How to sort your pension so you can retire well
Making good pension choices is normally worth hundreds of thousands of pounds over a lifetime
Pensions are essential because they will be the most valuable thing that most people will own (more than their home).
Despite their importance, we have a massive problem with pensions in the UK - we generally have no idea what's going on with them.
Do you know what your pension is invested in?
Do you know where all your pensions are (from previous employers)?
Do you know what fees you’re paying?
Do you know if you’re one of the millions of people in the UK who don't claim back the thousands of pounds in tax relief they're owed by HMRC every year?
Most people don't know the answers to these questions because we're not taught this stuff.
This means we're faced with a situation where everyone wants to be able to retire one day - to not have to work.
And yet, despite this being the most common financial goal people have, very few people are engaged with their pension which is the key tool that makes a good retirement possible.
Very few people realise how much money they'll need to retire - or the small changes they can make to their pension today so they can make that a reality.
Now this is quite a hefty read - about 15 minutes - but it can change your life (promise) so only keep going if you’ve got the energy.
How much do you need to retire?
This is tricky to answer so we’ll give you a crude guideline.
It’s based on the 4% rule, which says that you can safely withdraw 4% a year from your investable assets without reducing your pot too much (so you don’t run out of money) .
Let’s imagine you have £1 million. The 4% rule says you can take out £40k/year (4%) without eroding the £1m too quickly.
To figure out how much you’ll need to retire using the 4% rule, you simply multiply the annual income you think you’d need today by 25.
So if you think you’d need £40k/year to retire the way you want, then you’d multiply £40k x 25 = £1 million.
That’s a big, scary number and we’ll come to how you can get there in a bit. But you also need to remember that number doesn’t take into account tax or inflation.
You might need £40k/year today, but what if you’re not planning to retire for 30 years?
The purchasing power of money has roughly halved in 30 years (source), so if that trend continues, you’d need £80k/year in 30 years to live like you are today on £40k/year.
This also means you wouldn’t need £1 million in 30 years, you’d need £2 million (because £80k X 25 = £2 million).
This seems like a massive amount, because it is - but you can get a lot of help in a few different ways.
Two key levers to build your pension pot
It’s amazing how small changes can add up to a lot - and there are two key levers you can pull with your pension:
Increase your pension contributions
Make good pension fund choices so you get better investment returns
Let’s look at increasing your pension contributions first. Have a play with this small changes calculator to see how small changes (even 1%) can add up to a lot).
For example, if you’re 30 years old and earning the average salary (which is £36,000 at the time of writing) and you’re planning to retire at 68 - paying just 1% extra into your pension, which is £30 a month, would get you an extra £66,200 in retirement.
This is the power of contributing more to your pension - the first lever.
Can you increase your pension contributions by 1% this year? Would you really miss it?
And then maybe you can try 1% the next year?
And then maybe 1% a few years after that?
We’ll talk about how to increase your contributions practically later, but for now, let’s look at the second key lever with your pension - improving your investment returns.
A lot of people don’t know this but if they have a pension, their money is already being invested.
We think this is probably the biggest untapped source of wealth for people in the UK.
The difference between the average UK worker making good pension fund choices and not over a career is potentially worth hundreds of thousands of pounds.
Let’s look again at the average UK earner, making £36k/year today.
Unless they opt out, employees in the UK are legally obliged to have at least 8% of their salary contributed to their pension - normally 4% from themselves, 3% from their employer and 1% from tax relief. It’s a bit more complicated than that because the 8% only needs to be paid on qualifying earnings but let’s leave it there for now for simplicity.
This is already happening all over the country. People are paying 8% or more into their pension and then don’t have a clue what sort of returns they’re getting - and the return is critical.
Let’s imagine that average UK employee…
Puts 8% a year of their qualifying earnings into their pension (the legal minimum contribution), and
They get a 3.5% increase in salary per year to adjust for inflation, and
They get an investment return of 4% a year, then…
Over a 40-year career, their pension will be worth £412k (source).
Not bad.
But what if instead of getting a 4% a year return, they get 8.5%, which is what the global stock market has historically delivered. How much would they have?
£1.18 million. Nearly triple the money. Check it out here.
This is why making good pension fund choices is so critical.
So you have your two key levers with your pension - i) the amount you contribute and ii) the investment return you get on the money you contribute.
If you can increase them each by a few percentage points, it can deliver wildly different outcomes for you - and a much better retirement.
But the way you do these things depends on whether you’re employed or not (including self-employed, a company Director etc.)
What employees should consider
Employees have it easier in the UK because they are put into auto-enrollment workplace pension schemes, as explained above (at least 8% of their qualifying earnings are put into their pension).
You can opt out from auto-enrollment, but fortunately only 10% of people do. Still, most of the 90% don’t even log into their pension. Now’s the time for you to take charge of it - it’s your money and what you do with it is critical to how wealthy you become.
How to contribute more as an employee
Speak to your HR team to see what contributions they’ll match because a lot of employers will contribute more than the minimum of 8% overall. Maybe you can contribute another 2% and they can do 2% - so you can get 4% more.
