Why should you pay into your pension when you’re young?

Half of all UK adults reported an increase in their cost of living last year. Worse still, the Office for Budget Responsibility (OBR) projects the disposable income of the average Briton will drop a further 1.5% per head throughout 2024. While covering your outgoings is essential, Mark Norman explains why ignoring your pension contributions at a young age is an especially high-risk decision.

With energy costs having gone up a further 5% in January and inflation holding steady at 5.25%, many UK taxpayers are understandably worried about their increasing outgoings. For young working people, this is especially true.

While navigating your current circumstances is crucial, you can’t overlook planning for your future financial security, and one of the most effective ways to achieve this is by contributing to your pension from a young age. Of course, it may be tempting to prioritise short-term disposable income, but the long-term benefits of early pension contributions cannot be overstated. 

Read on to explore five key reasons why paying into your pension while you're young is a smart financial move that will pay dividends in later life.

Harness the power of compound interest

One of the most compelling reasons to start contributing to your pension early is the magic of compound interest. By investing your money at a young age, you give it more time to grow exponentially. 

Compound interest allows your money to generate additional earnings, creating a snowball effect that significantly boosts your pension fund over time. The earlier you start, the more your money works for you. 

In fact, compounding returns are further increased by the tax reliefs available. For every £100 an individual pays into their pension, they receive a £25 top up from the tax man - and then, at retirement, they are only taxed on 75% of the total fund (below lifetime allowance level).

What’s more, if your employer pays directly (via salary sacrifice), then you save on National insurance contributions as well.

Take advantage of automatic enrolment 

Automatic enrolment has been in place since October 2012. This means that young people now become eligible to pay into a workplace pension scheme from the age of 18. This process happens (as the name suggests) automatically - meaning that you have to make a conscious effort to opt-out.

I would strongly advise against doing so, as automatic enrolment presents a golden opportunity to kickstart your pension savings effortlessly. By staying in the programme, you lay the foundation for a secure financial future without the need for complex processes or significant effort on your part. Your employer also pays in a proportionate amount based on your contributions - so, if anything, I would advise paying the higher 10% salary sacrifice now to more than double your earnings down the line.

Build a solid financial foundation

Starting your pension contributions early gives you a keen advantage against your peers who don’t, as you’ll be regularly adding to your future financial safety net. Inevitably, as you progress in your career, life's unavoidable twists and turns will rear their head. 

There will be times when your expenses are higher and income perhaps lower, but the journey to financial wellbeing becomes more manageable when you have a well-funded pension. This financial security not only provides peace of mind but also gives you the freedom to pursue opportunities without the constant worry about your long-term financial well-being.

Mitigate the impact of inflation

Inflation erodes the purchasing power of your money over time. We’ve all been reminded lately of just how powerful the effects of inflation are - so why not use it to your advantage?

By contributing to your pension early and consistently, you can help to drastically minimise the impact of inflation on your retirement savings. The growth potential of your investments, combined with regular contributions, ensures that your pension fund keeps pace with or even outpaces inflation, maintaining its real value.

By starting early and staying committed, you are not only securing your future but also setting yourself up for a more financially stable and fulfilling retirement. 

For advice on how you can best grow your pension pot with specialist guidance and savvy investments, get in touch with our expert team of financial advisers today.


Money Vault

How to reduce tax by increasing pension contributions and retirement savings

Saving into your pension is not only important to secure a comfortable retirement lifestyle, but can also unlock tax relief that boosts your savings and benefits you in the here and now. Mark Norman explains more.

How to reduce tax by increasing pension contributions and retirement savings - Matthew Douglas

Whatever stage you’re at in your career, it’s never too early to start planning for your retirement. Of course, the main benefit of retirement saving is ensuring that you have a comfortable income to live off once you’ve stopped working.

However, by being savvy with your pension contributions, you can also reduce the amount of tax you pay. That’s because all the money you pay into a pension qualifies for tax relief. 

What is pension tax relief?

Pension tax relief is a government incentive to promote retirement savings by allowing your pension provider to reclaim tax from HMRC and add it to your contributions, effectively boosting your savings. 

