Pay into a pension as early and for as long as possible is the standard advice. But for those of us able to take that route, is it still worth paying into a pension as we get close to retirement? What are the benefits of pension saving into your 60s? Is it worth it at age 70?
These questions have become more complicated by the government’s decision to include pensions in inheritance tax (IHT) calculations from April 2027.
Currently, unused pensions are not subject to inheritance tax, and paying in extra to boost pension savings has been also used as a way to reduce the inheritance tax bill your loved ones receive when it comes to passing on wealth. From next April, pensions will no longer be a viable way to avoid IHT.
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Even beyond inheritance tax considerations, when working out how much you need to retire, is there really much gain to be had from paying into a pension just a few years before you need to spend it?
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Sue Allen, chartered financial planner at wealth manager Chester Rose, said: “This should be considered in the context of your financial plan – do you need to save more? If you have enough, you may as well enjoy it. Life isn’t a dress rehearsal.”
However, if you are in a position where you could save more into your pension, but are on the fence, you might be swayed either way by seeing some cold, hard numbers. Wealth adviser Chester Rose has conducted exclusive analysis for Moneyweek to test the benefits.
We also compare an ISA vs pensions for retirement saving in a separate article.
Pension tax-free cash
A big benefit of pensions is that they allow you to build up a significant tax-free cash lump sum – the lump sum allowance (LSA). This is set at 25% of the pot you are ‘crystallising’ (taking benefits from) up to a maximum amount of £268,275.
To reach this maximum tax-free cash, you would need an overall pension pot of £1,073,100.
Simply put, if you still have some allowance left in your 60s – that is, you have a pension pot of less than £1,073,100 – then you can build up tax-free cash. Money you will not pay tax on when you come to withdraw it.
“That must be attractive. We don’t have many tax perks left in the UK, but this is certainly one of the best,” said Allen.
Pension tax relief vs marginal pension withdrawal tax rate
When it comes to paying into your pension during your 60s – likely to be your peak earning years – it is also worth considering the difference in the tax you pay now versus the income tax you may pay in future.
Most people have a personal allowance of £12,570 with zero tax on income at this level. Then, from this amount up to £50,270, you pay basic-rate tax at 20%, not including National Insurance Contributions. Over this, you are paying 40% and over £125,140, you’re paying 45%. (Though thanks to a quirk in the tax laws, people earning above £100,000 pay an effective 60% income-tax rate on part of their salary.)
You get tax relief on pension contributions at your current marginal income tax rate (up to the £60,000 annual allowance).
If you are a higher- or additional-rate taxpayer now and expect to be a basic-rate taxpayer in retirement, then putting money into a pension and getting 40% or 45% tax relief now, and only paying 20% income tax at a later date, is a decent strategy.
“What’s even better is if you took a pension income using part tax-free cash, then your effective tax rate is actually 15%,” Allen pointed out.
How much could my pension still grow in my 60s?
A key consideration when evaluating whether to continue contributing to a pension in your 60s is the growth factor – specifically, how much your pension might increase from, for example, age 60 to a retirement age of around 68. Chester Rose crunched the numbers on this.
For simple maths, let’s consider the value of £1 invested in a pension (a gross, i.e. before-tax, contribution) with an assumed growth rate of 5% and not taking into account inflation.
By Chester Rose’s calculations, that £1 would grow to £1.4775 over eight years (from age 60 to age 68, at a 5% growth rate).
Now we need to multiply this by the average pension pot of a 60-year-old. According to average pension data by age, someone in the 55-64 age bracket has an average pot of £137,800.
From age 60 to age 68, based on that same growth rate, this pension could increase from £137,800 to £203,600. That is a 47.7% increase. So clearly, there is sizable growth potential even without any further contributions.
However – from the same starting point, £137,800, and same 5% growth rate – but with an added £500 a month in gross pension contributions from age 60 to age 68, the pot could be boosted further to £263,752, by Chester Rose’s calculations. That’s a 91% increase on the original starting pot (including your contributions).
What about inheritance tax?
Now, you may well be thinking, what is the point of all this diligent pension saving, if it is going to be taxed when I die (from April 2027).
Consider this: you already have an estate that exceeds both the inheritance tax-free threshold (also known as the nil-rate band, currently £325,000 per person) and the residential nil rate band (an additional £175,000 per person). Essentially, this means assuming your loved ones will pay 40% IHT on your unused funds upon your death, whether in a pension or an ISA. Which makes you better off?
So, let’s assume you put £10,000 in the pension at age 70 and it grows at 5% per year. You then die at 100.
The calculation is complex, but the result is that £10,000 increases to £42,219, according to Chester Rose’s figures.
Your loved ones then pay inheritance tax at 40%, leaving £25,931 after tax to pass to beneficiaries, so £16,287 in IHT is paid.
Now let’s assume instead that you pay tax at the basic rate (20%) and put that £8,000 (£10,000 after 20% tax) into your ISA at age 70, and then leave it until age 100.
It grows from £10,000 to £34,575. Your loved ones pay £13,830 tax upon death, so you have £20,745 to pass to beneficiaries.
“So yes, you paid more inheritance tax by investing in the pension option – but the amount to pass to beneficiaries is still larger, at £25,931 versus £20,745 – a difference of £5,185.65,” Allen, from Chester Rose, said.
Is it still worth paying into a pension at age 60?
The figures speak for themselves – growing cash gross in a pension can significantly boost your wealth, even from age 60.
“Recent government changes have certainly made pensions less attractive as a wealth transfer tool. However, do not let that obscure what it is – a very efficient way to save, even in later life,” said Allen from Chester Rose.
However, something to remember is that turning 75 acts as a major tax milestone for private pensions, ending tax relief on contributions and changing death benefit taxes.
After 75, you can no longer get tax relief on personal contributions, though employer contributions may continue. Also if you die after age 75, your beneficiaries usually pay income tax on inherited pensions, and from 6 April 2027, these will be included in the estate for inheritance tax.
As always, the general advice to get the most bang for your buck with pension saving is to start as early as possible. And if in doubt, speak to a financial adviser.
