Why you should boost your pension with your savings

If you think savings rates just aren't good enough, should you plough your hard-earned cash into your pension instead?

There's no question savings rates are pretty rubbish these days. If you want easy access to your cash, the best return you can hope for is about 3%. And if you lock your money away in a fixed rate bond, the most competitive accounts are only paying around 4%.

Worse still, there are plenty of accounts which pay even lower rates. The average easy access savings account is now paying a truly pathetic return of 0.63%. No thanks!

But is there a better way to save?

Many savers are starting to think shares could be a more profitable home for their cash, particularly now savings rates are so poor. I'm not suggesting you risk all your savings on a stock market flutter, but have you thought about starting - or topping up - your pension instead? After all, to build up a decent-sized pension pot, you should put in as much money as you possibly can.

Of course, if you need to be able to get your hands on your cash for spending, pensions are a no-go area because your money will be tied up until you retire. But if that doesn't worry you, a pension could give you much healthier returns.

Let's say you have £100 to put by every month. How much could you potentially earn over the next 30 years if you chucked it in a traditional savings account compared with a pension scheme?

Savings accounts versus pensions

 *1% is deducted from this rate to represent the annual charge on the pension fund to give the final fund value. The figures don't take tax or inflation into consideration.

I'll assume your pension fund is invested in the stock market. Historical data shows that shares generally perform better than the return on cash over the long term. But there's no way of knowing whether this will continue to happen in the future.

Of course, the estimated rates of return I have used could be very different from actual performance over the next 30 years. That said, if we accept my estimates for now, you could end up with a nest egg worth over £58,000 using a traditional savings account.

But you would be far better off with a pension fund that performs well over the next three decades. This time you could accumulate a final fund value of more than £100,000 - that's an extra £42,437!

But you could argue a 7% annual rate of return on a pension is a pretty ambitious target in the current climate. How likely is it that the stock market will return this level of growth every year for the next 30 years? Not very, I would guess. And on top of that, if your particular pension fund isn't well managed, it could easily underperform the market. (My editor, however, is more optimistic. He reckons there's a good chance we'll see a 7% annual rate of return over the next 30 years.)

Anyway, if you're happy to take the risk and you pick a top performing pension fund which does well over the long term, you could reap far higher rewards than a savings account could generate.

Tax relief

Another plus for pensions is that you will benefit from an instant boost in the form of tax relief. Getting tax relief effectively means you'll get the tax back that you have already paid on any money you earn, and then place in a pension scheme.

If you're a non-taxpayer or a basic rate taxpayer, you'll enjoy tax relief of 20%, while higher rate taxpayers will benefit from an uplift of 40%.

So, how does this affect your pension contributions?

If you want £100 to be invested in your pension, then as a non- or basic rate taxpayer, you'll only need to pay in £80 out of your own pocket with £20 in tax relief paid into your pension by the revenue. Meanwhile higher rate taxpayers will only need to pay in £60, with a £40 boost in tax relief taking the total contribution to £100.

But by putting your savings into an ordinary savings account, there are no tax benefits. If you want to save £100, then you'll need to pay in £100 - simple as that.  

Pension or savings, savings or pension?

If you're truly ticked off with savings rates then it may be time to look elsewhere. We all need to save up for retirement, so there's nothing stopping you paying extra into your pension - at least until the return on cash improves.

But don't forget, unlike savings, investing in a pension is more risky. That said while the stock market has certainly been choppy lately, money invested for the long haul always has the potential to provide better returns.

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