Reduce your income tax bill by paying into a workplace pension. Benefit from reduced tax and employer contributions to massively increase your savings for retirement.
It is a legal obligation for employers to offer a workplace pension and you should take time to understand how to make best use of this benefit.
Pay Yourself Instead of the Tax Authorities
When you save into a workplace pension, your contributions are tax free at the point of saving. Your contributions can be taken out of your salary by your employer before tax is charged, known as ‘salary sacrifice’ or by your pension provider whom add the tax saved into your pension pot instead as ‘relief at source.’
For every £1 you put extra into your pension than leave in your salary then you are taking 20p (lower tax rate payers) or 40p (higher tax rate payers) out of that £1 and putting it into your pension instead of paying the government. When you consider most investments are likely to make between 5-8% per year, to legally get a 20% to 40% boost through your pension is an opportunity to be taken.
It took me a while to trigger this obvious benefit and I wasted a few years thinking the small extra in my pocket now was better than the clear long term winner of maximising my pension contributions. Now the penny has dropped (literally) and I now put maximum contributions I can in.
Employer Matching Pension Contributions
Best of all, many employers match your contributions up to a certain level, eg you put 3% they put 3% of salary into the pension. Often times there is a range of contribution levels you can choose to pay in that will be matched. It is important you decide what is right for you personally but for many it is a no brainer to max out whatever the employer will match.
Continuing the example above:
For every £1 you put in, your employer may match your £1.
So if you were on 40% tax rate and you did not contribute to your pension then you would take home 60p or less after national insurance; or you can put £1 into your pension and it is matched by employer.
£2 into the pension pot or 60p now! Then multiply this by 45 years or so of working life and add the fact that the invested pension will grow and compound over time. The delta is huge.
Lets follow this through with a rough example.
£5000 per year directed into a pension and matched by employer up to this level. £10,000 per year, 45 years (ignoring salary will rise with inflation also). Compounded by 7% (just less than average returns of the stock market for last 100 years.
Or you could get 60p per £1 now, so £3000 per year in your salary instead.
£3,400,000 Pension Pot! vs £135,000 total extra in your monthly pay packet spread over entire career.
Mindset and the Investment bug
We are trained in a consumer society to place a high emphasis on instant gratification. Reward yourself immediately all the time. This mindset is the enemy of the informed investor and across a range of wealth building opportunities will reduce the likelihood of financial independence.
By putting a modest percentage of your total income away from early as possible in your working life, through the government tax relief and employer contributions, you are giving yourself a great opportunity to increase your savings for retirement and live a comfortable if not wealthy lifestyle. You therefore also have a flexibility when you can retire.
A pension once established is also psychologically easy to implement and forget it is happening. Why? Its taken before tax and before you see it, feel it and get used to having it. Also its locked up until 55 and so you cannot easily access it and this prevents temptation to use it when life events come up.
Seeing the growth of pension through compounding was actually one of the drivers that triggered me to start investing independently outside of workplace pensions. The same mindset of putting money to work consistently each month rather than spending it all on lifestyle was required and patience to watch it grow.