How much should you put into your pension?

babyb06

Hi all

I started a pension a couple of years ago, but am only putting a small amount away and know I should up my contribution.

I have been reading the pension guide and sticky and the comment that you should put away half your age as a percentage of your salary

So, I am 27 (lets round it up for calucation to 28 as I am almost there!) and I should be putting away 14% of my salary -

QUESTION 1 - is this 14% of my gross or net income?
QUESTION 2 - can I count the tax relief towards my 14%? (put away 11.2% rather than 14% of my salary because the tax relief will add the extra 2.8% (i.e. 20% tax relief))

Thanks!!

Lokolo

1) 14% of gross.

2) If you use gross then theres no need to calculate your net and add tax relief as it will be the same as your gross.

sandsy

I've always understood it to be gross.

I did a quick check on a pension calculator. A 28yo who saved towards retirement for 40 years paying in 14% of salary every year would be able to purchase a pension of around 2/3rd of their salary (in real terms) at age 68 (no allowance for tax free cash or spouse's pension).

JoeCrystal

The other thing to keep in mind is what kind of income you want from the pension fund as well.

babyb06

Lokolo wrote: »

1) 14% of gross.

2) If you use gross then theres no need to calculate your net and add tax relief as it will be the same as your gross.

Not sure if it is me being really thick (and maths is not my storng point), but, if i put 14% of gross away, won't I get tax relief on top at 20%........

E.G. if my gross salary is £1142 a month - 14% is £160, but then tax rebate will add 20% to this and so £200 a month will go into my pension pot which is about 17.5% of my gross salary....

JoeCrystal

babyb06 wrote: »

Not sure if it is me being really thick (and maths is not my storng point), but, if i put 14% of gross away, won't I get tax relief on top at 20%........

E.G. if my gross salary is £1142 a month - 14% is £160, but then tax rebate will add 20% to this and so £200 a month will go into my pension pot which is about 17.5% of my gross salary....

No... that £160 also include tax relief within it. (Gross is before tax is taken away while Net is after tax is taken away)

If you was paying net, then it would be £128 which get increased to £160 due to tax relief.

hugheskevi

I started a pension a couple of years ago, but am only putting a small amount away and know I should up my contribution.

Something to bear in mind is that at different points in your life the incentive to contribute to a pension can change quite significantly.

The key things that will make pension contributions attractive are:

1. Any pension contribution required to get an employer contribution, including any matching the employer offers
2. Paying higher or additional rate tax
3. Receipt of a means-tested benefit such as Tax Credits or (in the future) Universal Credit
4. An employer offering salary sacrifice, especially if they put the employer National Insurance contributions into your pension

The less of the things in the list above which apply, the less advantage there is in contributing to pension.

Saving the same amount instead into an S+S ISA, where you can invest in the same things that you would invest in within the pension, means you can time when you move it into a pension to maximise the reward.

If none of the things above apply, I would argue it is much better to instead invest the money in an S+S ISA, and at a time in the future when one or more of the above applies, increase pension contributions (drawing down on the S+S ISA to replace the income going into the pension, so effectively moving the ISA into the pension).

Following rules of thumb about contributions won't see you far wrong and will be best if you aren't disciplined, but by optimising when you contribute to a pension you could increase the pot significantly compared to blindly following rules of thumb regardless of incentives.

Optimising compared to constant contributions would lead to increases of 20% or more in the final pot if you had a varied career (say 3 or more employers or different type of pension options) each with some of the above applying at different times.

The main problem with this is discipline about saving, as ISAs are more easily accessed than pensions so many would be unable to resist raiding it at some point. ISAs would also affect benefits if out of work or on a low income whereas a pension pot wouldn't - but that will often be small beer compared to the rewards.

babyb06

Thank you all for your help!

Joe Crystal - it is the actual figures that make sense for me, so thanks for that - I thought I would actually have to pay 14% of my gross earnings and then have the tax relief added. So now I can work out how much I need to pay each month.

Sandsy - what calculator did you use? I like playing around with spreadsheets/calculaltors to see how little changes will affect me.

Hugheskevi - I am self employed and a high rate taxpayer. I currently put around 7% of my net income into a pension (then it gets tax relief on top). I did have an ISA, but removed the money to put against my mortgage which made sense at the time, but I am conscious I need to start building up my ISA again - hadn't really considered an S+S one as I am a little risk averse and wouldn't know where to start. Maybe something to look into for me......

Lokolo

So you put 7% of your net income in, as a 40% tax payer you will then have 11.7% of your gross income going into your pension. Personally I would be putting enough of your salary in to take you to the lower band (but obviously it depends how high you are in the band).

Loughton_Monkey

At age 27, you don't need to overcomplicate it. Yes, half your age as a percentage of gross salary going in is a good rule of thumb in the absence of anything better.

Remember that a working life is rarely 'smooth'. There are times when mortgage repayments might need to take preference over pension, good promotions, or redundancy, children to pay for....... and amongst all that, you have to provide enough resources to keep you going into retirement. Sadly, this tends to work out at something above 20% on average over your whole working life. Maybe 25%. That's a very tall order.

Try to think of it, though, less in terms of how much (or what percentage) you should save, but more in terms of how much you spend. Ultimately, you can spend 100% of your net salary for life - in which case you will retire on your state pension only. Or you can be more sensible and budget to spend X% on your 'lifestyle', where X is calculated as the amount that will make (100-X)% equal to a sufficient retirement fund to continue that lifestyle.

You can only do this, I feel, by taking control of your finances by making assumptions between now and retirement. Map out what you think could happen - income, expenditure, housing cost/mortgage, cost of children.... Assume inflation, investments rates... At age 27, this will be quite 'loose' and a bit unrealistic, but it will give you a rough idea of the scale of the task. But this should inform you about optimum spending budgets. By definition, earnings less spending = 'savings'. [Which in turn mainly means 'investment']. It is through this process that you will prove to yourself that you really cannot afford to spend much more than 75% of income.

All a bit simplistic but the real benefit is that you can update this every year, and decide whether things are getting better or worse. It gives you time to 'change course' - just like a large ship that takes a long time to turn. Far better to do this than wait until 45 before you learn that to achieve a good retirement income, you can only afford to spend 60% of your income!

I say this from personal experience. You will find this process extremely valuable, and it is more important, really, than the other key point which is where to put your retirement investments [pension, S&S ISA, which funds.... etc.]. Treat this as an important, but secondary task compared to your retirement planning and budgetting (as outlined above).

Otherwise, as Lewis Carroll might suggest, you will not know where you are going and hence any road will take you there.