Can you treble your pension pot?

Annie Shaw / 04 August 2014

Can workers in their 50s and 60s use some nifty financial footwork to treble their pension pot in just a handful of years running up to retirement, as a leading financial adviser recently suggested, and then take the money out in cash without paying a penny of tax?

Indeed, it seems they can, and here’s how to do it:

Many older savers have never bothered with a designated scheme to save for their retirement, and have believed that once they reach two decades before they put down their tools they are too old to bother with cumbersome things such as a pension scheme. 

They couldn’t be more wrong.

Changes to the way company pensions are run, with large employers already obliged to pay into employee schemes – and smaller employers soon to join them – have been coupled with changes to the rules about what money you can take out of your pension without having to pay tax. 

This has meant that there is “free money” to be had from pension saving, that can boost your retirement nest egg by more than 200%.

It works like this: 

The Government is encouraging everyone employed by a company to save by making signing up to a pension scheme compulsory. 

True, you can opt out if you don’t want to be in you firm’s scheme, but you will be enrolled automatically and must then formally withdraw.

Once you are enrolled, the minimum amount you must contribute is 1% of your earnings. Your employer must contribute a minimum 1% on top of this. 

Because you don’t pay tax on your pension contributions, each £1 you pay in costs you just 80p, with the other 20p being added by the Government. 

Along with your employer’s contribution, you’ve already saved £2 for every £1 you earn at a cost of 80p to yourself.

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By 2018, the pension rules will require you pay in 4% of your earnings, employers will boost this with a another 3% and once again the Government will chip in tax relief of 1%, giving you 8% – so £8 for a cost to yourself of just £4.

But the money is not sitting in a bank account gathering dust: it will be invested and hopefully will be growing with rises in the stock market.

See your money treble

If today at the age of 55 you have an annual pre-tax income of £24,000, make the minimum contributions now, and increase your contributions in 2018 to the new minimum.

If you have modest pay increases in the meantime, and your savings grow at 5% a year, you will have accrued by the age of 65 a pension pot of £14,134 – or so the financial advisers say. 

The beauty of the scheme is that the saver would have contributed just £5,479, while the £4,315 from their employer, £1,370 tax relief from the Government and £2,970 investment growth would have done the rest – giving an increase of 258%.

A 60-year-old could put aside £5,383, costing them £2,556 from their own money, and with £2,181 from their employer, £639 tax relief and £631 investment growth they would still get a not inconsiderable 210% hike.

Ah, you say: if I do that, then, when I retire, all the money will go to some pension company or annuity firm, and I’ll never get the benefit of doing what I like with my own cash. 

Not any more. The rules have changed to make it easier for people with small pension pots to get their hands on their cash. 

You can also boost your income by deferring your state pension.

More freedom with your pension

While it is hoped you will use the money to help fund your retirement, you don’t have to do so if you feel you have better use for the money immediately.

Just as before, under the old rules, you can take 25% of your pension fund tax-free whenever you like after the age of 55

While before there were rules governing the other 75%, which meant a big tax charge if you tried to cash in your fund, this has all changed, and now you only pay tax at your normal rate

For many people, this tax rate will be nil because you also get an annual tax-free allowance – currently £10,000, rising to £10,500 next year. 

Even if you are drawing a state pension – currently £5,888 a year – you could still have some of your allowance left over if you have no other income. 

If you haven’t got enough allowance left over after your state pension has been deducted, then you can make your withdrawals over more than one year, to ensure you always get the cash tax-free.

So, is there a catch?

Not in the way the rules work, but the above figures do make several assumptions. Many people don’t make pension contributions because they simply can’t afford to, and that’s not going to change. 

Although the new pension system “auto enrols” employees into a scheme, they can still opt out. The Government hopes they won’t, but many people on a tight budget will need every penny of their salary to pay their rent and their bills.

The calculations assume a good rate of growth. While the 5% rate assumed is not unreasonable, it is not guaranteed like interest on a savings account. Stock markets can fall and it is possible you could actually get less back that you put in, although that is unlikely.

They assume that you will continue to work into your 60s – as indeed many people will, and indeed beyond – but many people won’t because they lose their jobs, they don’t want to carry on or they suffer ill health.

Find out more about the pension rule changes. 

Is it a good idea?

Absolutely. While there are some marginal downsides, the benefit of “free money” from your employer and the Government can’t be overstated.

And now you will find it much easier to take your pension savings as cash if you need it sooner rather than later, there is very little reason be scared of putting your money into a pension scheme.

The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.