Should I opt out of my workplace pension and think about retirement savings later in life?

Workplace pensions can be incredibly powerful savings vehicles. Your contributions are topped up by additional money from your employer and the government that can double the value of what you put in before it’s invested. 

It’s also probably the simplest way to invest. If you work at a company, are aged 22 or older, and earn over £10,000 per year, you are automatically enrolled in a workplace pension unless you choose to opt out. As of 2022, about 10% of people chose not to put money into their pension, according to the Department for Work and Pensions.  

But is choosing not to invest in your pension ever the smart way to go? Someone in their twenties or even thirties might think they’ve got more pressing needs for their money and that retirement saving is something to worry about later in life. Perhaps you are focusing your savings on getting on the housing ladder, or simply feel your budget is too tight to be sacrificing any of it for the future. 

It’s understandable to think that way, yet everyone will need to save for retirement and the sooner you start, the better. You could live to regret opting out of a workplace pension. 

How your money is handled in a pension 

If you work in a job where you’re automatically enrolled in a pension, 8% of your salary goes into the scheme as a minimum. This is broken down as follows: you contribute 4% of your salary, while your employer contributes 3% and you receive an additional 1% in tax breaks from the government. That money is put into a pension fund, where it is invested in the market. 

Let’s say you begin your career at 22 and would like to retire at 60. You have 38 years to invest in your pension. If you begin on a salary of £30,000, you will contribute £1,200 into your pension in the first year, and the same amount again would come from your employer and tax breaks, based on the minimum levels under auto-enrolment rules. 

If your salary increases by 2% each year, and your pension generates a 5% return each year after charges, your pension pot could grow to £358,107 by the time you turn 60. If you delay paying into your pension for 20 years, by the time you are 60 you’ll accumulate less half that amount, at £122,119. 

Source: AJ Bell. Based on a £30,000 starting salary at age 22 that goes up by 2% every year. Assumes 4% personal contribution, 3% employer contribution and 1% tax relief is paid into the pension; 5% annual investment growth after charges 

Choosing to opt out 

A lot of younger people might think it’s pointless saving into a pension until they’re older because the money is locked away until they are at least 57.

What if you chose to opt out of your pension and save for a house instead? If you took that same £1,200 starting contribution and put it in a Lifetime ISA to save for your first home, you would also receive a government bonus of 25% each year (capped at £1,000) up until you turned 50. The bonus works out at £300 in the first year on this contribution amount – the same as the tax relief paid into the pension. 

But you wouldn't get money paid in by your employer too. With the pension, your £1,200 contribution in year one means £2,400 going into your pension via auto-enrolment when also factoring in the employer’s contribution and government tax relief. Going down the Lifetime ISA route means your £1,200 contribution turns into £1,500 being fed into the account when including the government bonus.  

If you start investing at 22, you can make contributions into a Lifetime ISA until you are 50. It’s likely that you would want to purchase a home well before that point, such as by the time you turn 30. 

Starting with £1,500 contribution in year one (including the government bonus) and increasing your contribution by 2% for eight years would equate to a pot worth £16,054 at the end, based on 5% annual investment growth after charges. 

At that point you would be 30 years old. If you then used the Lifetime ISA to start saving for retirement, you could make 20 years of contributions before you the account type will no longer accept new money. Once you turn 50, you would be dependent on existing investments growing in value as no further contributions could be made to the Lifetime ISA. You can withdraw money without penalty once you turn 60. 

Let’s assume you continue the strategy of increasing contributions by 2% a year. The final contribution to your Lifetime ISA for the home purchase strategy was £1,378, which means your first contribution for the retirement strategy is £1,406. Achieving 5% annual investment growth after charges would give you a pot worth £122,813 once you hit 60. That might seem like a lot of money, but it may not be sufficient to meet your lifestyle needs during retirement. 

An alternative to starting your retirement savings at age 30 is to use your workplace pension or a SIPP (self-invested invested personal pension) rather than a Lifetime ISA. 

If your starting salary at 22 was £30,000, a 2% annual pay rise would mean you’re on £35,150 at age 30. If you pay in 4% of your salary (which is going up by 2% a year), receive 3% employer contribution and 1% tax relief, together with 5% annual investment growth after charges, by age 60 your pension would be worth £264,793. 

Not all employers will make contributions into a SIPP so you might be restricted to a workplace pension if you want to make the most of their generosity. 

While the pension strategy means a much bigger pot at 60, a Lifetime ISA will be completely tax-free whereas 75% of the pension money is taxable when you take it out of the pot.