Some employers also allow salary sacrifice which is where you can reduce your earnings and put the difference into your pension - over and above the auto-enrollment amounts. This means neither you nor your employer has to pay national insurance on that amount.
This can be particularly attractive for older workers, approaching retirement, keen to build their pot whilst they’re still earning.
Consider getting out of the default fund
So that’s the first lever, increasing contributions - now you need to look at your pension fund choices.
If you haven’t made a specific fund choice, which about 90% of people don’t, then you’ll be in the default fund.
The default fund is a one-size-fit-all approach that’s supposed to work for as many people as possible - but ends up not being suitable for a lot of people, particularly younger people, let’s say under the age of 45.
The key thing to remember is that most default pension funds will dilute down the exposure to stocks, using assets like bonds.
The problem with this approach (for a lot of people) is that default funds tend to be pretty cautious and that ultimately leads to lower expected long term returns, but with lower volatility (ups and downs) along the way.
Remember in the last email on investing, we said the stock market can be up 23% one year and down 19% the next, but long term has always grown?
The short-term volatility is generally larger for stocks than other asset classes, but global equities are the asset class that has delivered an 8.5% compound annual growth rate over the long-term (pre-inflation).
You’ll often hear the saying ‘past performance is no guarantee of future results’ and it’s absolutely right because nobody knows what will happen, so please always bear that in mind.
But even so, stocks have always out-performed other asset classes over the long term, so if you’re not invested in 100% equities, you won’t be benefiting from that trend.
The question is…
If you are younger than, say, 45 years old, and
If you legally cannot touch your pension until you’re 55 (at the time of writing, going up to 57 soon) so you are forced to be invested for the long term, and
If stocks have always been the best performing asset class over the long term, then…
Why are you in a default fund which isn’t 100% stocks (also known as equities)? You saw the difference between getting 8.5% a year and 4%...
Of course we’re not saying that default funds are bad or that you should get out of them. They work for a great number of people. We’re asking if you’ve ever considered if there might be something better for you. So please have a look at what you’re invested in, engage with it and make a decision because it has a huge say in your financial future.
By the way, re: the stage of life point, historically the general guidance was that as you approach retirement you should de-risk by reducing your holding in stocks for bonds. The thinking is you don’t want your pension pot to drop by 30% in a year just before retirement because that can be devastating for your retirement, known as sequencing risk.
But even then, there are growing arguments to stay 100% invested in stocks because we are living longer (what if you live until 80? 90? 100?) so your investing horizon can still last decades after retiring.
For people who favour this approach - wanting to keep their investments in equities in retirement - they can take a few years worth of cash to live off in retirement, so that they can withstand a downturn in the stock market for a few years, reducing that sequencing risk.
By the way, whilst you're looking at your fund choices, it's worth checking if you've got a "With Profits" fund. These funds often include a maturity bonus that can become quite large if they're held until retirement - sometimes five or even six figures.
However, the annual growth rates of "With Profits" funds are typically underwhelming. This means, for younger people with longer time horizons, it can be worth switching to a fund with higher growth potential because this can outweigh the eventual bonus.
It's really important to consider this carefully, based on your circumstances. And please check what you'd actually get if you transfer out this kind of pension because they can come with Market Value Reductions, which might reduce the value if you move the pension.
This is all seriously worth considering, and retirement planning is an area where getting financial advice can be valuable because it’s complicated. If you’d like help planning your retirement from an advisor then please check out how our network can help.
Anyway, we digress. For now, the key thing is to find out where your pension is invested, and ask yourself, are you happy with it?
It’s worth doing this with your pensions from previous employers too. Reach out to their HR teams if you don’t have a log in. How much do you have and what are you invested in?
You might consider consolidating your money from previous employers into a SIPP, a self invested personal pension. From here you can manage your pensions in one place. Generally SIPPs are cheaper and offer more choice than workplace pension schemes.
But before you move a pension, please make sure you understand any costs or loss of benefits from moving it. This is absolutely key because sometimes you can be giving up something that’s not in the headline amount of money you have in a pension. Check this out carefully because it can be really costly.
If you want to open a SIPP, below are some of our favourite platforms that we use - but InvestEngine is an affiliate link:
InvestEngine
Get an up to £50 bonus when you invest at least £100.
Minimum contribution £500 or £100/month.
We are generally fans of investing in global index funds which we explain more about in our email on investing.
See if you’re owed money from extra tax you’ve paid
The other major thing to look at as an employee (if you’ve been employed in the last 4 years) is if your workplace pension schemes have automatically given you tax relief on your pension contributions.
The wonderful thing about pensions is they are tax free to put money in. You can add money to your pension from your gross, untaxed income. This means if you’re a higher rate tax payer, for example, you can contribute whole £1s rather than the 58p you earn after tax on every £1.
This makes a huge difference to the pension pot you end up with - remember the difference a few percent can make?
The problem is that some employers and pension schemes handle the tax relief automatically for you so you don’t need to think about it - but others don’t.
This means there are millions of people in the UK who need to claim back the tax relief they should’ve got - and it can be a massive amount.
To do this, first ask your employer if they or their pension scheme handle the tax relief on your pension automatically. If they do then it means you don’t need to worry about it (for your current employer).
