What’s the best way to save for retirement?

Retirement can feel like a long way away so it can be tempting to put off saving for it.

In this guide, we’ll discuss why it’s a good idea to start saving for your future as soon as you can afford to.

We’ll also talk about things you might want to consider to help you keep your financial independence when retirement arrives. 

Why is saving for retirement important? 

Saving for retirement is something many people struggle to do. However it is necessary if you want to enjoy your retirement without feeling stressed about your finances. With a good amount of savings, you'll be able to remain financially secure and keep your current lifestyle without worrying. Here’s a list of reasons why it’s important to consider starting to save for your retirement now:

Financial independence

Retirement planning may feel overwhelming, and not like a priority right now. However, being able to stay financially independent after you’ve stopped working is something many people aim for and this can require a bit of planning. By starting to save for your retirement now, you’re laying the foundation for a comfortable future and a reliable source of income once you stop working. 

Maintaining your lifestyle

When you stop working, it’s natural to want to keep your current standard of living. The good news is that your essential costs often decrease in retirement. For example, if you take out a mortgage in your 30s, you may have paid it off by the time you retire. Also, if you’ve chosen to have children, they may have grown up, moved out and become financially independent by this time. 

This means you may need to save less than you think to cover your essential costs and give you more money to put towards travel, hobbies and other activities that you enjoy.

Inflation

Planning for inflation is essential, because it can significantly impact your retirement savings. Over time, inflation weakens the purchasing power of money, meaning that the money you save could be worth less in the future. For example, using data from the Bank of England, items that cost £5 in 1997 would cost £9.20 today. Without investing that £5 wisely, it could buy you almost half of what it does today. 

By effectively saving and planning for when you stop working, you can combat the impact of inflation and maintain your standard of living, despite rising costs in the future. 

People are living longer

It’s become more common for people to live longer, meaning your retirement could last several decades. You need to make sure you have a big enough pension to support what is likely to be a longer retirement period than previous generations had.

Because people are living longer, many employers are also having to make their pension plans less generous to ensure they remain affordable.  For example defined benefit pensions, where you get a guaranteed amount every year in retirement, are becoming less common.

 Instead most companies now offer defined contribution pensions, where you build up a pension pot and withdraw from this in retirement. It’s therefore down to you to ensure this is big enough to support your whole retirement, however long that may last.

Your state pension may not be enough

If you’ve made enough national insurance contributions, you will receive the State Pension when you retire. You can find out more about national insurance contributions and how they influence what amount of State Pension you will receive on the gov.uk website (insert link).

Currently, the maximum State Pension is £203.85 per week. This usually rises with inflation so may be higher when you are eligible (though as discussed above, this doesn’t mean you will be able to buy more because the cost of products you are buying will also be higher!)

Depending on the lifestyle you’re used to, you may struggle to rely solely on your State Pension. This is especially likely if you’re still paying housing costs like rent or a mortgage, have children or grandchildren who are financially dependent on you, or you encounter unexpected expenses. 

Comparing your expected costs in retirement with the State Pension is a good place to start to see if this will be sufficient and if not, it will show you the size of the gap you need to cover from other places. 

When should I start saving for retirement?

Most experts recommend starting to save for retirement as early as possible. There are a few reasons why:

1. Compound interest: Starting to save early means you can benefit from compound interest. Compound interest is when you earn money on both your initial investment and the interest you earn. The longer you save, the longer your money has to compound and, therefore, the more significant the impact on your retirement fund. 

2. Market volatility: Saving for retirement often involves investing in financial markets because these have the potential to deliver high returns than savings accounts over the long-run, which gives them a better chance of beating inflation. However, unlike savings, the value of investments can go up and down. To maximise the benefits of long-term market growth and see out any dips, it’s sensible to open these accounts early in your career. Starting later may limit your ability to recover from market downturns and reduce your potential for long-term growth.

3. Make consistent smaller contributions: Starting your pension pot early can be a wise move because you can consistently save smaller, more manageable amounts over a longer period, avoiding the stress of having to make up for lost time with larger contributions later on. This approach makes it easier to achieve a comfortable retirement without impacting your standard of living day-to-day.

5. Tax Benefits: Workplace pensions, personal pensions, and ISAs are ways to save for your retirement and come with tax incentives. Starting early allows you to take full advantage of these benefits over a longer period, saving you more money in tax and increasing your overall savings.

6. Flexibility: Life is unpredictable – starting to save for your retirement early means you can adapt when circumstances change. You’ll have the flexibility to adjust how much you’re putting away to account for career changes and handle unexpected expenses. 

If you’re worried that you haven’t started saving for retirement yet, it’s important not to panic or stick your head in the sand. It’s never too late to start saving for your retirement and making small, consistent contributions will help make a big difference over time. 

What are the different ways to save for retirement?

There are several retirement savings options and the right one for you will depend on your circumstances. Many people find combining a pension and savings account an effective way to fund their retirement, but whether or not it suits you will depend on your appetite for risk and how much you can put away each month. 

Workplace pensions

Workplace pensions are provided by your employer, who will contribute to your pension every time you do. This effectively means you are getting free money from your employer to boost your pension savings.

Most workplace pensions are defined contribution pensions – with these types of pensions, the money you and your employer contribute is invested into stocks, bonds or funds. Your retirement income then comes from both the contributions made and the growth from investment. 

