When it comes to pensions, there’s a lot of varying advice about how much you should be saving. In reality, this is because there is no right or wrong answer. Everyone’s situation is different, and there are a lot of things to take into account. We’re going to look into a couple of things you’ll need to consider, so you can work out how much you should pay into your pension.
1. How Much Money Will You Need?
The first thing you need to think about when deciding how much you should pay into your pension is how much money you think you’ll need when you retire.
The government has an interesting approach to pension savings that focuses on how much money you’ll need to live off each year. It looks at your current salary, and then estimates how much money you’ll need to have each year to maintain your current standard of living. Their advice is as follows:
If you currently earn between £12,200 and £22,400 a year, you’ll need 70% of this income when you retire to maintain your current standard of living.
If you earn between £22,400 and £32,000 you’ll need 67% of your income.
Earn between £32,000 and £51,300 you’ll need 60% of your income.
And if your current income is over £51,300 you’ll need 50% of your income.
The reason behind this method is that you generally spend less money as you get older. You won’t be commuting to work, you probably won’t be paying for any childcare costs, and you might have paid off your mortgage.
Use the guidelines above to work out how much money you’ll need to maintain your standard of living. Then, find out how much your current pension pot is and forecast how much you’ll have saved by the time you retire. If you’re short on cash, now is the time to think carefully about prioritising your pension savings.
2. How Long Do You Have To Save?
Another method that can help you decide how much you should pay into your pension is to think about how long you have to save the money.
There is a general rule that says you should take the age at which you first start paying into your pension and divide it by two.
If you’re 30 years old, you should therefore be paying 15% toward your pension every month. If you earn 32K that’s £4,800 a year, or £400 a month.
On the other hand if you start paying into your pension at 20 years old, you only need to add 10% to your pension. You’ll be adding less into your pension pot every month, but you’ll have an extra 10 years worth of savings which could result in a bigger savings pot when you retire.
Paying into your pension as early as possible is always advised. This is because of a little thing called compound interest. Compound interest occurs when your money makes you more money. Here’s an example of why paying into your pension early is a good idea:
Person 1 starts adding to their pension at 20. They invest just £50 pm.
Person 2 starts their pension at age 40. They invest £100 pm.
Supposing their pension generates an average rate of 4%, when person 2 turns 60 they’ll have £36,500 in their pension pot. However, person 1 will have nearly £60,000. They’ve both invested the same amount of money over time, but the person who started earlier has more money because it compounded over time.
3. What Are The Government Contributions?
Continuing on from the example above, both of these people will actually have more money than we’ve suggested. This is because you get government contributions in the form of tax relief.
If you’re a basic rate taxpayer the government will top up your pension by 25%, i.e for every £100 you add to your pension, the government will add a further £25. Your pension provider will automatically claim this contribution and will then add it to your pension pot for you.
See more: The Different Types Of Tax In The UK
4. What About The Workplace Pension?
You might also have more money saved in your pension pot if you’re enrolled in a workplace pension. This is because by law your employer has to contribute a minimum of 3% toward your pension pot.
You should therefore take this into consideration when deciding how much you should pay into your pension. You’re also required by law to add a minimum of 5%, but based on the logic mentioned above consider if this is actually enough money to comfortably live off in retirement.
5. And The State Pension?
As well as your workplace pension and the government contributions, most people will also be eligible for the state pension.
The state pension is money paid by the UK government to anyone that has reached the state pension age. It ensures that everyone has some form of income to support themselves during retirement, although the amount received is usually not enough to live comfortably.
The most you can currently receive is £134.25 a week, or just under £7,000 a year.
The money you’ll receive from the state pension also depends on your national insurance contributions. To get the basic state pension you need a total of 30 years of national insurance contributions.
6. Is There A Limit To How Much I Can Save?
If reading this has made you think about adding more to your pension then you might be wondering if there’s a limit to the amount you can save?
There isn’t really a limit to the amount you can save, but there is a thing called a pension contribution limit.
This limit means you can add 100% of your income to your pension, but if the amount goes over £40K a year then you won’t receive the tax benefits normally associated with pensions.
For example, if you earn £30K a year you can add £30K to your pension, but if you earn £50K a year you can only save £40K into your pension and still benefit from tax relief.
It’s important to keep track of your pension contributions to ensure that you’re covered financially in later life.
If you need an easy way to manage your pension then head to the Save Money tab in Emma to sign up for PensionBee.
They are an online service and app that combines all your old pensions into one easy-to-manage plan. Having all your plans in one place can help you get to grips with saving for retirement, and can help identify how much you should pay into your pension.