Pension pot or cash savings - which is best?

This article was last updated on 23/09/2024

If you’re able to spare money to boost your savings, you’ll want the best rate of return. There’s plenty of distinct savings accounts available in the UK:

• bonds;
• easy-access savings;
• fixed-rate savings;
• investments;
• ISAs;
• cash saving accounts; and
• pensions.

With different benefits to consider like compounding returns, interest rates and tax relief - it can feel tricky to know which product’s best for your savings goals. It’s good to ask yourself:

1. Is the growth of your savings account determined by a fixed-interest rate or fluctuating investment performance?
2. Are contributions and withdrawals to your savings account permitted or restricted?
3. And are your savings taxable or do they benefit from a tax-exempt status?

Most important of all, are you looking for access or growth? Cash savings are usually easier to access money from, while investments (like pensions) usually offer better growth in the long-term. Here’s a breakdown of cash savings vs. topping up your pension pot to help you decide which could be the best place to put your spare money and boost your personal wealth.

Cash savings

For short-term, or emergency savings, you may wish to look for accounts which offer instant access to your money. Cash savings are widely considered a good option to squirrel money that you’re likely to need to dip into soon. By keeping your money in cash (instead of tied up in investments) you’re likely to get a fixed-interest rate on your savings.

There are three common types of cash accounts:

• Cash ISA;
• easy-access; and
• fixed-rate (including bonds).

Savings in a Cash ISA or Premium Bonds are tax-free. You can use your Personal Allowance to earn interest tax-free on other cash saving accounts, as long as you haven’t used it up on your income or pension withdrawals.

Benefits of saving into a cash account

• easier access to your money; and
• likely to offer guaranteed returns.

Drawbacks of saving into a cash account

• interest rates can be lower; and
• unlikely to outperform inflation.

Pension savings

For long-term saving goals, such as your retirement income, you may wish to prioritise growth over access. Pension savings are considered one of the most advantageous savings vehicles. Most basic rate taxpayers usually receive a tax top up from the government when they contribute to their pensions. For example, for every £100 you pay into your pension, HMRC would usually add £25, taking the total to £125. Plus, by spreading your money across a mixture of bonds, cash and company shares (a strategy known as diversification) you’re likely to get a competitive rate of return on your savings. Most pensions are already diversified, across a range of locations and asset classes.

There are three common types of pension:

• personal pension;
• the State Pension; and
• workplace pensions.

How you earn and grow these pensions are the biggest difference between them. You’ll accrue your State Pension from National Insurance contributions, and will need to have paid for over 35 years to qualify for the full amount.

Workplace pensions are either: defined benefit (calculated using your salary and years of service), or defined contribution (determined by the investment performance of you and your employer’s contributions). Personal pensions are also defined contribution and you can set one up yourself. They’re particularly useful for those with several old pensions they’d like to consolidate, or the self-employed who may never have started a workplace pension.

Pensions have two unique factors when compared to other savings: age-limit on withdrawals and the potential to receive free money, in the form of tax relief and employer contributions. Currently withdrawals are available from 66 (rising to 67 by 2028) for the State Pension, and normally from 55 (57 by 2028) for both personal and workplace pensions. This benefits long-term savers as their initial contributions are often boosted with tax relief and their annual growth is reinvested into their plan, so it can snowball into an even bigger amount over time.

Benefits of saving into a personal or workplace pension

• compounding growth;
• tax relief on contributions; and
• employer contributions if auto-enrolled.

Drawbacks of saving into a personal or workplace pension

• age-restricted access; and
• no guaranteed returns.

Pension vs. savings

Keeping up with regular savings isn’t always easy. From market volatility to inflation, various factors can impact how much you’re able to put into savings or contribute to a pension. Tools like our inflation calculator can help you understand more about the impact of inflation on your pension savings and how far they could go in retirement. However, even putting aside a few pounds a month can help us save for the future.

What would saving £8 a month look like in cash savings vs. a PensionBee pension?

The following scenario is for illustrative purposes only and assumes:

• monthly saving of £8, with £2 tax relief added by HMRC;
• paying an annual management fee of 0.70% on pension; and
• both savings achieving investment growth of 5% per year.

A decade of saving £8 a month amounts to £960 of contributions. Saving the same amount in a 5% fixed-rate cash account would earn you £307.85 in interest. Whereas saving your money in a pension accumulating 5% growth (and costing 0.70% in fees) would grow your savings by £563.76 (of which £240 is from tax relief alone).

Pension or savings - which is best?

The answer will depend on your existing financial situation and your retirement expectations. Ultimately we save money to build our financial resilience and enjoy ourselves. If you’re still paying down expensive debt, or you haven’t set up an emergency fund yet, that’s a great focus if you’re wondering how to efficiently save any spare cash. That being said, if you have a little leftover each month, you could start to build up your future retirement wealth with a regular contribution to your pension.

Listen to episode 29 of The Pension Confident Podcast and hear from our panel of expert guests as they discuss the pros and cons of pensions and cash - and how you can make the most of both. You can also watch the episode on YouTube or read the transcript.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.