In our Pensions Crisis Coach series, we aim to help ease your retirement worries. Are you concerned you’re not saving enough for your later years? Do you want to know if you have enough to retire or don’t know how to find your lost pensions?
Email us at money@theipaper.com. We’ll seek to get you on the right track with help from some of the best financial experts and advisers in the business.
Question: I am 26 and have around £70,000 saved in my pensions. I earn more than £100,000. I haven’t really focused on pension funding until now as I have started paying tax at the 40 per cent rate. How much should I be contributing to my pension, to ensure I pay less tax and am on track for a comfortable retirement? I am also in the process of saving for my first home and want to save around £100,000 by 35.
Alina Khan, the i Paper’s money coach reporter, responds: The good thing is that you are young. It means the fact you are thinking about your retirement now will put you in good stead to build up a healthy amount of money for later life.
And you’re earning good money: more than £100,000.
After some back and forth you told me you currently contribute 5 per cent via salary sacrifice into your workplace pension, with your employer matching your contribution, meaning you have 10 per cent going into your pension each month.
However, Patrick Haines, financial planner at Partners Wealth Management, said you appear to be caught in the “60 per cent tax trap”.
This is when your personal allowance – the point at which you pay tax for the first time – reduces by £1 for every £2 of income you earn above the £100,000 threshold and at the same time you are paying income tax at a rate of 40 per cent.
Essentially, for every £100 earned between £100,000 and £125,140, you effectively keep only £40, while £60 goes to tax, creating the 60 per cent trap.
Haines said: “The most effective way for you to save for retirement, whilst reducing your exposure to tax, is to make additional pension contributions, up to your maximum level of £60,000 gross per annum. This includes the current pension contributions being made.”
According to Haines, this will then allow you to claim tax relief on these contributions as well as reclaim your personal allowance as your income will be below the £100,000 threshold.
He added: “The tax savings don’t stop there – you could also look back at the preceding three tax years to assess how much of your annual pension allowance of £60,000 gross was unused and then make a single pension contribution this year as a catch-up payment.
“This will provide a real boost to your pension provision, especially given your age and the compounding effect on your pension fund between now and retirement.”
You also mention you want to buy a home in the next ten years and hopefully have a £100,000 deposit by then.
You currently have £35,000 saved in a Stocks and Shares ISA which you contribute £300 to each month but Haines said you may need to save a little more to reach your target.
Haines said: “Based on an annualised compound return of 5 per cent net of fees, we estimate a modest, revised funding level of £330 per month. However, if you wish to account for inflation of 3 per cent on your target of £100,000, you might need to increase this regular contribution sum to £545 per month. This could see an accumulated tax-free sum of £130,000 in 9 years’ time to put towards your property purchase.”
Given your age and the fact, you are a first-time buyer, Haines suggested opening a Lifetime ISA (LISA).
A LISA helps people to save for their first home or retirement, offering a 25 per cent Government bonus on savings.
You can contribute up to £4,000 per tax year into the LISA with the bonus being paid as you save.
However, it is important to note that LISA holders face a 25 per cent penalty if they are using the money for anything other than retirement, or to buy a first property worth under £450,000.
Haines also suggested checking that your pension and ISA savings are aligned to the level of risk you want to take.
“You should consider putting in place an Income Protection Policy and a Critical Illness policy to provide for you financially in the event you are unable to work due to prolonged illness or diagnosed with having a serious illness.”
Income protection can support you financially if you are unable to work because of injury or illness and it typically replaces part of your income if you lose earnings because you can’t work.
Critical illness cover pays you a tax-free lump sum if you get a serious illness or injury, most policies only pay out once at which point the cover ends.
“The drafting of a will should also be considered by the time you purchase your home, at the very latest,” Haines added.