Pensions are for risk takers

“If you’re not willing to risk you cannot grow”

— Les Brown

Pensions are for old people, right? They’re the puny amounts of money old dears have in their purses that’s just enough to buy them a newspaper, right?

Ah… no. Dare I say it, pensions are sexy… Alright, no, they’re not sexy. But they are pretty awesome. I wrote about the dazzling benefits of pensions here, but in this post I wanted to stress what a pension can do for you.

Personal finance is a lot about taking calculated risks. When we hear the word risk immediately we go into defence mode and want to avoid risk. But risk is what creates wealth. If you saved £100 a month for 45 years and stuffed it under your bed, you’d have a nice sum of £54,000. Not bad. But inflation, which is the increased cost of goods and services, would have eating into the £54,000. As I wrote before, my dad purchased our family home for £18,000 in 1980. Today, 2020, £18,000 won’t get a two year old VW Tiguan. But, if you were to put that £100 into a low cost index fund, such as one from Vanguard, and did that every month and got a yearly average return of 8%, then your £54,000 would be approximately £480,576. That’s over £400,000 difference just by taking a calculated risk.

And remember, you’re doing exactly the same with your pension. You’re putting money in each month and over the years that money is increasing and building more and more money with the compound interest it creates.

So, let’s get back to why pensions are for risk takers.

Let’s assume that age 20 you started putting in £210 into your pension each month for 45 years. Now if you are employed that £210 will be made up of at least 3% from your employer, and the government will give you either a 20% tax relief or 40% tax relief depending on your salary. So that £210 will actually cost you a lot less. Now after 45 years in a fund paying 8% average yearly return, your pension will be… wait for it… approximately £1,009,211.

Yes, you read that right. Your pension will be in the region of one million pounds!

How did that happen? It’s a combination of time, contributing every month, and compound interest.

So how are pensions for risk takers, if the above all seems pretty standard stuff? Well, that’s just it. The pension is an amazing safety net. If you contribute regularly over a long period of time it just keeps building and building. You don’t even notice it. But, because it’s building and building in the background and you know that if all else fails when you hit retirement you can live comfortably, then the world is yours to take.

Want to start a side business? Then do it. The business might be a success and you make millions, or it might be a complete failure. But because you’ve got the pension bubbling in the background you can afford to take that risk and seize the opportunity.

Want to invest in the stock market? Then do it. If you invest in low cost index funds you’ve got a great chance of making money in the long term, just like your pension.

Want to invest a lump sum on a single stock, such as Tesla? Then do it. There’s a chance you stock will race up, but, don’t forget there’s a chance it won’t, but if you’ve got the pension to fall back on when you retire than maybe take the risk… Note: this is hard for me to say the above as I’m not a single stock picker, but an index fund man.

Want to change jobs and do something less stressful? Then do it. As long as you keep contributing to your pension then the safety net is there for you.

Just from those four options above, they would halt most people into not taking action. The risk of losing money is just too risky. But most people don’t think about the pension safety net. Most people only think about what is in their bank now, what is in their wallet or purse now. They don’t think long term.

Personal finance is a long game. A long journey. If you have a pension that you contribute to every month, and you increase those contribute amounts on a regular basis, worst case every year, and you’re in a pension fund that offers good returns, by the time you retire you’ll be rich.

So why not take a risk? Life it there to be lived. You can’t afford not to take a risk.

Workplace pensions are for mugs

Motivation is what gets you started. Habit is what keeps you going.

— Jim Rohn

Workplace pensions are for mugs.

One of the basic rules with creative writing is to hook your reader with an exciting opening sentence. “Workplace pensions are for mugs” sparks interest for a type of person. This person is contributing into a workplace pension and is now panicking that they are a mug.

Well, the opening sentence was a trick. Actually, a lie. A bit like sending an email to your colleagues with “free lunch” in the subject, you just wanted to make sure they read it. I think workplace pensions are bloody amazing!

Below are the things I know about pensions. Please note, I’m no pensions expert. Please do research yourself, I might be wrong.

What’s a pension?

A pension is something your grandparents had. It’s a pot of money that gets saved up over their working lifetime, and they used it to pay for their retirement years once they stopped working and earning a salary. Pensions are about as sexy as a mauve, velour tracksuit.

There are three types of pensions… that I know of anyway.

