What's the best way to invest for retirement?

Income tax relief is available on pension contributions. This can be a significant advantage when investing for retirement.

| 9 min read

Whether you are nearing retirement or that time is still a long way off, it’s never too early to start planning. With advances in life expectancy, you may need your pension funds for several decades. Investing for retirement is one way to maintain a steady income through these years.

Early on in retirement, when hopefully still fit and healthy, many people want to travel and tick things off their ‘bucket list’ with new-found free time. Expenditure can then often dip due to becoming less active but rise again in later life owing to the cost of care – though everyone is different.

Whatever retirement looks like for you, investing wisely is likely to be a key factor in achieving it. Pensions are there to give you an extra ‘leg up’. When you contribute to your pension, the government adds money. This is called ‘tax relief’ and is the key advantage of using a pension.

Not everyone is aware of this special helping hand, but it can have a considerable impact on the size of your investment pot and the income you are paid. It usually makes pensions the most efficient way to invest for retirement.

Five ways to invest for retirement

1. Consider contributing to a personal pension

In the 2024/25 tax year, an investor can receive up to 45% tax relief when they make a contribution to a personal pension such as a SIPP (Self Invested Personal Pension), with 20% paid by the government into the pension and any higher and additional rate income tax reclaimable.

For example, an investor contributes £8,000 into their SIPP and £2,000 is claimed back from HMRC by the pension provider meaning £10,000 is invested overall. A higher rate taxpayer could claim back up to a further 20% via their tax return, reducing the overall cost of the contribution to as little as £6,000. In the same instance, additional rate taxpayers could claim back up to a further 25% making the cost just £5,500 for a £10,000 contribution.

In addition to upfront tax relief, money in a pension is free from capital gains or income tax on the investments. Remember that SIPPs are not investments in their own right, they represent a wrapper within which you can hold a range of assets, so it’s up to you where you want to invest the money – including your tax relief!

Read more: How does a SIPP work?

2. Use your annual investment allowances

The basic rule is that up to £60,000 can be invested into your pensions each year (including any tax relief), or a sum equal to your annual income if lower. However, higher earners get a lower annual allowance, which could limit their maximum contribution to as little as £10,000 a year. The rules on when this ‘tapered annual allowance’ kicks in are complicated but are only potentially an issue for very high earners.

There’s also a lower annual allowance for people that have started to access their pensions flexibly post-retirement age, for example by taking an income through drawdown and for those with very high income. Lower earners and those with no income at all get a minimum annual allowance of £3,600.

Remember, the tax treatment of pensions depends on individual circumstances and is subject to change in future.

Read more: 2024/25 tax brackets – how much will you pay?

3. Take advantage of pension tax relief

As it stands today, a pension remains the financially more appealing retirement investment vehicle for most people, including those remaining in the same tax band, or drop down a tax band or two, once they draw their pension. However, no one can be sure of pension rules in the future.

Pension tax relief may become less generous, especially for higher earners. For instance, a flat-rate incentive of 25% or 33% for all pension contributions has been suggested, so it may make sense for some people to secure pension tax relief in its current form while it lasts. It’s also important to note the money you withdraw from a personal pension is taxable as income, but you can take 25% of the total value tax-free, under current rules.

Read more: How to claim higher-rate tax relief on pension contributions

4. Consider the differences of ISAs and pensions

For those who may need access to their money before retirement age, an ISA, which currently has an annual limit of £20,000 and the facility of tax-free withdrawals at any time, offers greater flexibility. For those choosing a savings vehicle for retirement, the decision is a trickier one. Most investments are available in both ISAs and pensions.

Assuming investments grow at the same rate in both a pension and an ISA account, in most cases the benefit of upfront tax relief at a person’s highest income tax rate means investing in a pension works out better. This reflects the fact that pension tax relief on the way in, makes an important contribution to overall return. The fact that you can generally take a quarter as a tax-free lump sum also helps.

The main exception to this is for a basic rate taxpayer funding a pension and then becoming a higher rate taxpayer when taking benefits – a situation that could arise accidentally if an entire fund is taken in a lump sum. In this scenario, an ISA would produce a better overall return. However, given that it is possible to take periodic income or variable lump sums from pension pots there is scope to plan how to withdraw money to minimise tax.

It is also worth noting that a further option, a Lifetime ISA, offers a modest ‘hybrid’ option. There is a 25% ‘bonus’ on contributions, broadly equivalent to basic rate tax relief, and no tax when money is taken out to buy a first home or for retirement after age 60. However, the maximum amount you can contribute each year is much lower at £4,000, which also counts towards the overall £20,000 annual ISA allowance.

Read more: ISA or pension?

5. Define your retirement income investment strategy

There are two main pension options at retirement: Continue investing and take out money from your pot as and when needed (also known as pension drawdown), or buy an annuity, an insurance policy that guarantees a regular income for life. This is a complex issue and it is worth thinking ahead to establish a plan as it could affect how you invest pre-retirement.

In particular, any decision to use drawdown must be carefully considered. Investing for income after retirement can be much more complex and challenging than investing for long-term growth. You will need to think about how your investment strategy might need to change as you make the transition from building up your assets to drawing on them.

In this context, it is vital to ensure your pension investment strategy remains appropriate for your needs in the run-up to retirement. It may be prudent to gradually alter the asset mix in order to meet your objectives during retirement. For instance, if you are planning to buy an annuity it is likely to be worth reducing investment risk and locking in on the cost through fixed interest investments. However, if you are primarily going to be drawing on your pensions via drawdown then you will need a completely different strategy that takes sufficient risk to grow your pot but avoids excessively volatility and loss of capital – especially in the early phase of commencing withdrawals.

Is rental property a good investment for retirement?

Property can be a good long-term investment offering the potential for both capital growth and a growing rental income. However, it can also be ‘hands on’ in terms of finding tenants, maintaining property and ensuring you keep to all the rules and regulations.

Many people prefer to keep to investments that are simply less hassle, especially given the increasing tax and regulatory burden and the extra risk of having a lot of money tied up in a single asset.

The evaluation of any prospective buy-to-let investment ultimately comes down to the prospects for income, growth of that income and the potential for capital appreciation. As such it needs to be compared with the returns available on other assets.

What sort of retirement can you afford?

Speak to us about planning your retirement and ensure you have enough money for the lifestyle you want. A free initial consultation with a dedicated planner can help you learn how to make the most of your retirement savings.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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The information in this article is based on our understanding of UK Legislation, Taxation and HMRC guidance, all of which are subject to change. The tax treatment of pensions depends on individual circumstances and is subject to change in future. This article is solely for information purposes and does not constitute advice or a personal recommendation.

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