Some workplace pensions will be defined benefit pensions, although these are less common and usually only found in a small number of public sector jobs. They pay out a certain amount every year when you retire, usually based on your total earnings with that employer (known as career average pensions), or the amount you were earning when you left the company or retired (known as final salary).

To ensure people save for retirement, the government introduced automatic enrolment, which requires employers to enrol all eligible employees into a workplace pension scheme. Typically eligible employees are “workers” over the age of 22 which earn at least £10,000 a year. Even if you don’t meet these criteria, you should still be able to join your workplace’s pension scheme and your employer can not refuse if you request to.  

One of the main benefits of workplace pensions is the employer contributions. Additionally, your contributions are tax-free. If you are a basic rate taxpayer you will automatically receive tax relief, but if you are a higher rate taxpayer you may have to claim this back yourself depending on whether your pension contributions are taken from your wages before tax is deducted or not.

Personal pensions

Personal pensions, otherwise known as private pensions, are set up by you outside of your workplace pension. Personal pensions are a tax-efficient way to save for your retirement and are particularly useful if you’re self-employed, don’t qualify for a workplace pension or want to combine previous workplace pensions you’ve had. 

When you pay into a personal pension, the government will boost your contributions through tax relief, adding the tax you’ve previously paid on your contributions to your pension pot. For basic rate taxpayers, the tax relief is usually added automatically, but if you’re a higher or additional rate taxpayer you may need to claim this back yourself. You can find out more about how tax on private pensions works on the government website.  

Like defined contribution workplace pensions, personal pensions are typically invested to try and outperform inflation and these investments are managed by the pension provider. All investments come with a level of risk, and your investments could go down as well as up. 

Self-invested personal pensions (SIPPs)

SIPPs are a type of personal pension where you choose where your money is invested rather than having it managed by the pension provider. 

You have the option to pay a financial advisor to help you decide where to invest your money through a SIPP, though this could be expensive.

SIPPs are great if you’re an experienced investor or are willing to make risky investments with the help of a financial advisor for higher potential returns. Like other personal pensions, SIPPs qualify for tax relief. 

Individual Savings Accounts (ISAs)

ISAs are another tax-efficient way of saving. You can deposit up to £20,000 into an ISA annually without paying tax on any interest or returns earned. ISAs could be a good way of saving for retirement if you have a lump sum to invest. There are three main types of ISA you could consider saving for retirement with. They are: 

Cash ISAs

Cash ISAs work similarly to normal savings accounts, allowing you to deposit your savings and get paid interest on the balance. There are three types of Cash ISAs: fixed-rate, notice, and easy access. It's important to note that you’re limited to opening and paying into one cash ISA annually. ISAs operate based on tax years, from April 6th to April 5th of the next year.

Stocks & Shares ISAs

Stocks and Shares ISAs, also known as Investment ISAs, work in a similar way as cash ISAs. The difference is that instead of earning interest on your balance, your money is invested in stocks, shares, bonds or funds. You can self-manage your investments or invest in a ready-made portfolio if you’re new to investing. 

Stocks and shares ISAs have the potential for more significant returns than cash ISAs, but they come with risks which means you could lose some or all of your investment. 

Lifetime ISAs (LISA)

Lifetime ISAs are designed to help people save for their retirement or purchase their first home. You can open a Lifetime ISA if you’re between the ages of 18 and 39 and can make contributions until you’re 50. You can hold either stocks and shares or cash Lifetime ISAs. 

For every £4 you contribute to a Lifetime ISA, the government adds a 25% bonus, up to a maximum of £1,000. The maximum amount you can contribute to a Lifetime ISA each tax year is £4,000. You can access your LISA funds after you turn 60 (you can access them before, but you’ll lose your 25% bonus). You can withdraw funds without penalty before you’re 60 if you’re using them to purchase your first home. 

It’s important to note that the £4,000 annual Lifetime ISA limit counts towards your £20,000 annual ISA limit. This means if you were to put £4,000 into a Lifetime ISA, you’d only be able to put £16,000 into other ISAs in the same tax year. 

Savings accounts

If you have a low appetite for risk, and don’t feel comfortable with putting your money into pensions or accounts that invest your money, then a savings account may be a better choice for you. 

Typically savings accounts offer lower returns than investments, but there’s no chance of losing your contributions through market fluctuations. Easy access or regular savings accounts will allow you to make small, consistent contributions to your retirement fund, whilst earning interest on your balance.  

Fixed-rate accounts can be a good option because they often provide higher interest rates than easy-access accounts and can help to remove the temptation to dip into your retirement savings. However, it’s typical for fixed-rate savings accounts to have a maximum term of ten years, although it’s possible to find providers who offer longer terms.

Is it better to have a pension or a savings account?

Whether a pension or savings account is best for you will depend on your circumstances and appetite for risk. Savings accounts are low-risk and provide a safe place to save for retirement. 

The main drawback of keeping cash in savings accounts for an extended period of time is that most providers don’t offer interest that will offset long-term inflation, so the money you save may be worth less in your retirement than it was when you deposited it. 

Pensions and other forms of investment typically increase in line with inflation and can therefore offer more significant returns. However, they come with risks and, like all investments, can potentially lose money. This is less likely if you invest in established companies over a long period of time.

However, you don’t have to pick one or the other – many people choose to save for their pension through both investments and savings. This enables them to make the most of both tax-efficient, higher-earning pensions and investment accounts and low-risk, reliable savings account. You might also consider putting more into the stock market when you’re younger and have more time to ride out any market dips, then switching to lower risk investment assets or savings accounts as you get closer to retirement.