tend to be higher than from other investments such as ISAs. For instance, despite the interest you get from an ISA being tax-exempt, the money you put into it has already been taxed. So, pensions are an incredibly tax-efficient means of investing for your retirement.
3. Employer Contributions
Being enrolled in a workplace pension means that you will receive contributions from your employer. Typically, your employer will contribute 3% of your gross income to your pension pot. This amount is on top of the 5% that is automatically taken in from your gross salary.
4. Provides a Guaranteed Income
When you retire, you can purchase an annuity, which will provide you with a guaranteed income. Annuities can be tailored to provide a fixed income, one that increases at a set percentage rate each year, or one that rises in line with inflation.
Other than purchasing an annuity, another option is to draw income from your pension while it remains invested. Choosing this option means that your pension still has the potential to grow and provide you with an income.
1. Challenging to Understand
Pensions are such a critical aspect of our financial lives, but many people put off planning them, and one of the reasons for this is that they can be quite challenging to understand. Even if you’ve prepared early for your retirement, as you approach your retirement age, you have to make decisions about your pension options.
Will you take a 25% tax-free lump sum? Taking this option will reduce the amount that you have in your pot to provide a regular income. How about buying an annuity? Buying one, you will need to decide whether you want a fixed income or one that rises annually.
Ultimately, the option you choose for accessing your pension will depend on your circumstances. It is certainly worth putting some thought into what you will do, and you may want to consult with a regulated financial advisor to help with this decision.
2. Restricted Access
One of the significant disadvantages of a pension is that access to your funds is restricted. Since 2015, access to pensions has been relaxed, and you can now access your funds from the age of fifty-five. However, this is still a long time to go without having access to your money. For this reason, many people prefer to invest in ISAs for their retirement, as they have much easier access to their money.
3. Potentially Poor Returns
Your pension fund gains its growth by being invested in the stock market. As it is invested for such a long time, there is a high probability that there will be several shifts in the economy during its investment lifetime. So there is an element of risk with pensions, as there is with all investments.
However, pension investments’ longevity does mean that there is plenty of time for your pension fund to recover if it does suffer some setbacks. Moreover, if the stock market does fall, you will be able to buy more shares with the money going into your pension pot.
The risk of your pension underperforming is mitigated by the time you have your money invested. However, as you approach retirement age, the risk increases, so you may want to consider moving your money into lower-risk investments.
There are many things to consider regarding your pension, which can make them challenging to understand and make decisions about them. Hopefully, this brief article outlining a pension’s pros and cons will help you decide what’s best for you. Before looking at options for your pension, consider using a regulated adviser like Portafina or, have a read of the information over at The Money Advice Service.