What to do with your pension in your 40s

When it comes to saving for retirement many of us bury our heads in the sand. It’s easy to leave it so long that you fall into the trap of feeling it is too late to start. However, this is not the case and there are lots of things that savers in their 40s should be thinking about as they build their retirement pot.

It’s never too late to start

Although ideally you would have already started saving in a pension by your 40s, this won’t be the case for everyone.

If you are employed your workplace pension is the first place to start when saving for retirement. At a minimum your personal auto-enrolment contribution will be 4% of your earnings between £6,240 and £50,000, with your employer matching up to 3% and a further 1% coming via pension tax relief. But some employers may offer more generous matching. Bear in mind that if you opt out of your auto-enrolment scheme you’ll effectively be refusing free money, so make sure you stay in if you can afford to.

One very rough rule of thumb is to take the age at which you started saving into a pension and halve it. That should then be the percentage of your salary you contribute each year. For example, if you’re 40 and have just started saving for your pension this would mean you need to save 20% of your salary.

Don’t let these numbers scare you though – these percentages would include any contributions from your employer and tax relief. Even so, such a level might be beyond your means, but the principle should be to put as much as you can afford into your retirement savings.

Don’t panic

If you are in your 40s and haven’t started saving for retirement yet, don’t panic – you are not alone. Lots of people at this stage of life will have spent most of their 20s and 30s saving for a house, building up their career, raising young children or in training or education.

On top of that, millions of people – including low earning employees and the self-employed – are not included in auto-enrolment. It means you might have missed out on contributing to a pension or have put it off until another day.

Remember that even if you don’t qualify for a matched employer contribution through auto-enrolment, pension tax relief still provides a strong incentive to save for retirement. This will automatically convert an £80 contribution into a £100 in a pension, while higher and additional-rate taxpayers can claim back extra tax relief from HMRC. Some workplace schemes – such as salary sacrifice pension arrangements and ‘net-pay’ schemes – will pay this extra tax relief automatically, provided your contribution comes from salary 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.

Make a plan (if you haven’t already)

For most people in their 40s, there will be competing financial priorities. For example, many will have their sights set on paying off debts, saving for a first home or building a pot of money for their children’s further education. But if you can get a plan in place you’ll be able to work out how much you can afford to put into your pension.

Try and block out a wet Sunday afternoon when you can write down your outgoings and incomings, so you know what you can spare each month. If you haven’t already, it also makes sense to build up a decent-sized ‘rainy day’ fund in an easy access cash account in case of emergency. Aiming to have around three months’ fixed expenses in this emergency account is a good place to start, and make sure you shop around for the best interest rate you can find.

Once you’ve got that sorted, you can figure out how much you can afford to pay into your pension.

The right investment strategy

Getting the right investment strategy in place is a crucial part of retirement planning. This will be determined by several things, including your attitude to risk and how long you have until you plan to retire.

If you’re in your 40s, in most cases you won’t be planning to access your retirement pot for 20 or even 30 years. This is a long period in anybody’s book and should provide scope to take some investment risk.

Your employer picks your auto-enrolment pension for you. The ‘default’ investment fund, assuming you do nothing, benefits from a cap on charges currently set at 0.75%. But this fund won’t be tailored to your risk appetite and needs, so it’s worth checking out whether it’s right for you.

If you’re choosing your own investments in a product like a SIPP, once you’ve established the level of risk that you’re happy with, it’s crucial to keep your costs as low as possible. Over times costs can really eat into the value of your pension, particularly when you are dealing with a time frame which runs into decades.

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

It’s also important to ensure your investments are spread or ‘diversified’ around different sectors and countries so you don’t have all your eggs in one basket. If you aren’t confident in doing this yourself, you can pay a fund manager to do it for you.

Having reached the point where you are comfortable and satisfied with the risk profile and individual components of your investment portfolio, you should be able to sit tight until you are around five or 10 years from retirement. Most of the time the last thing you want to do is trade too often as this will layer on extra costs with no guaranteed benefit.

The tapered annual allowance

While most people enjoy a £60,000 pensions annual allowance, higher earners face a smaller limit. There are two different measures of income, and you must earn more than £200,000 (threshold income) in one measure of it and more than £260,000 (adjusted income) in another. Both income measures include not just salary but other taxable income too. Threshold income also deducts any personal pension contributions, while adjusted income adds employer contributions.

Anyone who exceeds these limits will have their annual pension allowance reduced by £1 for every £2 of adjusted income earned above £260,000, to a minimum of £10,000 for those with adjusted income of £360,000 or more. If you breach your allowance the taxman will come for any tax relief you have received over and above your annual allowance.

You can find out more information here to see if you breach the limits.