But if they don’t, then you need to claim back the money from HMRC. You can learn more on their website here.
You can call up HRMC to get the relief paid back (or you can do it via a self-assessment if you’re doing one anyway) - and it gets paid directly into your bank account. Of course the guidance is to put it straight into your pension because that’s the point of the relief and is how you see the benefit long term, in the retirement you can have.
Brits leave billions of pounds on the table like this because HMRC obvi don’t tell you about it. And one of the great things is you can claim back for up to four years.
This is why it’s worth checking previous employers you’ve had in the last 4 years too.
It’s an amazing unlock. Please let us know if you do this because we want to celebrate with you.
What if you’re self-employed or a company Director?
The tough part of being self-employed or a company Director when it comes to pensions is that you have to make conscious decisions to contribute to them because you’re not in auto-enrollment.
80% of self-employed people in the UK don’t bother because the temptation is to use the money for other things rather than their pension, which we understand.
This is a big missed opportunity though. A pension is a great tool to secure a good financial future because it’s tax free to contribute.
And it’s even more attractive from a tax perspective if you’re a Director of a Limited Company. You can contribute from your company’s untaxed earnings, so it’s a way to ‘get money out of the business’, to you, without paying corporation or income tax.
Sure, you can’t touch the money in your pension until you’re 55 - but then you are forced to benefit from compounding.
Paying yourself as a Director can be complicated, not least from a tax perspective. If you’d like to speak to a financial advisor 1:1 about the best way to do this then here’s more info about the advisors we work with.
If you’re self-employed or a Director, the most popular way to contribute to your pension is through a SIPP.
There are lots of platforms you can use but we like Invest Engine for company Directors in particular because they make it easy to invest company money in stuff like index funds, which can be a way to grow the excess capital in a business.
We use both of these platforms but the InvestEngine one is an affiliate link:
InvestEngine
Get an up to £50 bonus when you invest at least £100.
Minimum contribution £500 or £100/month.
Because the temptation is to spend the money rather than put it towards your pension, consider how much you can safely contribute every month so you don’t have to think about it - a bit like why auto-enrollment works for 90% of UK people. Automation is key.
On top of that, at least once a year, consider how much more you can top up your pension (which you can discuss with your accountant). The earlier you contribute to your pension in your career, the less you have to contribute overall because you can benefit from compounding over time.
As it’s a SIPP (self-invested) you’ll need to choose which fund(s) to invest in. For more information on that, please check our previous email on investing.
At the time of writing, you can pay up to £60k into your pension every year, tax free. You can do this straight from your company, or personally and then you can claim back tax relief.
And one of the great things is you can use up any allowances that you haven’t used for the previous three years, as long as you've been a part of a registered pension scheme.
A word on the state pension
If you qualify for the full state pension, which you get if you’ve paid National Insurance for 35 years, then you’ll get an income of £12k/year from April 2025. And of course it’s double that amount for a couple who qualify.
This is important because if you were planning on an income of £40k/year in retirement, and you qualify for the state pension of £12k/year, suddenly you only need £28k/year.
If you’re short of the 35 years of National Insurance then it can be worth buying them because each year costs about £900, and each year pays out an extra £300/year roughly - so if you get paid the state pension for more than three years then it starts to pay off.
But, there are a lot of concerns that the state pension won’t be around forever (or will be vastly different) so a lot of financial planners don’t take it into account for clients unless they are close to retiring.
Key steps
Figure out how much you might need to retire. A crude rule of thumb is to take the annual income you think you’d need today and multiply it by 25. But remember this doesn’t take into account tax or inflation (use this inflation calculator).
Find all your pensions, from all the jobs you’ve ever done. How much do you have? What are you invested in?
If you’re an employee (or have been in the last 4 years):
See if you can reclaim tax relief from your pension contributions from the last four years of employment (if your employer/pension scheme didn't handle this automatically).
Find out how much extra you and your employer could contribute through auto-enrollment and maybe salary sacrifice on top.
Consider getting out of the default fund(s) if they don't suit you.
Consider consolidating your pensions from previous employers in one place, like a SIPP. And then managing your SIPP yourself by picking your own fund(s). But make sure you understand any costs or loss of benefits from moving any pensions first. Be careful about this because it can be costly.
If you’re self-employed or a company Director:
Consider opening a SIPP if you don’t have one.
Pick a fund or funds you like to invest in via your SIPP (see our previous email on investing).
Figure out how much you can contribute to your pension every month, and then potentially top up at least once a year.
Want to learn more about pensions?
Check out our first episode with Lisa Conway-Hughes.
This is not financial advice. The reason it’s not financial advice is because it’s not tailored to you. We are here to talk about the principles of building wealth but if you want personalised help, it’s worth speaking to a financial advisor - you can find more info here. As with everything financial, please do your own research. We really encourage that because no one cares more about your money than you and if you learn the basics then it’s life-changing.
If you purchase a product or service using one of the links above, including working with a financial advisor, we may receive a commission. There will be no additional charge for you. Remember investments can fall and rise - and past performance is no guarantee of future results. Other fees may apply. Your money is at risk.
