Bettiefrombingo asks: “Should I join my employer’s pension scheme?”
Question 1 – Joining Your Employer’s Pension Scheme – Shownotes
The full question is from bettiefrombingo and is:
“I’m 20, on a year long work placement and was wondering if it’s worth me contributing to my pension? My employer will take 5.8% of my salary and then match it. It’s automatically deducted from my salary, so I’d have to request to opt out.”
For me, this is a nice easy question to get us started. The very short answer is “yes”.
Firstly, what is a pension? Well, simply, it’s a place where you keep your money, where it can’t be touched until you’re 55. You can invest this money in different things within your pension, but the special thing about it is the tax advantages.
With a pension, you are not taxed when you put your money in. So, say you earn £20k a year, and you put £2k into your pension, the tax man treats you as if you have only earned £18k.
Instead, you are taxed when you take your money out. When you reach the age of 55 (this may change in the future as the state retirement age increases), you can take 25% of your pension pot completely tax free, and the rest that you take out is treated as income and taxed as such.
Quick example, say you have £133k when you retire, 25% (£33k) is tax free and the remainder of the £100k will be taxed as income as you withdraw it. Therefore, say you withdrew £10,000 each year, you wouldn’t pay tax because it would be below your tax-free allowance.
So, the fact that ¼ of your savings will be tax-free is a big advantage. However, what other advantages are there compared to an ISA. Not that many, in reality, and these are detailed in our ISA vs Pension articles below:
However, there is one BIG advantage with employer pension schemes which bettiefrombingo mentions – the employer match. Often, employers will match your contributions up to a certain amount. Here, it is 5.8% of the salary. This means that for every £ you put into your pension, your employer will also put a £ in.
Why is this such a big deal? Well, it’s because it gives you a 100% return on your money in year 1 and then that reaps the benefit of co mpound interest for the rest of the time it sits in the pension.
Let’s run an example. Just say your annual placement is paid at £15k/yr. The 5.8% would be £870 for the year. They match it so you get £1,740 in your pension account. When you are 65, that money alone (if you invest at 6% above inflation) will be worth £24,000 in today’s money.
So, for money that you never even see in your net salary (and so it doesn’t really impact you that it’s not there at the end of each month) bettiefrombingo would have 160% of their entire annual salary when you retire.
Are there any exceptions where bettie should opt out of this pension scheme?
Well, she needs to just check a few things:
- What can she invest in in the pension scheme?
Getting the 100% match is great, but if she can only invest in assets that return 1% a year, that benefit would soon be lost. However, she could still transfer to another pension scheme later down the road. Which brings us to the second possible exception.
- What are the rules for transferring out?
Are there any specific restrictions in the scheme for transferring out to another pension scheme? Are there any costs related to doing so. If bettiefrombingo is only on the placement for one year, and then doesn’t intend to work with this employer again, then the rules for transferring the pension after that year will be important.
- Finally, can your budget handle it?
Hopefully, bettiefrombingo has a full detailed budget. If that 5.8% (which would probably only be around £50-100 per month depending on the salary) means that they cannot balance their budget each month and that will lead to a spiral down into overdrafts and payday loans, clearly locking their money into the pension isn’t the best idea. However, for £50-100 a month now to give £20-30k when she retires, I’d be looking to cut back on the budget wherever possible.
What I always like to remember when it comes to pensions :
“I don’t know many people who wished they had a smaller pension when they retired”.
So, to conclude, check a couple of points first, but absolutely contribute to your pension up to the maximum that the employer match allows if your current budget can handle it.
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