Should I pay into a private pension or a savings account?
Find out more about private pensions and savings accounts and their benefits to help you save for retirement.
We're all aware that we'll need money to support us when we finally stop working. But what's the best way to save for your retirement? Should you rely on a savings account? Or is a pension a better choice?
We'll break down the important stuff here, like tax you may have to pay, and when and how you can withdraw money.
What are the different kinds of private pension?
There are two main types of private pension: defined benefit or defined contribution.
Defined benefit pensions are also known as final salary pensions. These workplace pensions give you a guaranteed income on retirement based on your salary and years of employment. They’re much rarer these days due to the high cost for the employer.
Defined contribution pensions grow a pension pot over the years based on your contributions and how the pension is invested. As most pensions are now defined contribution we'll only deal with how they compare to savings accounts here.
There are also different versions of defined contribution pensions
Self-Invested Personal Pension (SIPP)
This is a personal pension that gives you the freedom to choose from a wide range of investments – including stocks and shares, bonds and investment funds. You can also decide how much you pay in and when, which is ideal if you’re self-employed and don’t have a regular income. Check out whether an Aviva SIPP would be right for you.
Workplace pension
This is a pension scheme put together for workers by an employer. In the UK now, most employees will be auto-enrolled into a workplace pension to encourage saving for retirement. One of the big benefits of this is that the employer will add contributions alongside the employee, which boosts any retirement savings. When you leave a job, you can transfer your workplace pension to a personal pension.
Stakeholder pension
This is a personal pension designed for people on lower incomes. It has flexible contributions, lower charges and simpler investment options.
Benefits of private pensions vs savings
A private pension is any pension scheme outside the UK State Pension. This can either be from your workplace or a personal pension you've set up.
Tax benefits
Paying into a private pension can be tax-efficient. You will usually get tax relief, this means that every £100 you put in only costs you £80 - with the other £20 coming from tax you don't pay or money the government adds to your pension. When you take your pension there can also be tax advantages. The first 25% of your pension pot can be taken tax-free from age 55 (57 from 2028).
With a savings account you have a Personal Savings Allowance (PSA) each tax year. Any interest you earn over that amount will be liable for UK income tax.
Tax benefits are based on your personal circumstances and are subject to change.
Investment performance
The money that people put into private pensions is often invested in a mix of assets like company shares, bonds, and investment funds. This brings the risk of losses based on investment performance, but it can also give the potential for higher returns than savings accounts over the long term. Interest on savings accounts may be lower than inflation, which would reduce the buying power of money you’ve saved.
The value of your pension investments can fall as well as rise, and you may get back less than has been paid in.
Created for retirement
Pensions are designed to provide an income in retirement, with options for how you can take the money you’ve built up in a defined contribution scheme, which includes personal pensions. For example, you can choose to buy an annuity, which is a guaranteed income you'll get in exchange for the money you have in your pension pot - so it's affected by how much you take tax-free first. Another option is to use income from both drawdown and a annuity both are taxed in the same way as your salary.
What are the different types of savings accounts?
There are several types of savings accounts, designed to meet different goals.
Easy access account
These allow you to deposit and withdraw money whenever you like with no restrictions. This makes them ideal for money you need to dip into at short notice. This flexibility means that they generally offer the lowest interest of savings accounts. This interest rate can change while you hold the account.
Notice account
This type of account ties your money up for longer as it require you to let the bank or building society know that you plan to withdraw money. You can be required to give anything from 30 days or more notice. Usually, the longer the notice required, the higher the interest will be. Again, interest on these accounts can change while you hold them.
Fixed term account
Fixed term (or fixed rate) accounts require you to lock your money away for a set period, usually 1 to 5 years, in exchange for a fixed interest rate. They typically offer higher interest rates compared to easy access accounts, rewarding you for committing your funds for a longer period. The benefit of a fixed rate account is you’ll be sure exactly how much interest you’ll earn.
Cash ISA
If you’re looking for a tax-efficient way to save, you can choose Cash ISA. Like a savings account you’ll earn interest, but you won’t pay UK income tax or Capital Gains Tax on your profits. This has a £20,000 limit on contributions for the tax year 2024/2025.
At Aviva we have a savings marketplace called Aviva Save. There you can choose from a range of easy-access, notice or fixed term options with one single account. You can read more about how to make the most of saving here.
Can I have a pension and a savings account?
Yes, you can have both private pensions and savings accounts in the UK. In fact, many people choose to use both as part of their financial planning because, as you’ve seen, they offer different benefits.
With a pension you’re limited to the annual contribution limit, which for the tax year 2024/2025 is 100% of your earnings or £60,000, whichever is lower. Anything above that and you may have tax to pay. It may also be worth checking whether you can increase your contributions by using carry forward relief.
Savings accounts will have higher limits on how much you can pay in, although you should be careful not to save more than £85,000 with the same banking group, so that the FSCS guarantee protects your savings. The FSCS also protects pensions, you can find out more on their website.
Is a private pension or savings account better long term?
In a nutshell, savings accounts are great if you want to earn interest on money you’ll need in the short to medium term. Over the long term though, they may give you returns that don't keep up with inflation. You’ll also possibly have tax to pay on any interest if you have a large amount saved. A defined contribution pension is designed to build a pot of money over many years using investing, and has tax benefits to encourage you to pay in. This long timeline means that accepting some risk can lead to higher returns.
Whether you pay more into a pension or savings will depend on your personal circumstances and retirement goals. It’s a good idea to chat to a financial adviser about your plans. If you don’t have one you can find one at Unbiased.co.uk – there will be a charge for advice.
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