What to do with your pension in your 20s and 30s

Pensions offer people of all ages the opportunity to grow their hard-earned savings in a tax efficient way, providing an upfront incentive via tax relief and tax-free investment growth.

On top of that, when you reach the age of 55 you can access 25% of your pot tax-free and have total flexibility over how you draw an income.

However, what you prioritise is likely to evolve as you go through different phases of your life. Let’s now consider some of the key things that savers in their 20s or 30s should be thinking about as they get started on their retirement journey.

The earlier you start, the easier it is

Anyone aged 22 or over who is employed and earning £10,000 or more should be automatically enrolled into a workplace pension scheme.

When you are auto-enrolled at least your first 3% of contributions are matched by your employer. If you opt out of auto-enrolment you’ll be waving goodbye to this free money forever, so make sure you stay in the scheme if you can afford to.

The minimum auto-enrolment contribution is 8% of earnings between £6,240 and £50,000 – of this, 4% comes from the employee, 3% from the employer and 1% via pension tax relief.

How much should I save?

A rule of thumb is to take the age at which you started saving into a pension and halve it. That should be the percentage of your salary you contribute each year. For example, if you start saving at 20 then you aim for 10%, while delaying until 30 means you’ll be targeting 15%, and waiting until you’re 40 will mean you need to set aside 20%.

Don’t let these numbers scare you though – these percentages would include any contributions from your employer and tax relief. Also, any money saved in a pension is a good investment. Be aware that by taking the bull by the horns and starting early, the journey will be much easier.

Have a budget and write down your savings goals

For most people in their 20s and 30s there will be many competing financial priorities. For example, you may have your sights set on paying off debts or saving for a first home (or both).

Clearly all of us only have so much money and it’s unrealistic to save every penny you earn, but writing down what you have coming in and going out is a good first step to understanding what you can afford to set aside for later life. And the earlier you do this, the easier it will be.

What is pension tax relief?

If you think you can afford to save above and beyond your workplace pension, your contributions will benefit from pension tax relief, which is 20% of your contribution. This will automatically convert an £80 contribution into £100 in a pension, while higher and additional-rate taxpayers can claim back extra tax relief from HMRC.

Some workplace pensions – such as salary sacrifice pension arrangements and so-called ‘net pay’ schemes – will pay this extra tax relief into your account automatically, provided your contribution comes from salary that is taxed at 20% or higher.

Because of this generous tax treatment, you can usually only pay up to £60,000 into a pension each year, so long as you have earnings up to that amount.

Think about your investments

While how much you pay into your pension (and how early you start) is arguably the key factor in determining your eventual retirement outcome, your choice of investments can provide a significant boost too – particularly over the longer term. If you’re in your 20s or 30s, your investment time horizon is likely to be 30 to 50 years, which is a long time in anyone’s book.

Your auto-enrolment pension will be picked for you by your employer. If you take no action, you will be placed into the ‘default’ investment fund, which benefits from a cap on charges currently set at 0.75%. This fund will not be designed based on your personal attitude to risk. Different default funds have vastly different investment strategies, meaning they deliver different investment outcomes for their members.

At the very least you should have a look at the default fund your money is going into and make sure you are happy with the investments you own and the level of risk you are taking. You might decide that you’d rather pick your own investments from the range on offer to you.

While attitude to risk differs from person to person, generally younger investors can tolerate greater fluctuations in the value of their pot over the short-term as they don’t need to access the money for decades. Historically, those who have been willing to accept volatility over the short-term have generally been rewarded via returns over the long-term.

Can I run a pension myself?

As a general rule of thumb, you should maximise any employer pension contributions before setting up your own personal pension. But if you want to save in a pension such as a SIPP (self-invested personal pension), you’ll enjoy a whole world of choice for your investments.

If you aren’t confident in choosing individual stocks or bonds, you may want to look at funds or investment trusts where a fund manager will select everything that goes into their portfolio.

An alternative is to use a tracker fund or exchange-traded fund that mirrors the performance of a specific basket of stocks, bonds or other asset classes, or a mixture of them.

Lots of ISA and SIPP providers also offer ready-made portfolios based on attitude to risk, ranging from cautious to adventurous. You can usually choose between ‘active’ funds – which are run by a manager trying to beat the market – or ‘passive’ funds, which simply track an index.

Look at the charges

If you’re picking your own investments, once you’ve established the appropriate level of risk it’s crucial to make sure that you keep your costs as low as possible. This is because even small differences in charges can compound over time to wipe thousands of pounds off the value of your pension.

In terms of cost, active funds tend to have higher charges than passive ones (although active managers say this charge is justified because they have the skill to deliver higher returns).

Once you’re happy with your attitude to risk and the investments you have chosen, there should be no need to do anything to your portfolio until you are around five to 10 years from retirement, apart from checking that nothing has changed to the investment case of each asset. In fact, in most cases the last thing you want to do is trade too often as this will layer on extra costs with no guaranteed benefit.