For those of us investing in our pension pots, at least one fear has disappeared after chancellor George Osborne revealed on Friday that he’s dropped plans to end or alter tax relief on pension contributions. The possible details were uncertain, but one thing is sure, he wouldn’t have been doing it for our benefit.
But don’t let that lull you into a false sense of security, and don’t just assume that any occupational pension scheme you have will necessarily be adequate for your retirement needs, because a new review conducted for the Labour Party has concluded that most workers are only stashing away around half the amount they’ll need to see them comfortable in their old age.
We need to save more
The Independent Review of Retirement Income (IRRI) has determined that workers should be aiming to put away around 15% of their salaries for their retirement, and a number of investment professionals agree that the figure is about right. And at the moment, typical contributions to workplace pensions amount to a mere 4.7%.
The government’s automatic enrolment scheme (which obliges all employers to provide pension schemes for eligible workers) is partly to blame. How so? In order to soften the impact, the early contribution requirements were deliberately set low. Minimum total contributions started out at 2% of earnings, though that should rise to 5% by 2018 and 8% a year later.
But even then, that would still leave members of such plans with contributions amounting to only a little over half the IRRI recommended rate — most of us, it seems, just aren’t saving enough. The big question is, what’s the best vehicle to use for those extra retirement savings?
Contributing more to your company pension scheme might be beneficial, but I think it depends on how much your employer is going to contribute too — so that needs to be decided on an individual basis. Other than that, there are two attractive options — a Self Invested Personal Pension (SIPP) or an Individual Savings Account (ISA), which have different tax advantages.
Which is better?
If you go for a SIPP, your contributions will be taken from your income before tax, but when you retire and draw down your pension, the money will then be taxed. No overall benefit then, you might think — but no. Firstly, in retirement you’ll still have an annual tax-free allowance. And secondly, if you’re a higher rate taxpayer when you’re paying-in, you’ll get better tax relief and you’ll benefit from your basic rate allowance in retirement.
With an ISA you can invest up to £15,240 in the current tax year — and the tax difference is that you don’t get any tax relief on contributions, but your gains within the ISA attract no capital gains tax and no higher-rate income tax on dividends.
Whichever way you go (and the best option might be a combination of SIPP and ISA depending on your circumstances), by far the best investment you can make is to put the money in shares. Investment charges are low these days, and the stock market has far outperformed cash savings for a century and more — and when you’re investing for a lifetime, short-term ups and downs get ironed out.