What benefits does a pension plan have over a normal savings account?
Question I am age 25 and have been working for several years and I am considering saving for retirement but haven’t started a pension plan. What benefits does a pension plan have over a normal savings account? Would a savings account be a suitable vehicle for retirement? C McI, Newtownabbey.
Answer: There are a numbers of things to consider here. But firstly, can I say well done for planning for the future.
Two of the most popular forms of regular saving for retirement are pensions plans and Individual Savings Accounts “ISA’s”. You can invest in an ISA to build up savings in a bank account. Any interest is paid with out income tax deducted from it – saving you 20% and you can get access to the fund at any time. It’s a great way of building up an emergency fund for those unknown expenses.
A pension plan is a long term savings plan and money which you invest in a pension benefits from tax relief. If you pay £80 to your pension, the government help you save by giving an additional 20% tax relief. The contribution is therefore grossed up to £100. But remember the earliest age from which you can get access to your pension fund will be 55. A future government could push this minimum retirement age to 60 or 65.
When you want to get access to the fund, you can take up to 25% of the fund value as a Pension Commencement Lump Sum. The rest of the fund is used to provide a regular income.
If you save in an ISA, you don’t get tax relief on the contributions you make. However the fund grows in the same tax efficient way as a pension plan. An ISA is a very flexible savings vehicle and you can get access to the accumulated fund at any time.
Both pension plans and ISA’s are investment based and you can place your money in a wide range of investment funds. Be careful to consider the level of risk you want to take and select an investment fund which matches this. Remember the value of your fund will go down and up – so be prepared for the odd shock. That said, over the long term the growth should be better than the interest you receive from a savings account.
Therefore, I think that either a pension or Stocks and Shares ISA is an attractive way to save for your retirement. A savings account is great for short term savings but the potential for real growth over the long term is limited.
Depending on your budget, I would build up an emergency fund in a Cash ISA and then save regularly in a Pension Plan and Stocks and Shares ISA to build up funds to finance your future plans.