How to Best Use Your Pension and Savings
Pension pots and savings accounts both save for the future. Knowing how they compare is key to using each most effectively.
Pensions and savings accounts are both excellent ways of building a pot of cash for your future, but they are very different products and will help you achieve very different goals.
This means it is a good idea to have both in your financial armoury.
Do I need a pension or savings account?
Ideally, you’d want to be able to save for both your short-term goals and your retirement, so it’s sensible to have both.
Saving up enough cash for your next holiday or to buy a home may well feel more pressing, but the sooner you start saving for retirement the better, as this means your money can grow over a longer period of time.
How you split your money between a savings account and a pension will come down to your priorities and goals. If you already have a healthy savings balance with enough to deal with any emergencies, you may choose to prioritize your pension. Alternatively, if you want to buy a home or are striving for other shorter-term milestones, that may need to be prioritized.
What is a savings account?
A savings account is a bank account that you can use to build a nest egg. While it can make a good home for any lump sums you might have, it’s also a good idea to pay some spare cash into your account every month to encourage a healthy savings habit.
Your bank will pay interest on the money.
Current interest rates on savings accounts aren’t much to get excited about, but the real benefit is that your money is ring-fenced and you won’t accidentally spend it, as you might if it was left in your current account.
And then if you have something like an easy access savings account, which lets you withdraw money whenever you need it, it can be a great home for your emergency fund - ensuring you always have cash for unexpected bills or surprise expenses.
Savings accounts can also help you save money for short-term goals like a holiday, a wedding or a deposit on your first home.
What is a pension?
A pension, on the other hand, is a long-term savings plan, structured specifically to encourage retirement saving.
Not only do savings in pensions grow tax-free, you also get tax relief on your contributions. This is effectively a rebate from the government of the tax you will have paid on your money and means it will only cost a basic rate taxpayer £80 to pay £100 into their pension. A higher rate taxpayer would only need to pay £60 to save the same sum, while an additional rate taxpayer would pay just £55.
This isn’t the only incentive to squirrel money away for retirement. If you are in a workplace pension your employer will also make contributions on your behalf - at a minimum rate of 3% of your qualifying salary.
In return for these incentives, however, you aren’t able to access the money in your pension until you are much older. Currently, you need to be 55 to start accessing your pension, but in 2028 that age will rise to 57.
Unlike a savings account, where your money is held as cash, you also have a choice of where to invest your contributions. This is usually in a managed pension fund that is invested in the stock market. While you can choose which funds to invest in yourself, workplace pensions will also have a default fund for those that don’t wish to make investment decisions.
Investing in the stock market does carry a degree of risk because investment performance isn’t guaranteed, however over the long term, your money is likely to grow faster than it would if it was saved in a cash account.
Pension and savings accounts compared
|Tax||Money grows tax-free and there is tax relief on contributions. Tax may be payable when accessing funds at retirement.||No tax relief to boost contributions to savings accounts. Tax may be payable on interest earned,depending on the amount.|
|Access||You cannot access money in a pension until you are 55 (rising to 57 in 2028)||Instant access savings accounts let you withdraw cash whenever you need it|
|Growth potential||Investing in the stock market means your money has the potential for higher growth, but returns aren’t guaranteed||With interest rates on savings accounts low, savings growth is limited|
|Use||Structured for retirement savings only||Ideal for shorter term savings where you don't want to risk your money on the stock market - for example a rainy day fund or holiday|
Compare savings accounts
When researching savings accounts, focus on getting the best rate you can, that still gives you the access you need. Instant access is important if you are saving for an emergency fund, but if you are saving for a goal like a home purchase or a wedding you may be able to get a higher rate with a fixed-rate or notice account.
Also check that your chosen account can be managed in a way that is convenient to you - for example, some accounts are online only and you won’t be able to use a bank branch.
Starting a pension
Setting up a pension may feel like an overwhelming task, but most people don’t actually need to lift a finger.
If you are employed - and meet certain eligibility criteria - you should be automatically enrolled into your workplace pension. Employees that do not want to save for retirement have to talk to their employer and opt themselves out of the scheme.
You can choose where your pension contributions are invested but if you do not want to make investment decisions your money will be invested in its default fund.
Pension contributions will automatically be deducted from your salary and, with the minimum employee contribution just 5% of your qualifying earnings, you shouldn’t see too much of a dent in your pay cheque. With government tax relief included, this works out at around 4% of your take-home salary.
It is just a minimum contribution, however, and if you can afford to do so, it makes sense to pay more to increase your eventual retirement income.
Most workplace pensions are likely to be defined contribution pensions. This means your money, along with employer contributions and tax relief is invested over the long term, with the eventual retirement income it is able to give you dependent on the amount of money that was paid in and investment performance. When you retire, you will need to decide how to turn your pension into a retirement income.
Some workers however may get a defined benefit pension. Although these are increasingly rare in the private sector, you’re likely to get one if you work in the public sector, for example as a teacher, firefighter or NHS worker. These schemes provide a guaranteed income in retirement based on your salary and the number of years you were a member.
If you are self-employed or do not have access to a workplace scheme you can set up a personal pension or self-invested personal pension. Non-taxpayers can still get tax relief on contributions up to £2,880 (totally £3,600 after tax relief).
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
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Rachel Lacey is freelance journalist with 20 years experience. She specialises in personal finance and retirement planning and is passionate about simplifying money matters for all. Read more