If you’re entitled to a workplace pension, it usually makes sense to take advantage and begin contributing to it. If you don’t, and you keep the money in your bank account to spend on something else, you could effectively be choosing to take a pay cut.

What is a workplace pension?

A workplace pension is the easiest way to start saving for your retirement. You don’t need to seek financial advice because your employer will handle everything for you.

If you’re an employee, when you reach the age of 22 and earn more than £10,000, you will automatically be enrolled into your company’s workplace pension. If you’re younger and earning more than £6,240, you can still opt-in and benefit from your employer’s contributions.

When you’re automatically enrolled, your employer must contribute a minimum of 3% of your earnings to your pension, while you must contribute 5%. If your employer is more generous, they may contribute a larger percentage, meaning you will be able to contribute less.

The younger you are when you start saving, the easier it will be to build up your pension pot

What are the benefits of a workplace pension?

You can choose to opt out of a workplace pension. But with benefits like those we’ve summarised below, why would you?

1. The snowball effect of compound growth

Compounding is a general investment principle, so it applies to personal pensions as well as a workplace pension.

Ultimately, it’s all about the long term. The younger you are when you start saving, the easier it will be to build up your pension pot to a level that will give you a comfortable retirement – and may even allow you to retire early. That’s because of the effects of ‘compound growth’ over time.

Compound growth (similar to ‘compound interest’) is when you earn ‘growth-on-top-of-growth’ on your pension savings.

An easy way to visualise the effect of compounding is to think of your pension pot as a snowball. As it rolls downhill, it collects more snow, and the further it rolls, the bigger it gets. If you start rolling your snowball halfway down the hill, it will never catch up and be as big as someone who started at the top – unless you pile a lot more snow into it when you start.

2. Employer contributions

Together, you and your employer will be required to contribute 8% of your qualifying earnings into your workplace pension. Your employer will contribute a minimum of 3%, which means you’d need to contribute 5%.

Qualifying earnings are anything you earn as an employee between £6,240 and £50,270. So, if you earn £35,000 a year, your annual qualifying earnings will be £28,760 (£35,000 minus £6,240).

If we take the qualifying earnings example of £28,760, your 5% contribution would be £119.83 per month, and your employer will top that up with an additional 3%, or £71.90.

You can choose to increase your contributions to more than 5%, and some employers are more generous and will make a higher contribution. It’s important to check your employment contract to see what you’re entitled to.

Tax relief means you don’t pay tax on the amount you contribute to your pension

3. Workplace pension tax-relief

As well as contributions from your employer, you’ll also receive ‘tax relief’, which means you don’t pay tax on the amount you contribute to your pension. Instead, the tax that would normally be deducted from your wages is added to your pension pot.

If you’re a basic rate taxpayer you’ll receive 20% tax relief on the contributions, which will be added to your workplace pension. That means that when taking the previous example, your £119.83 monthly contribution will include £23.97 that’s been contributed by the taxman.

If you are a higher-rate taxpayer, you’ll receive 40% tax relief on your pension contributions, which will also usually go directly into your pension.

As you can see, if you’re entitled to a workplace pension, it may be in your best interests to take advantage and opt-in. It doesn’t stop you from setting up your own private pension as well, but if you do, you should first ensure you’re making the most of your employer’s scheme.

Your employer is responsible for your workplace pension, but if you are considering setting up a personal pension it’s best to seek independent financial advice.

Do remember, though, that the money you contribute to your pension is an investment. As such its value can go down as well as up and you may get back less than you’ve invested. None of the information provided in this article should be considered as personalised advice.

There have been significant changes to pension savings in the Spring Budget 2023 that may impact your retirement planning. To find out more, see: How does the 2023 Budget affect your pension and retirement planning?

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