The amount of tax relief you receive is based on your income tax rate, with basic rate taxpayers getting 20%, which means each pound contributed becomes £1.25. Higher-rate taxpayers receive 40% (turning every pound into around £1.66), and additional rate taxpayers get 45% (effectively an 80% boost). However, higher and additional rate taxpayers must claim this additional relief through their tax return.

In essence, pension tax relief offers a substantial financial advantage, making pensions a compelling investment choice for long-term savings, especially for high earners. In some cases, higher-rate taxpayers can put money into their pensions via salary sacrifice and reduce their taxable income to below the higher-rate threshold, making them even more tax efficient. 

Things to consider

While maxing out your pension contributions is generally a good idea for a lot of people, it’s not necessarily always the best thing to do. It’s important to consider that your money will be locked away and, from 2028, you will need to be 57 to access a private pension. If you have high-interest debts like credit card debt, it's advisable to prioritise paying them off first before maxing out your pension contributions.

It is, however, important to start saving into your pension as early as you can, even if it’s just a little bit per month to start with, to avoid playing catch up later. Auto-enrolment schemes offered by employers are a convenient way to begin saving for retirement, but it's worth noting that they may not provide sufficient savings as the amount needed for a comfortable retirement can be surprisingly substantial.

Lifetime ISAs 

A Lifetime ISA (Individual Savings Account) is another option that offers tax savings for those looking to save towards their retirement. Just like other types of ISAs, Lifetime ISAs are tax free.

They can be opened by those aged 18 to 40 and you can contribute up to £4,000 annually until age 50, with the government providing a 25% bonus, capped at £1,000 per year. 

Once you reach 50, contributions and the 25% bonus cease, but your account remains open and continues to earn interest. You can then access your savings from your Lifetime ISA at age 60 without incurring penalties. Withdrawing funds or transferring the account to another ISA type before then will result in a 25% charge. 

Lifetime ISAs are cheap and simple investment solutions, and are very easy to set up, with many banks and providers allowing you to open them via an app. People tend to have a Lifetime ISA in conjunction with a pension so you can essentially max out your tax relief. 

At Matthew Douglas, our team of retirement planning experts are here to help you ensure your pension and savings are right for you. Get in touch with us to discuss your options.


Senior couple in sports car

Should I delay my retirement?

Delaying retirement could boost your chances of a secure financial future

With the persistently high inflation rate, it’s crucial for individuals nearing retirement to evaluate the impact of escalating living expenses. Adjusting or postponing retirement plans may provide enhanced financial stability in their golden years.

Delaying retirement has various benefits for your financial future. It can provide more time to build up pension contributions, which can lead to a more significant income in later life, access to additional support from the government, and more extended periods for employers to contribute to workplace pensions.

Consider your circumstances
On the other hand, there are some drawbacks of delaying retirement, including fewer years of employment for younger people entering the workforce, an additional taxation period; and potential inflationary pressures on wages if salaries remain static over an extended period. It is also essential to consider your circumstances before deciding whether to delay retirement.

Factors such as your current health, lifestyle, and financial situation should all be considered before deciding. Obtaining professional financial advice is essential to help you understand the implications of delaying retirement for your particular circumstances.

Here are some reasons why you might consider postponing your retirement
Increased State Pension: 
In the UK, you can defer your State Pension, resulting in a higher weekly payment when you later claim it. For every nine weeks you delay, your pension increases by 1%, which equates to just under 5.8% for each full year deferred[1].
Greater workplace pension: By working longer, you can continue contributing to your workplace pension, potentially resulting in a larger pension pot when you retire. Additionally, your employer’s contributions and potential tax relief will continue to boost your savings.
Maximise personal savings: Delaying retirement allows you to save more money, providing a more substantial financial cushion when you eventually stop working. This extra time also gives your investments more opportunity to grow.
Pay off debts: If you have outstanding debts, continuing to work can help you pay them off faster, reducing the financial burden during your retirement.
Improved health and wellbeing: Studies have shown that staying in the workforce can positively impact your mental and physical health, contributing to a higher quality of life during retirement.
Social Security Benefits: If you’re eligible for social security benefits from another country, delaying retirement might enable you to receive higher benefits based on your age and work history.

