Martin Lewis: An important warning to every employee in the UK

It costs as little as £80 to get £160 added to pension savings

In the 2024/25 tax year, on earnings over the standard £12,570 personal allowance, you'll pay the basic 20% rate of tax until your earnings hit £50,270. Above that, it's the higher 40% tax, unless you're a seriously high earner, above £125,140, when you hit the top 45% rate. Figures differ for Scottish taxpayers.

But pension savings come from PRE-TAX salary, so putting £100 a month in your pension only reduces your pay packet by £80 (£60 for higher 40% rate taxpayers).

Plus at the minimum level, if you put 5% in, your employer has to put 3% in. That means even with the minimum contribution, if you put in £100 a month, your employer would put in £60, so there's a total £160 a month added to your pension, but that only costs you £80 (£60 at higher rate).

Over a year, at this level of saving, you'd have your pay packet reduced by pay £960 as a basic rate taxpayer (£720 higher rate), but your pension would have a whopping £1,920 added to it. That's unbeatable.

It is worth noting, for many employees, the tax gain is automatic, but if your employer operates its pension under the 'relief at source' scheme (as opposed to net pay), you'll only get 20% tax-relief automatically. So if you're a higher-rate taxpayer you should double check you claim the extra you're entitled to.

Now that's the main stay of the blog over, but as I'm writing, and there are always questions when people are thinking about auto-enrolment pensions, let me quickly bash out answers to some of the most common on this...
 

Q. Aren't private pensions a waste of cash?

A. You often hear people, especially those currently near retirement age, swear about how their pension has massively underperformed. Well, that's simply not true. No private pension has ever underperformed.

OK, I am playing a little with words here, but this all stems from a fundamental misunderstanding of what a private pension is. It's not a product. It can't underperform. It's just a special wrapper everyone is given by the Government with the huge advantage that you save from pre-tax salary.

The problem is that historically many people invested their pension savings in 'with-profits' funds, and these were often crap and many substantially underperformed. Yet don't blame the pension wrapper for what was put inside it.

These days, the choice of investment is much better, with lower charges and more transparency. Your firm's pension provider should give guidance on what your options are.

Much of the choice is about 'investment risk'. That sounds scary, but higher risk means you're aiming for fast growth, but accept the fact there's a bigger chance it may shrink. The younger you are, the more room you have to take some risk; as if it goes wrong, there's more time for things to even out.

Q. Isn't property better for retirement than a pension?

A. This is a very common question, many ask it. Yet in fact, in many ways it's a misunderstanding, as pensions and property are like chalk and ducks. They're totally different things.

A pension is a tax wrapper you use to save assets or investments in for retirement. Property is an asset class, something you own. In fact, you can put some types of property investments within a pension (though not the home you live in).

Yet having said that, I know what most people mean when they ask they question, so let me answer with that in mind. 

Unlike a pension, you pay for property from your AFTER tax salary and your employer won't contribute. Plus even if house prices rise, at retirement it's not easy to spend the house you live in, unless you sell, downsize, or do equity release so it's only a paper gain. Though, a mortgage-free property does reduce your outgoings, which is a big help to ease living costs. 

A pension on the other hand is money which you should be able to spend when you need it – supplementing any income you get from the state pension – which is more convenient.  

So if you have access to an auto-enrolment pensions, I'd usually look to at first try to max it out so you get the biggest employer contribution 'pay rise' and tax relief. Of course the best option between property and pension is to try and balance both – never easy.

For those asking about investment properties (rather than the home you live in) versus pensions, then it gets really complex and isn't really my expertise – especially as the answer would often require a crystal ball. 

In general though, a pension is generally more tax-efficient and has the employer contribution (and, as mentioned, you could choose investments where the underlying returns are based on the property market), but owning a house is something you can often put your own work into, and if you get it right, that may enable you to get quick growth. There's no right answer (and there is only a wrong answer with hindsight).

Q. Is there anyone who should be opting out?

A. If you really can't afford to contribute to your pension, you've a right to opt out. Think carefully before you do though – generally you're sacrificing long-term cash for short-term gain. However, there are some circumstances where opting out or reducing contributions does make sense, including...

• If you've very expensive debts, eg, payday loans or a high 40% overdraft interest. Here it's likely worth clearing these before you start to contribute to your pension. See our Debt Help guide.
  
  
• If you're near retirement and have little savings. There is a chance that having a bigger pension pot could reduce your benefits, but this is a rare scenario. Use our 10-minute benefit check-up tool.
  
  
• Until this year (April 2024) if you had a VERY large pension, there was a risk auto-enrolment will put you over the lifetime allowance (which was just over £1m) yet this limit has now been abolished (though there is a still a limit on how much tax free cash you can take from your pension – currently just under £270,000). So some who may’ve been worse of allowing money to go into their pension may now be able to contribute again. Yet be careful you don’t bust the limits, with this and other complex pension arrangements, it's worth speaking to your independent financial adviser. If you don't have one, speak to Pension Wise.