Going back to work is a big step for many people, and it can be a step-change for your retirement finances too. Andrew Marker from Vanguard Europe tells you what you might need to consider, including childcare costs.
There’s lots to get your head around if you’re coming back to work after a break. You might be focused on how you’ll pay for childcare, or you may be thinking about how best to put the extra income to work.
If you’re starting your own business, you might need to think about your own pension provision for the first time. To help make things simpler, we’ve outlined some of the key elements for those going back to work, whether as an employee or someone self-employed.
For younger returnees, potentially the most significant issue is childcare. If you live in England, for example, you may currently be eligible to receive 30 hours of free childcare during term time if your child is three to four years old.
The 2023 Budget announced an expansion of childcare funding, however. From April 2024, working parents of two-year-olds will be able to access 15 hours of free childcare each week, with this extended to children older than nine months from September 2024. The number of free hours will rise to 30 from September 2025.
There were also several changes to the pension rules in the Spring Budget back in April, which may make a difference to your plan for retirement.
While it might not seem like much, taking a break from work means taking a break from pension contributions, potentially making a big difference to the eventual size of your retirement pot. Most employees contribute to a pension through auto-enrolment, with your employer automatically setting up a pension for you and paying money in, including part of your own salary.
While you can turn off the auto-enrolment contributions, you lose the contribution from your employer if you do so. The minimum amount you pay into a pension through auto-enrolment is 8% of your salary between £6,240 and £50,270, made up of a 4% employer contribution, 3% employee contribution, and 1% tax relief from the government.
Our calculations show that the loss of auto-enrolment alone for a period of five years could be worth more than £50,000 to your eventual pension over the course of your career if, say, you were currently earning £30,000 a year.
You can see what happens if you lose auto-enrolment contributions for five years in the chart below, as well as how you could make up the deficit. The solid turquoise line is what would happen if you simply continued making pension contributions, year-in, year-out, for 40 years with an investment return of 5.5% after costs per annum. The solid yellow line is what would happen if you took a career break between years 7 and 12 of your overall working lifetime. It shows the growing pension gap.
However, there is scope to make up for lost time, which we’ve shown using the dotted red line. After their career break, our hypothetical pension saver chooses to add an additional 2.2% of their salary each year into the pension. By doing so, they manage to catch up with where they would have been had they never taken any time out.
Source: Vanguard calculations. Assumes salary growth of 2.5% per annum, with an 8% contribution on earnings above £6,240 and investment growth after costs of 5.5% per annum. We have assumed that the upper earnings limit for auto-enrolment rises as salary increases. The 40-year time horizon is designed to approximate the length of time someone may save for retirement, though this may be greater or less than 40 years. The gap in the chart appears to open up before Year 7. This is because the data points in the chart show the position at the end of the year. You stop making pension contributions at the end of year 6. By the time the end of year 7 rolls around, you can already see the difference that’s beginning to make.
So, if you have more money coming in, it may be worth setting a bit more aside to catch up on the pension contributions you may have missed.
It’s worth making the most of any pension offered through your employer, with some offering more than the legally required minimum.
A self-invested personal pension (SIPP) is a good option if you don’t have a workplace scheme though, or if you want to make additional contributions to a pension or consolidate old pensions. You can contribute up to £60,000 each tax year to a SIPP [this allowance may be lower if you have a high income or have flexibly accessed your pension pot], with your investments growing free of capital gains, income and dividend tax.
If you are joining a new employer, you may also have old workplace pensions. Depending on your circumstances, these can be consolidated into a single pension, giving you a clearer overview of your retirement planning and enabling you to manage your retirement finances more easily. Any transfers in will not count towards your annual allowance, but be careful if you have pensions which offer guaranteed benefits as these are hard to replicate. You should seek financial advice before transferring a defined benefit pension.
SIPPs can also be ideal if you decide to work for yourself. Many self-employed people choose to make one-off contributions to their SIPPs, as they have volatile earnings, making it difficult to put away a regular monthly amount.
This is where the carry-forward rules can help since they allow you to carry forward unused allowances from the previous three tax years [provided you have been a member of a UK-registered pension scheme or qualifying overseas scheme in each tax year].
In theory, this means you can contribute up to £180,000 into a SIPP for the 2023-24 tax year – i.e., the £60,000 annual allowance for 2023-24 and three-years’ worth of the previous annual allowance, which was set at £40,000**.
*Andrew Marker is Head of UK retail and pensions, Vanguard, Europe. Workingmums.co.uk is holding it first Return to Work Week from 25th September with advice and support on everything from writing your cv to where to find the best flexible jobs.
**For more information on pension taxation rules, visit the UK government website around pension rules.