More time to save and invest for later life
Delaying retirement can give you more time to save and invest for later life. However, it is essential to weigh up the advantages and disadvantages carefully before deciding if this option is right for you. If you are considering delaying retirement, speak with us so that you can make an informed decision that aligns with your individual needs and goals.

Source data:
[1] https://www.gov.uk/state-pension

A PENSION IS A LONG-TERM INVESTMENT NOT NORMALLY ACCESSIBLE UNTIL AGE 55 (57 FROM APRIL 2028 UNLESS THE PLAN HAS A PROTECTED PENSION AGE).

THE VALUE OF YOUR INVESTMENTS (AND ANY INCOME FROM THEM) CAN GO DOWN AS WELL AS UP, WHICH WOULD HAVE AN IMPACT ON THE LEVEL OF PENSION BENEFITS AVAILABLE.

YOUR PENSION INCOME COULD ALSO BE AFFECTED BY THE INTEREST RATES AT THE TIME YOU TAKE YOUR BENEFITS.


Man calculating a sum

The importance of understanding tax free pension withdrawals

Many over 55s are unaware that they can access 25% of their pension pot tax-free

A surprising 43% of individuals over 55 need to be made aware that they can withdraw 25% of their pension pot tax-free, according to recent research[1]. Knowledge could lead to better decision-making when it comes to accessing pension savings.

Similarly, 52% of those surveyed between the ages of 50 and 54 were also unaware of this rule, indicating a widespread lack of understanding about pension withdrawal options.

Maximising your tax-free pension withdrawal
The study found that among the 57% of over-55s who know about the tax-free pension withdrawal option, 21% have already taken advantage of this benefit, while 9% plan to do so in the future.

Most individuals who plan to take their tax-free lump sum did or will do so at retirement (69%). However, 16% have made or intend to withdraw at different points during retirement.

Understanding the various options available
The study emphasises the importance of understanding the various options available when withdrawing from your pension pot, including the 25% tax-free cash entitlement.

Considering factors such as whether to take the lump sum all at once or split withdrawals into smaller chunks over time and the potential implications and benefits of each approach are essential.

Important questions regarding tax-free pension withdrawals

How much can you withdraw tax-free?
Typically, most people can withdraw 25% of their total pension pot tax-free, although this may vary depending on the type of pension plan and if you’ve exceeded your lifetime allowance. The remaining 75% is subject to Income Tax.

When can you access your tax-free lump sum?
Generally, you can access your pension savings, including the tax-free lump sum, at age 55 (rising to 57 in 2028). In rare cases, you may be able to access your pension earlier due to ill health or a protected scheme.

Can you take the lump sum in smaller amounts?
This depends on your pension product and its terms. Taking smaller withdrawals over time can be beneficial in most cases, as it allows for potential growth and tax-efficiency.

Should you take the lump sum immediately?
It’s essential to consider the longevity of your pension savings throughout retirement. Taking too much too soon could result in running out of funds later in life. Delaying access to your savings may allow for additional growth.

Are there any implications to be aware of?
Accessing your pension savings can impact state benefits, such as Universal Credit or Pension Credit. Additionally, taking a tax-free lump sum won’t affect the amount you can contribute to your pension plan, but accessing taxable income may reduce your annual allowance.

Source data:
[1] Opinium conducted research among 2000 UK adults aged 18+ between 12th and 16th May 2023 for Standard Life, part of Phoenix Group. Results have been weighted to be nationally representative.

A PENSION IS A LONG-TERM INVESTMENT NOT NORMALLY ACCESSIBLE UNTIL AGE 55 (57 FROM APRIL 2028 UNLESS THE PLAN HAS A PROTECTED PENSION AGE).

THE VALUE OF YOUR INVESTMENTS (AND ANY INCOME FROM THEM) CAN GO DOWN AS WELL AS UP, WHICH WOULD HAVE AN IMPACT ON THE LEVEL OF PENSION BENEFITS AVAILABLE.

YOUR PENSION INCOME COULD ALSO BE AFFECTED BY THE INTEREST RATES AT THE TIME YOU TAKE YOUR BENEFITS.


Serious confident middle aged female journalist with cup of coffee sitting at desk with books and laptop

Should I invest as early as I can?

Does the early bird get the ISA worm?

