If you are lucky enough to find yourself with some extra funds and are considering putting the money into your pension, this can be a great tax efficient idea to save for your future. There are a number of ways you could look to do this which will bring different benefits depending on your individual circumstances.
Lump sum payment
Perhaps you have been given a bonus at work or inherited some money and are looking at how best to use this for your future. Going above your regular pension contributions can help get you closer to achieving your retirement saving goals and paying a lump sum can be a quick and easy way to give your saving plan a boost. Whatever you pay in could benefit from pension tax relief, meaning you can get a top up from the government on payments into your pension plan, effectively costing you less to save more.
With a workplace pension, some employers match contributions to your pension too, so putting any extra money you have into your pension plan could be a great way to make it work harder for you.
The sooner you can invest your lump sum, the more time it will have to grow and potentially give you more money in retirement. However, you need to make sure that any sum you are paying in doesn’t take you over your pension annual allowance or you could face a tax charge.
Increasing regular pension contributions
Using extra money to increase your regular pension contributions is another way of looking to save towards your retirement. The main reason you may want to consider this over investing a lump sum in one go is because it can reduce the risk of investing a lot of money just before any potential market drops.
As an example, if you were to invest a lump sum of £12,000 and the market was to drop over the year, your investment could end up down by 10%. However, if you were to spread that investment and invest £1000 each month instead, then you would be buying into the market at a lower price each time, so your overall investment may only drop by 5%. This is known as pound cost averaging.
It’s important to remember that this could also have the opposite effect and if markets were to rise rather than fall over the same period, you would then make smaller profits than if you had paid in a lump sum.
Historical data shows that markets usually recover in the long term so although paying in smaller regular payments may not bring you better returns compared to a lump sum, it could make it easier to deal with any significant drops in the market.
How do I decide which option is best?
This depends hugely on your individual circumstances and it’s vital to seek expert advice before taking any action, you could even look to do a combination of both a lump sum payment and increasing your regular contributions. Essentially, it will come down to what you are able to afford and the level of risk you are happy to take.
Plus, it’s important to remember that as the minimum pension age is set to increase to 57/58 over the coming years, why not make the most of your ISA allowances (currently £20,000 per tax year). ISAs benefit from tax free growth. You can either drip feed in to an ISA or make lump sum contributions.
A member of our financial planning team can run through all your options, discuss the end goal you are looking to achieve from your pension saving plan and the most efficient way to get you there.
Get in touch today by emailing financialplanning@pmm.co.uk or call 01254 679131.
The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction.
The value of investments can fall as well as rise. You may not get back what you invest.