The New State Pension – This is the pension the government gives you. It is currently £168.60 a week. I hear people moan about how low this is, but I’m not too sure. If I wasn’t getting robbed each month with my extortionate mortgage repayments, I think £674.40 a month covers a good number of my expenses: electricity, gas, water, council tax, internet, TV licence, petrol, internet, line rental, mobile phone and still I’d have about £140 spare. That’s not bad, but I do work hard on keeping those expenses low. Now of course, I can’t survive on £140 a month, £35 a week, £5 a day; well I could, but it wouldn’t be much fun and there’s only so many Tesco’s value price beans a man can eat. My windows would be constantly open and I’ll spend a fortune on Febreze. Anyway, don’t knock the new state pension. There are rules to getting the full amount of £168.60, such as you need to have paid National Insurance Contributions for 35 years, but over a normal working life that should be achievable. When writing this I’m 39 and when I calculated this on the government website I should have reached my 35 year target in about 12 more years. One other plus point is the pension rises with inflation, which as we should all know, inflation is the killer of savings in the bank.

Personal pensions – These are pensions you set up without your employer contributing. An example would be someone who is self employed, like a trades person. They don’t have an employer, they are their employer, so they open a pension and add money in there every month.

Workplace pensions – This is a type of pension where you contribute money every month and so does your employer. It all goes into your pension pot. This post is all about the workplace pension.

What’s a workplace pension?

Pensions can be complicated beasts, but don’t let that stop you reading, I’m dumbing this down to a level that I can understand. If you need more information on pensions, go to the government’s amazing website The Money Advice Service. The work that department have done is superb. If you read everything on their website you’ll be set for life. One thing that is often mentioned with pensions is when you’re approaching your retirement age, you should consult a financial adviser to help you make a decision.

Alright then, a workplace pension is a beautiful thing.

But let us first work out what “contributions” means. A contribution is an amount of money you contribute (put it) to your pension “pot”. So when someone says, “I’m contributing £100 into my pension” they are putting in £100 a month into their retirement pot. If they did this every month for a year they would have contributed £1,200 in their pension.

Now, with workplace pensions your employer (the company you work for) has to also contribute to it. And they have to use their money, not your money. Result! So, if they contribute £50 a month, they are putting in £50 a month into your retirement pot. If they did this every month for a year they would have contributed £600 into your pension pot.

So you’d have your £1,200, plus their £600, resulting in £1,800 contributed.

That’s contributions.

The magic of workplace pensions

When you join a company as an employee, you are automatically enrolled into your workplace pension plan. This means that you must contribute a minimum of 5% of your salary and your employer must contribute 3%. I’m hesitant to write this, but you can then decide to opt out and not be in the pension. Only a raving lunatic would do that, which I did at a previous company as I thought I’d only be there for three months. Eight and a half years later I left… with no pension. Idiot! The company was contributing 6%! That’s a lot of free money I missed. Idiot! Move along now.

Let my foolish mistake be a lesson you can learn from and avoid.

Below are as many benefits of workplace pensions that I can think of:

