Why pensions aren't always worth it

Does saving up for a pension always make good financial sense?

If you don’t have pension savings or any other source of income, you’re destined for a retirement on nothing more than the basic state pension. At today’s rates that amounts to just £97.65 a week, assuming you have paid enough national insurance contributions to qualify for full amount from the government.

That's not a lot of money, so, at first glance, it seems obvious that we should all try and build a bigger pension pot for our twilight years. But the trouble is, the government may effectively take back some of what you've saved,  and render the whole exercise a bit pointless. In other words, if you’re on a low income in retirement but you have managed to save up for a small pension, you may not actually be that much better off. So what should you do?

First, let's look in more detail at what pensioners are entitled to from the state.

Pension Credit

On top of the basic state pension, you may be entitled to Pension Credit, as long as you have reached state pension age. It guarantees a minimum weekly income of £132.60 if you’re single or £202.40 if you have a partner. This benefit is known as the Guarantee Credit.

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The Savings Credit provides a maximum extra weekly payment of £20.52 if you’re single or £27.09 if you have a partner.

So what happens if you have pension savings? Will you lose your right to Guarantee Credit and Savings Credit?

How does Pension Credit work?

Let’s assume you’re 65, single and you’re entitled to the full basic pension. You haven't saved in a pension of your own and you have no other income/earnings/savings. In this situation your income in retirement would be just £97.65 a week. This means, you’ll get Guarantee Credit of £34.95 to bring your income up to the minimum of £132.60 a week.

In the next example, let's assume you saved in a pension during your working life which now provides you with an income of a further £20 a week. This means your retirement income will step up to £117.65 a week. But, because this falls short of the minimum guaranteed income of £132.60 a week, you'll be eligible for extra payments.  

Because you have made some provision for yourself by saving up enough to buy an extra weekly pension of £20, your total income will be step up to £144.15 a week. This includes extra Guarantee Credit and Savings Credit payments of £26.50 a week.

Here's how this amount is calculated:

To work out how much Savings Credit you qualify for we need to look at how much money you have coming in each week over a set level which is currently £98.40 (for a single person). In this case, you have £19.25 a week over this amount (£117.65 - £98.40).

You can qualify for an extra 60p for each £1 over that level which amounts to £11.55 a week. Remember, in any case, the minimum guaranteed income is £132.60 a week, so with an extra £11.55 of Savings Credit to reward your personal pension savings, your total weekly income then comes to £144.15 (£132.60 + £11.55).  

Comparing these two examples, you'll have an extra £11.55 a week in return for saving in your own personal pension compared with making no provision of your own whatsoever. But you can see this is problematic. You have saved enough during your working life to provide yourself with an extra £20 a week. But you'll actually only end up £11.55 a week better off than someone who hasn't bothered to save at all because of the means-tested pension benefit system.

This is one situation where you might consider saving in your own right might not be worth it if you expect to be on a relatively low income once you retire. After all, to generate a pension of £20 a week, you’ll need to save up a pension pot of around £15,000 over the years*.

You should also note that Savings Credit is reduced by 40p for each £1 of income you have above the Guarantee Credit level of £132.60, or £202.40 if you have a partner.

What about my savings?

You’ll also need to be careful about the amount you have in savings/capital if you think you may have a low to moderate income in retirement. If your savings are too high, it could affect your means-tested benefits too.

For the purposes of calculating your entitlement to Pension Credit, your ‘assumed income’ will also be deducted. This means you'll be considered as having £1 of extra income a week for every £500 - or part of £500 - you have in capital over £10,000. Capital includes your savings, investments and property that isn’t your main residence.

Other sources of income will also be deducted from your entitlement to Pension Credit. This includes:

• Income from the State pension
• Income from occupational and personal pensions
• Most social security benefits such as Carer’s Allowance
• Any post-tax earnings you have from continued employment or self-employment
• Half of any occupational or personal pension contribution

Should I stop saving?

Recent question on this topic

• hammer asks:

  I am contributing £110 per month in order to receive a monthly pension of £123. Am I stupid? Should I save in an ISA instead?

  • 
    SoftwareBear answered "How old are you now ? What age does this plan say you will retire ?..."
  • 
    hammer answered "I am 58 and retire in 8 years...."
  • Read more answers

Even though a small personal pension could be reduced by means-tested benefits, I think it’s extremelyrisky to stop saving for your retirement altogether. That's because there’s no promise that benefits which are available to pensioners today will still be around when you come to retire. If you have made no provision for your retirement yourself, you could be left in a very sticky financial position once you stop working.

There’s also no certainty that the basic State pension will continue to be paid to future generations of pensioners. So I think it’s important you do something to plan for your retirement, whether you choose the traditional pension route or a different strategy.

If you’re close to retirement and you think you may be eligible, get a Pension Credit estimate.

*Based on a male retiring at age 65, with no spouse’s pension provided, level payments and no guarantee period.

This article has been updated for 2010.

More: How David Cameron plans to mess with your pension | Stop using a pension to save for retirement