If you’ve had a promotion, started a side project in lockdown or have received an unexpected sum of money, you could direct some of your disposable cash into your pension plan. But is it better to do this through a lump sum or by increasing your regular contributions? Here’s what you need to know.
Saving for your future is an important part of any financial plan. So it’s natural that you want make sure you’re doing it in the best way possible.
Most people pay into their pension plan on a regular basis, particularly if they have a workplace pension. But what if you want to save more? Is it best to pay in a lump sum, or should you increase your regular contributions?
We talk you through the pros and cons of each option to help you decide what’s right for you and your goals.
Why should I put money into my pension plan?
First, it’s important to understand the benefits of putting money into your plan. It goes without saying that saving for your future in any way is a great thing – but your pension plan is one of the most tax efficient ways to do it.
For starters you get pension tax relief on your contributions. Typically, this means you can get a top up from the government on the contributions you make into your pension plan, so it can effectively cost you less to save more. Some workplace pension schemes offer tax benefits in a different way, so do check with your employer how this works for you if you’re not sure. You can find out how it works in our guide to pension tax relief.
Also, if you’ve got a workplace pension then your employer has to contribute to your plan too. Your employer might even offer a matching scheme where they match what you pay up to a certain percentage.
Plus, your pension savings are invested. So anything you pay into your plan has the potential to grow and benefit from compounding. Remember the value of investments can go down as well as up and you may get back less than was paid in.
When you take all these benefits into account, putting any extra money you have into your pension plan could be a good way to make it work harder for you.
Is it worth putting a lump sum into your pension plan?
If you find yourself with a sudden windfall – for example an inheritance, a work bonus, a tax refund, or you’ve just managed to save a little more than you’d planned – should you put it into your pension plan?
Going above and beyond your regular pension contributions can get you closer to achieving your retirement savings goals. And paying in a lump sum is a quick and easy way to give your plan a boost. It could also be a handy way to use up some of your pension annual allowance before the end of the tax year.
Anything you pay in could benefit from the tax benefits and investment growth we mentioned earlier. In fact, the sooner you can invest your lump sum, the more time it will have to grow, potentially giving you more money in retirement.
Putting a work bonus into your pension plan could mean that you save on tax and National Insurance deductions, meaning you get to keep more of it in the long run. Find out how this works in our article on bonus sacrifice.
Just make sure that the amount you’re paying in won’t take you over your annual allowance – which is currently £40,000 but might be less if you’re a high earner or have already started taking money out of your pension savings. If you pay in more than your limit then you might face a tax charge.
Is it worth increasing my pension contributions?
Maybe you can’t afford to make a single payment now but you do want to save more towards your future. You might not have a lump sum of money but you’ve had a salary increase or maybe your outgoings have changed.
In this case increasing your regular contributions might be the way to go. And if your pension contributions are coming out of your monthly pay before it hits your bank account then you might not even notice a big difference.
Increasing your regular pension contributions when you can afford to is a really great habit to get into. A small increase may not seem like much, but over time it can add up, particularly when you take into account the tax benefits and potential investment growth we mentioned earlier. Plus paying in smaller amounts regularly could also benefit from pound cost averaging.
What is pound cost averaging?
This is where you invest a smaller sum of money at regular intervals, rather than investing a larger chunk in one go. The reason you might want to do this is because it can reduce the risk and impact of investing a lot of money just before any potential market drops.
For example, if you invest a lump sum of £12,000 and the market then drops over the next year, your investment could end up down 10%. But if you spread that investment out and invest £1000 each month across the year and the market drops in the same way, then you buy into the market at a lower price each time, meaning your overall investment may only drop by 5% in total. Although on the flip side, if markets rise rather than fall over the same period, you’ll make smaller profits than you would have if you’d invested the lump sum.
History has shown that markets usually recover in the long term, so although pound cost averaging might not necessarily bring you better returns, it could make it a bit easier to deal with any significant drops in the market. It’s natural to panic when you see the value of your investments fall and you could be tempted to switch investments, but doing this could impact your returns in the long run. So it’s important to really understand the effect of any investment decisions you make before you act.
Which option is right for me?
Ultimately the best option for you is the one you can stick with. Do whatever you can afford to, and even consider doing a combination of both if your circumstances allow it. Both options will allow you to potentially grow your pension pot and give you more for your future.
And don’t forget the last day of the tax year is 5 April – that’s your deadline for making the most of your pension annual allowance for the 2021/22 tax year. Watch our video for five quick tips on how to take advantage of your pension benefits before tax year end.
If you want to pay more into your Standard Life pension plan, whether that’s topping up your regular contributions or paying in a lump sum, you can do it easily online. Just log in or register for our online services to get started.
A pension is an investment and its value can go down as well as up and may be worth less than was paid in.
Your own personal circumstances, including where you live in the UK, will have an impact on the tax you pay. Laws and tax rules may change in the future.
The information here is based on our understanding in March 2022 and shouldn’t be taken as financial advice.