  1. Automatic enrolment – As above, this is all set up for you when you join a company. You don’t have to think about pension providers, setting up direct debits, how much to pay in, etc.
  2. Regular contributions – If you’re reading this blog because you’re struggling to save, then workplace pensions are a great thing for you, as the money comes out of your salary before it goes into your bank account, every month. So you can’t get your hands on it and blow it on more junk like a backup plasma screen TV in case your other one breaks.
  3. Free money – Your company contributes at least 3%, every month, so that’s like getting a 3% pay rise. A lot of companies do more. Mine does 7%! I heard if you work for The Bank of England it contributes 55%. That can’t be true, but I wish it was.
  4. More free money – The government are pushing workplace pensions hard. They understand how difficult life will be when we’re pensioners and a Mars bar costs the equivalent of a VW Tiguan nowadays. The government gives you tax relief on all your contributions, so you don’t pay tax. Let me say that again in case you read it fast. You. Don’t. Pay. Tax. Yes, you don’t pay take on your contributions. And that tax you saved goes back into your pension pot as well!
  5. Percentage increase – One of the keys to building wealth is percentage increases. If you are contributing 5% of your salary, let’s say that’s £100 a month. Next year, if and when you get a pay rise, the 5% will no longer be £100, but say £120, so you’re saving £20 more a month. The same goes for your employer’s contributions, their 3% which was £50 is now £55! You didn’t need to do anything, it’s automatically done for you. And the great thing is, as it changes when you get a pay rise, you don’t even feel the loss in your pay packet, as you’ll still get a bit more from the pay rise. I should also note here that your 5% contribution is the minimum. You can contribute much more that 5%. The annual allowance limit, as of 2019, for the current tax year is £40,000. I believe you can use allowances from the previous three years, but best to do some research first.
  6. Investing – Pensions are invested into “funds” by your pension provider. They put your money in a fund that holds things like shares, bonds, property, cash, all that stock market jazz that the majority of us are not aware of. They do it all for you. So if people ask if you invest in the stock market, you can say, “Yes”. Look at you, you’re a regular Gordon Gekko!
  7. Locked away – People get a little concerned when they realise they can’t get to their money until they’re old. This was a big blocker for me. But as Hunter S Thompson said, ” Buy the ticket, take the ride“, now I’m pleased that the money’s locked away. Currently, the earliest you can get to it is 55 without incurring crippling fees. But experts recommend you take it much later than that to enjoy adding more contributions and compound interest. But, actually, not being able to pull the money out and blow it on a holiday to dusty, boiling Spain is a good thing. The money keeps increasing and the interest keeps compounding and the more money you save, the better it is for you when you want to retire. If you’re reading this and trying to learn how to save, this is a full-proof way to save. That money is automatically taken and locked up.
  8. Take it with you – One reason why I never got into pensions in my early years was because I loved to have the freedom to move jobs. I was worried I’d have 15 little pensions scattered all around and wouldn’t be able to keep hold of them. Now, this is no longer a problem, it probably never was, I was just financially naive. You can easily move your pension value from your old company to your new company and accumulate all the pensions into one, so it’s easy to manage. I did this with a customer and it took two minutes to move an old pensions to his new company. Note: always read your pension document before moving it, as there might be great benefits that you’ll lose by moving your pension from one provider to another, or there might be charges. So have a check and if you need help consult the government’s website The Money Advice Service or the government’s Pension Advisory Service website, or a Financial Adviser.
  9. Lump sum – When you’re retired and ready to start taking your pension, the government allows you to take a lump sum of 25% of your entire pension tax free. Let’s say you have £800,000 in your pension when you retire. That means you can withdraw a cool £200,000 tax free. Imagine that hitting your bank account and the good you can do with it.
  10. Pass it on – Not planning on living to 75? Great! You can pass the pension onto your spouse and they receive it, wait for it… tax free! Plus, wait for it… it doesn’t come out of your inheritance tax. See government website about inheritance tax, it’s the only tax I hate. Die after 75 and you can still pass it on, but your spouse gets taxed on it like a salary. Still, better than it disappearing.
  11. Tax relief – I hinted on this above, but it’s just wonderful to get tax relief. If you are a basic tax rate payer and you contribute £100, it only costs you £80, as the government return the other £20% to your pension pot. So you’re getting an immediate 20% return on your investment. That’s Warren Buffett type of investment returns. Also, speak to your employer as you can also add bonuses, again tax free, into your pension. If you get a £1,000 bonus it all goes into the pension. If you were to tax the bonus and put it into an ISA rather than your pension, then you’ve lost £200 big ones in tax. If you’re a higher rate tax payer, you’d lose 40% of that bonus, £400! Plus don’t forget good old National Insurance Contributions on top of that as well. But, if you invest it in your pension, you get to keep all £1,000.
  12. Compound interest – And, and, and, the best thing is, that £400 that you didn’t get taxed on goes into your pension, and what does it do? It grows. It builds and builds, generating more and more money over the years. £400 investing in a fund that provides 8% returns equals £4,025 over 30 years, over 40 year it’s £8,690. And remember, that’s only £400. You’re pension will be vastly bigger. So imagine how much a decent sized pension can grow. As they say, “Get rich slowly“.

There must be dozen more benefits to workplace pensions that I’ve not mentioned, but the things I’ve said should indicate they are essential. If the above still doesn’t convince you, then ask yourself this, if at the end of each month you have a little amount of money, or no money, or worse, go into debt to pay for your lifestyle, what’s going to happen when you stop working and no longer get a salary? As they say in John Grisham novels, “I rest my case.”

Here’s the government’s website about workplace pensions. Their website is great. Clear to read, easy to understand, and remember, they run the shop, so that’s always the best place to begin when doing your own research into anything regarding finance.