Why pensions have the edge over a savings account - Jenny Ross

My husband has been made redundant and is in line for a £60,000 pay out after tax. He's 58 and I'm 56. He's managed to get some contract work and we've just paid off our mortgage. Someone has suggested putting this money into a pension because it will earn more interest. Is this sensible?

Putting money into a pension is generally a very sensible idea. What gives them the edge over any ordinary type of savings account is that whatever you pay in, the government will also contribute - in the form of tax relief.

This means that the money that you would normally have paid in tax on your earnings goes into your pension pot rather than to the government. The level of pension tax relief you get is based on the highest rate of income tax you pay. So if you’re a higher rate taxpayer (i.e. you pay income tax at 40%), a £100 pension contribution would cost you just £60 as the government would cover £40 of this. Even if you don’t work or pay tax, the government will still give you 20% tax relief on your pension contributions.

There’s no limit to how much you can pay into your pension each year, but the government sets a limit on the amount you can receive tax relief on – this is known as the pension annual allowance. It’s set at £40,000 a year or 100% of your earnings - whichever is lower.

You mention that by putting money into a pension you’ll ‘earn more interest.’ That’s not quite right. Yes, a pension is effectively a very long-term savings account, but it doesn’t pay interest in the way a savings account does. Instead, with defined contribution pensions (the most common type) your money is invested, and the amount you end up with in your pot when you come to access it depends on how these investments have performed.

The idea is that these investments will have had plenty of time to grow over the course of your working life and - combined with the tax relief boost - will leave you with a much healthier pot than if you’d just put this money in a savings account.

But as with all investments, the value of your pot can go down as well as up. This is important to consider when deciding what to do with your husband’s redundancy windfall. If you were planning to access the money in less than five years or so, for example, it wouldn’t have much time to recover from any falls.

To help protect savers’ money, a pension scheme’s ‘default’ fund (i.e. where your money will be invested if you don’t choose a different one) will usually move you into less risky investments as you get closer to retirement.

It sounds like you’re in a fairly comfortable financial position and aren’t relying on the redundancy money for any immediate needs, so putting it in a pension to benefit from tax relief and (hopefully) investment growth could make sense. But bear in mind that you might not benefit from tax relief on the whole amount if you pay it into a pension in one go, as it’s above the £40,000 annual allowance. The exception is if you have any unused allowance from the past three tax years, as this can be carried forward.

To help you decide on the best course of action, consider speaking to an independent financial adviser, who can make a personalised recommendation based on full knowledge of your circumstances. For free, impartial guidance, there’s Pension Wise - the government service designed to help over-50s understand their pension options.