How to afford your pension (without neglecting other expenses)

Most of us know that we should be saving into our pension. But when there are more immediate costs, it can easily stay at the back of the queue.  

Early in your career, it might not feel like there’s enough money coming into your account. Starting salaries in the UK for those who went to university typically range from £25,000 to £33,000, according to Save the Student. This can be a slim margin for affording rent, bills, and other day to day costs, and that extra hundred quid a month can be significant. And just as salaries seem to increase, so do the prospects of weddings, mortgages, and children, which nibble our budgets down to a nub once again.  

The irony of saving into your pension is that by the time you feel you have the extra cash to afford it, you’ll have missed out on many years of pension growth and might need to make massive contributions to claw your way back.

If you started contributing to a pension at age 20, you could retire at 65 with £1 million if £264 went into your pension each month, assuming a 7% yearly return. This could includes employer contributions as well as what you pay in and any tax relief top up. The total amount paid in would be just £142,560, and the rest would all be from compound returns. But if you waited until 40 to start contributing with the same goal of retiring at 65 with £1 million, you’d need contributions of £1,235 each month assuming the same return. Total contributions would be £370,500, nearly triple the amount as at age 20.  

If you can manage contributions early on, it can end up saving you hundreds of thousands of pounds in the long term. And if the amounts above are too much for your budget, remember that little and often still helps. But how do we get there?  

Affording a pension on a tight budget

It’s a lot easier not to miss the money we didn’t have in the first place. This is part of the beauty of auto-enrolment, the scheme that automatically puts employees in a pension scheme at the age of 22, if they are earning over £10,000 a year. In this scheme, employees will pay in 5% of their annual salary while their employer pays in at least an additional 3%. What employees pay in gets a boost because it’s not subject to income tax.

If you have an employer, and meet these criteria, then you’re likely already saving into your workplace pension, unless you actively opted out. If you're able to get by on your income while keeping these contributions up, your future self will thank you.

One case where giving up that pension contribution may be the right move is if you truly cannot afford to live on your current salary and are getting into credit card or other high-interest debt. Rates on credit card debt are extremely high and outpace any gains you make on your pension further down the line.  

But if you did opt out, or are considering it, it’s worth calculating how much more it would really mean in your pocket first.  

Let’s say Bea, a 22-year-old trainee accountant, is considering stopping her pension contributions. She currently makes £30,000 per year. The total that would go into her pot is £2,400 per year (8% of £30,000). Stopping sounds pretty good to her if it means some extra cash in the pocket.  

But Bea would only receive £1,200 more per year if she stopped contributing to her pension, which is just £100 per month. This is because she’d completely lose her employer’s 3% contribution as well as the government’s tax relief boost which is worth another 1%. That is a lot to lose for just £100 a month in her pocket.  

For those who aren’t currently contributing, that means £100 might be all you need to save to start building your pension. And if you make less than £30,000 the figure will be even smaller.  

We’re all sick of hearing how our daily coffees are what make us poor, but the idea of finding those excess areas in your budget can make a big difference. A survey by OpenTable found that the average Brit eats at a restaurant 1.5 times in a week, and meals, especially with a drink, can easily soar above £50 per head. Skipping a meal or two out could take out a big slice of the money towards your monthly pension contribution.  

One of the least painful ways to cut your budget can be through cancelling subscriptions. Research by Nationwide suggests that we spend on average £1,200 on subscriptions each year, £400 of which we don’t use. Your banking app will likely show you a list of regular payments that come out of your account, so you can take a look and assess which ones you use. In solidarity, I have cancelled my Deliveroo subscription.  

Saving for immediate goals alongside your pension

Once we start earning a bit more than a starting salary, it seems it’s suddenly time for the next expenses in life. Getting on the housing ladder is one of the most common goals for people, and it can mean quite a dent in the budget. That might make it tempting to take a break from the pension contributions to save up a little extra cash.

But like explained above, the money in your pocket from opting out of a pension equates to about half of what actually gets added to your fund. And once your income breaches the basic rate tax bracket, the money that would filter back into your pocket from stopping becomes smaller and smaller thanks to higher rate tax relief, while your pension continues to enjoy extra top ups.  

One of the most powerful tactics to create a comfortable savings pot for more immediate goals, while keeping up pension contributions, is avoiding lifestyle creep. Lifestyle creep is the concept that as we earn more, we start spending more, and soon the things we didn’t even think to purchase a year ago have become an essential part of our life. As our budget expands, it can easily be eaten up by spending more. One tactic is finding an amount where life feels comfortable. This means a budget where you can do the activities you enjoy and afford a few nice holidays, if that’s your cup of tea. But once you’ve reached that level of comfortable living, the key is putting a stopper on the spending, even when your salary goes up. Hear more about lifestyle creep in our recent AJ Bell Money Matters podcast episode.

Of course, you might have to spend a bit more over time due to inflation, but your lifestyle doesn’t have to massively change. Instead, those extra salary funds can go to the bigger goals down the line, like a home or dream wedding.  By setting up a direct deposit to an investment account at the beginning of the month for that extra cash, you can stop yourself from being tempted to spend it instead.  

There’s no easy hack to saving for the future, but there is a lot of motivation to do so. The contributions and tax relief that go towards your pension make these goals much more achievable, and other government boosts, like the Lifetime ISA, can help you on your way to your first house purchase.