Should I pay into savings or my pension plan?

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MoneyPlus Features Team

May 04, 2022

5 mins read

If you have money to save, it’s important to find the right place for it to help achieve your short and long-term goals. Savings, pension plans and investments can all offer a different mix of flexibility, accessibility, potential for growth and tax benefits. Here’s what to consider.

Save for your future. It sounds such a simple, sensible plan. But when it runs up against reality, there’s a lot to consider. How far in the future are we talking? What do we need to fund along the way and how might these priorities shift over time?

Sometimes it’s hard to see past your immediate needs, but it can help to think of saving not as a cost, but rather an investment in opening up your choices in the future. Once you’ve identified how much you can afford to put aside for your future at the end of each month, it’s about striking the right balance between those important short-term goals and saving towards retirement. 

What's the difference between saving, investing and pension plans?

Savings, pension plans and other investments can each be great for trying to build up a pot, but they’re all very different and can help achieve different goals. 

Bank or building society savings accounts are deposit accounts that give you a secure place to put money aside for short or medium-term goals. Saving for a house deposit or towards a holiday, for example. They may offer some interest on the money you save and in most cases you won’t pay tax on it.

For longer-term goals – generally five years or more – investing can be a great way to help grow your money. You can find out more about the basics of investing in our guide, Investing for beginners: what you need to know.

Pension plans are long-term investments and a tax-efficient way to save and invest money for when you decide to reduce your working hours in later life or stop working altogether. You can find out more about pension plans and how they work in our Pension basics guide or compare the different types of personal pension plans and see how they can help you reach your retirement saving goals.

Remember that the value of pension plans and other investments can go down as well as up and you may get back less than was paid in.

The pros and cons of savings accounts

Quick access to your money

If the first thing you need is a bit of a savings cushion to cover an emergency or some spending within the next five years, then saving into a bank, building society or Cash ISA (Individual Savings Account) could give you the quick access you need while providing relative security for your money.

The impact of interest and inflation

They are generally quick and easy to set up and you may be able to earn some interest, however, with interest rates generally low and the cost of living rising rapidly at the moment your money could lose value over time because of the impact of inflation. It’s important to shop around for the best rate you can find, especially in the current climate. You may be able to get more competitive rates from accounts where you commit to leaving your money for a set time or by providing an agreed notice before withdrawing your money.

Tax-free saving

Most people can earn some interest from their savings without having to pay tax on it but you can find out more about the allowances for earning interest before you pay tax on it on the Government’s website.

You also have a £20,000 ISA allowance for the 2022-23 tax year which you can split across cash and stocks and shares ISAs. Although some ISAs, such as the Lifetime ISA, may have a lower limit. To find out more about how ISAs compare to pension plans read our article Pension or ISA? How to decide where to put your savings.

Pros and cons of saving in your pension plan

Your money is invested

The money paid into any pension plan is invested and will have the chance to grow and hopefully beat the rate of inflation, although its value can go down as well as up and you could get back less than what was paid in.

It’s an easy saving habit to form

When you have a pension plan in place, especially through your job, it’s easy to stay in the habit of saving because payments usually come straight from your salary. Choosing to increase the amount you contribute each month, even just a little, extra could make a big difference over the long term.

If you want to top up your pension payments or make a one-off payment to any Standard Life pension plan, you can do this by logging in or registering for online services.

Using our pension calculator you can get an idea of whether your pension savings are on track to give you the lifestyle you want and also how adjusting your pension payments could affect this.

Employer contributions and tax relief give your savings a boost

Because you get pension payments from your employer and tax relief from the Government, workplace pensions are a good way for most to save for retirement. Not making the most of your pension plan is a bit like turning down a rise in salary, although you won’t get the benefit of it until you retire.

When you’re in a workplace pension scheme your employer is contributing a minimum of 3% of your qualifying earnings towards your future. Some employers will pay more than the minimum and others will pay more into your pot if you do – known as matching.

Tax relief is what makes pension plans one of the most tax efficient ways to save for your retirement, effectively making it cheaper to save into your pension plan. This means most individuals will get 20% tax relief from the UK Government on their personal pension payments, so it will only cost you £80 to have £100 invested into your pension plan.

Most people are entitled to claim tax relief on the pension payments they make based on the highest rate of income tax they pay. This means the benefits are usually even more for higher or additional rate taxpayers. 

Please note you may need to claim anything above 20% directly back from the Government depending on how your payments have been paid. Some employers offer workplace pension schemes and are willing to deduct the payments you wish to make to your pension plan on your behalf. Some employers allow payments to be deducted from your salary before any tax is calculated or provide a salary sacrifice or exchange schemes, for example. Others make the deduction from your net salary. 

If your employer is making the payments to the pension scheme on your behalf you’ll need to double check with your employer how this works for you. If you’re a higher or additional rate taxpayer, it will affect whether you need to take any action to claim the additional tax relief back. If you’re paying payments directly from your personal bank account into your pension plan you will need to contact the Government in order to claim the extra tax relief. You can find out more about tax relief and how it works in our article How does pension tax relief work?

You have annual and lifetime pension allowances

There are certain limits to the amount you can save into your pension plan without paying additional tax. The current rules let you pay up to 100% of your salary, or £3,600 a year into your pension plan, whichever is higher, and still get tax relief. There’s also the annual allowance to consider, which is currently £40,000, but might be less if you’re a high or non-earner, or have already started taking money out of your pension savings. If you pay more than the annual allowance into your pension plan in any one tax year, you’ll be hit with a tax charge. You can find out more about the pension annual allowance in our annual allowance guide.

There is also a pension lifetime allowance of £1,073,100, which is the total amount of pension benefits that you can build up during your lifetime across all pension schemes before an additional tax charge applies.

You can only take your pension from age 55

One of the important differences with a pension plan is that you can’t withdraw your pension money before the age of 55 at the earliest. Last year the Government confirmed that this will rise to age 57 from 2028, and it may change again in the future.

This is different from your State Pension age, which is currently 66, will rise to 67 in 2028 and is due to increase to 68 between 2044 and 2046. You can find out how the State Pension differs from pension plans, how much you can expect to get from it and when in our article Changes to state pension - here is what you need to know.

Is it better to pay into a pension plan or savings?

Ultimately, the best place for your savings will depend on your goals and priorities and these will shift over time. In your 20s and 30s the biggest financial pressures can be paying rent or saving towards a deposit for a house, but by your 40s you may be able to focus more on saving towards your retirement. 

It makes sense to have a mix of savings options and adapt where and how much you’re saving and investing as your needs and priorities change, and depending on what you can afford.

Savings accounts generally give you accessibility for those short-term needs without as much potential for growth whereas money in your pension plan is invested but can only be accessed from age 55 at the earliest.

There’s a lot to think about so it might be worth considering taking professional financial advice. You can find a list of regulated advisers on the FCA website or unbiased.co.uk is an independent site that can help you find the right adviser for you. There’s usually a charge for getting advice.

Pension plans and Stocks and Shares ISAs are investments. They can go down as well as up in value and you could get back less than was paid in.

Savings accounts aren’t exposed to investment risk, so your money is generally more secure in a bank account or cash ISA.

Tax rules and legislation may change and your individual circumstances and where you live in the UK will have an impact on the tax you pay.

The information here is based on our understanding in April 2022 and should not be taken as financial advice.

 

 

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