If you’re an investor looking to maximise your Individual Savings Accounts (ISA) returns, it’s worth considering investing your ISA allowance as soon as possible each year, as soon as it becomes available on 6 April. Not only will this help ensure that your money is protected from taxes right off the bat, but it also means that your investment has more time to grow in the market. This can result in a bigger ISA pot in the long run.

Of course, this strategy may not be right for everyone, and there are risks to investing in the market. It’s important to carefully consider your investment goals, risk tolerance and overall financial situation before making any investment decisions. However, for many investors, investing their ISA allowance early on can be a smart move that pays off over time.

Highly efficient way to protect investments from tax
An Individual Savings Account (ISA) is a highly tax-efficient way for people to protect their investments from tax. In the 2022/23 tax year, everyone in the UK had an annual Capital Gains allowance of £12,300, which was reduced to £6,000 in the Autumn Statement on
17 November 2022. This will reduce further to £3,000 from April 2024.

However, when you invest into an ISA, you can enjoy tax-efficient returns and don’t need to declare any interest from an ISA or any income or capital gains made from it when completing your annual tax return.

Make sure you use your full ISA allowance
The maximum amount that can be invested into an ISA in the 2023/24 tax year is £20,000. This allowance hasn’t changed since April 2017 when it was increased from £15,240 and is higher than the £7,000 maximum allowance offered in 2008. However, any unused allowance will not carry over to the next tax year, meaning that it’s essential to make sure you use your full ISA allowance during the current tax year if possible.

Investing early can certainly offer many benefits, including an extra year of tax-sheltered growth. However, it’s important to be aware that investing outside of an ISA can come with tax risks. The halving of the dividend tax allowance this tax year means that you may end up paying tax on dividends earlier in the year if you hold investments outside of an ISA.

Take advantage of pound cost averaging
Starting an ISA early in the tax year provides many benefits when investing, particularly when it comes to setting up regular monthly payments into a Stocks & Shares ISA. By doing so, you can take advantage of pound cost averaging, which is a process of drip-feeding money into an investment over time in order to reduce the impact of market ups and downs.

The idea behind pound cost averaging is that when you invest a fixed sum every month, you’ll buy more units when an investment’s price falls, which can provide the potential for greater profits if they then rise.

Establishing a regular investment plan early on
Of course, the opposite can also be true – if prices rise, you’ll buy less. However, over time, pound cost averaging can help to smooth out the ups and downs in an investment’s value, reducing the risk of dramatic swings in your portfolio.

By establishing a regular investment plan early on, you’ll also be able to take advantage of the full tax year for your investments, allowing you to spread your investments across the entire year. This can help to reduce the risk of investing all of your money at a time when the market may be overvalued.

Good news is that you can transfer your ISA
Transferring an existing ISA could also be a practical option if you’re looking for a more competitive deal or want to consolidate your investments. The good news is that you can transfer your ISA at any point during the tax year, but it’s essential to take note of some things before you do.

For instance, you need to transfer the whole ISA, so you cannot partially transfer your existing Stocks & Shares ISA for the current tax year. It’s wise to check with your current provider if they impose fees for transferring out. Taking this step can help you avoid unnecessary costs and ensure that you get the most out of your investment.

Consistently max out your ISA allowance each year
The old adage holds true when it comes to investing: time in the market is more important than timing the market. This means that the longer your money is invested, the more time it has to grow and potentially compound over time.

Investing in an ISA can be a great way to grow your savings pot beyond the limits of a tax-efficient allowance. It’s important to consistently max out your ISA allowance each year, if affordable, and enjoy generous investment returns. Even if you don’t have a large lump sum to invest, you can still benefit from regular, small contributions from the beginning of the new tax year. So start saving and investing today and see how far you can go!

THIS ARTICLE DOES NOT CONSTITUTE TAX OR LEGAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. TAX TREATMENT DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF EACH CLIENT AND MAY BE SUBJECT TO CHANGE IN THE FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE.

THE VALUE OF YOUR INVESTMENTS (AND ANY INCOME FROM THEM) CAN GO DOWN AS WELL AS UP, SO YOU COULD GET BACK LESS THAN YOU INVESTED. PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.