Pension or savings: Which is better?

How do you choose between a pension or savings, and which is better?

Planning for your future is crucial, but it can be tricky to get your head around all of the various options. Should you start adding to a savings account? Or, is it better to top up your pension every month? And where do you go for support? 

If you’re feeling overwhelmed, confused or even intrigued, this guide is for you. 

From outlining the pros and cons of pension plans and savings accounts to helping you understand which is right for you, we have everything you need to make an informed decision. 

After all, it’s never too early to start thinking about retirement…

Pension or savings: Which is better?

There’s not necessarily a right or wrong answer here. Ultimately, the route you go down will depend on your financial situation, goals and preferences. 

For example, if you value financial security and a guaranteed income in retirement, you may want to explore the idea of a pension plan. On the other hand, if you’re looking for a little more flexibility or you prefer more control over your investments, setting up a savings account might be the way to go. 

What to consider before choosing between a pension or savings

  1. What are your long-term financial goals? 
  2. What stage of life are you in? Are you at the start of your career or are you nearing retirement?
  3. What is your current employment situation?
  4. What is your risk tolerance?
  5. Do you want easy access to funds?
  6. Do you fully understand the tax implications of both options?
  7. What sort of lifestyle do you want when you retire?

These questions should get you thinking about which option is right for you. But to make things a little clearer, here is a breakdown of each:

A quick guide to pensions

In simple terms, a pension is a retirement plan that provides regular income to individuals once they’ve stopped working. This is usually offered by employers, although personal pension plans are also an option. It works a bit like a savings account, although you can’t actually set up a pension savings account. 

For a workplace pension, you (and your employer) will make monthly contributions into a pot. These will be deducted from your salary. In some instances, your employer may match your pension contributions, doubling your funds.

To make sure you don’t dip in and out of your funds, you can only access your pension once you’ve retired. You will also need to be a minimum of 55 years old (this will increase to 57 from 2028). 

The benefits of a pension are:

  • A predictable source of income: Being retired doesn’t mean that you no longer need to budget. With bills, day-to-day expenses and perhaps a holiday or two to think about, having a steady income stream is vital. 
  • An extra layer of protection: Even for the savviest savers, it can be tempting to take a bit of money out of your savings from time to time. With a pension, you simply won’t have this option.
  • Less financial responsibility: If you’re in full-time employment, you will likely have a workplace pension scheme. This takes all the complexities of money management off your hands. 
  • A few tax benefits: Generally speaking, you won’t have to pay any tax on your pension contribution. This is because the sum of money that’s paid into your pension will usually be deducted from your salary (before tax). 
  • An investment: Each time you contribute towards a pension, you are investing your money. This has the potential to grow over time and beat the rate of inflation (although it can fluctuate). You may even have the chance to invest your money into a high or low-risk fund – depending on the type of pension scheme. 

The drawbacks of a pension are:

  • Can’t be accessed easily: Although not being able to use your pension ahead of retirement is clearly a good thing, there are some potential issues. For example, if you are overpaying into your pension. 
  • Potential for risk: Because pensions are invested into stocks and shares, they can still be affected by fluctuations in the wider market. In simple terms, this means that your return could be considerably less than the amount you invested. 
  • Can feel a bit complicated: For many, the ins and outs of a pension plan are difficult to understand. Luckily, there are plenty of resources out there, like our guide on the types of pensions available. Your employer or pension provider is also there to answer any questions or queries you may have. 
  • Some tax limitations: You will receive a tax charge if you put more than the annual allowance into your pension pot (within one tax year).  

Additional support and guidance

How much money should you put into your pension?

If you have been automatically enrolled on a pension scheme, the minimum contribution level is set at 8%. 

However, if you want a comfortable retirement, you should be paying more (if you can). Pay rises are a good time to increase your monthly pension contribution, allowing you to save more without impacting your current lifestyle or falling into financial strain. 

Top tip: Create a percentage by halving the age you started a pension. This can then be used to determine the amount of your pre-taxed salary that you should be putting into your pension pot.

How does tax work on a personal pension?

Personal pension plans work a little differently from a workplace pension. In this instance, you will pay income tax on your salary before setting an amount aside for your pension pot. 

But don’t worry! You can claim this tax back through your pension provider, so you’re not losing out. 

A quick guide to savings

Aside from a pension, there are a few other saving options available. For example, many people opt for an Individual Savings Account (ISA). 

Essentially, a savings account is a secure place to put some money aside for the future. Both banks and building societies offer a wide range of saving accounts, from instant access to fixed-rate bonds. 

You won’t have to pay tax in most cases, similar to a pension. Depending on your provider and the type of account you hold, you may also benefit from interest on the money you save. 

The benefits of a savings account are:

  • A little more flexibility: When it comes to a savings account, you can choose how long the funds will be fixed for, as well as when you use the money. 
  • Simple set-up process: In general, this type of account is a lot less complicated to set up than a pension. You may also have the option to transfer your savings from one provider to another, again giving you financial flexibility. 
  • A few tax benefits: The opportunity to earn interest on your savings without paying tax is an appealing one to many. In fact, one of the reasons that an ISA is so popular is because of the annual tax-free allowance, which can also be split across multiple ISAs. 
  • More accessible: One of the main arguments around a pension vs a savings account is the level of accessibility you get. And whereas pensions have an age limit, you are free to access your savings account whenever you need (depending on the type, of course).  

The drawbacks of a savings account are:

  • Can be impacted by inflation: The issue with inflation is that it can erode the value of your savings over time, especially when it’s high. This essentially means that your savings will be worth less than they were when you started the account. 
  • Withdrawal restrictions and penalties: While savings accounts do offer you more freedom than a pension, they aren’t without a few restrictions. For example, there may be a set number of withdrawals that you can make each month. This can therefore limit your ability to use the funds for unexpected expenses. 

Additional support and guidance

What is a fixed-rate savings account? 

Also referred to as a fixed-term bond, a fixed-rate account means that your savings will be locked away for a set period of time, at a fixed interest rate. If you do access your savings prematurely, you could receive a penalty. 

As a result of this agreed-upon rate, your savings won’t be affected by any fluctuations in market interest rates during the term. 

What is the minimum balance requirement for a savings account?

This will all depend on the account provider and the type of account that you choose to open. Here are a few scenarios to be aware of:

  1. A basic savings account with no minimum balance requirement.
  2. A low minimum balance requirement which is designed to be accessible.
  3. An account with premium features or higher interest rates which requires a more substantial minimum balance.
  4. No minimum balance requirement but monthly maintenance fees if the account falls below a certain threshold.

So, should you opt for savings or a pension? 

Now that you are fully equipped with information on savings accounts and pensions, you should be able to choose the option that works for you and your financial needs. 

And remember, you don’t have to make an all-or-nothing decision. A combination of both will allow you to secure a stable future while having a bit of extra financial support, should you need it. For many, it’s the perfect solution. 

At Finance Rate, we are making finance as straightforward and accessible as possible – none of this complicated small print. Our complete guide to pensions covers everything from what a pension scheme actually is to what to do if you’re approaching retirement and support with withdrawing your pension. Be sure to check it out.