The Ant and the Grasshopper

For millennia people have been passing down stories, using these stories to impart on us the lesson’s they’ve learnt during their lives.

Aesop’s fables are believed to have been written by Aesop (a slave and storyteller) in Ancient Greece between 620 and 564 BC. In the story Aesop tells of how the ant works all summer, storing food and preparing for winter. The grasshopper is lazy, enjoys life and doesn’t worry about what might happen tomorrow or what will happen when winter comes.

Inevitably, winter does come and with it the Ant is able to survive using the food it stored working during the summer. The grasshopper, having no food stored away, dies of starvation.

This story was written to show us the benefits of working hard and planning for the future. If we put money away when we’re able to we’ll have money there when we need it at a later date.

Pensions are one of the best ways for us to plan for the future. Using those monthly contributions to help provide for us in retirement. When you make those monthly payments they get invested. Often this will include investing in some of the biggest and most profitable companies in the world.

So what happens when you make those monthly payments?

1. Tax efficient – the government want to incentivise us to save for our own retirement. As such, you will normally get tax relief on your pension savings. If you are a basic rate tax payer this means you avoid having to pay 20% income tax on contributions paid into your pension pot. For higher rate tax payers you avoid paying 40% tax on your contributions. Often these payments are set up each month so you won’t have to pay national insurance on your pension contributions either (a process known as salary sacrifice).
2. Employer matching contribution – A further benefit it that many employers will also match your monthly pension contributions up to a certain level. For example, if you pay 5% of your salary into your pension each month they’ll match that amount.

Worked example

Let’s assume you earn £30,000 a year. Through your employer’s pension arrangements you decide to pay 5% of your monthly salary into your pension. Out of your £2,500 monthly salary this means you’ll pay £125 straight into your pension. Your employer also matches that payment so tops this up by a further £125. If you’d have opted out of their pension arrangements you’d have paid tax on this part of your income so would have paid £25 in tax and received £100 (you’d also have paid national insurance too). However, by paying into your pension pot you’ve saved paying £25 in income tax today and your company has topped up your contribution by a further £125. Instead of receiving £100 in your pay cheque today, £250 has been invested in your pension pot! The ant planning for the future would surely have seen this as a no-brainer…

The next blog post will focus on what happens to these contributions and where they get invested.

P.s. the above article is based on current UK tax law. Every individual should think about their own circumstances carefully and take tax advice as and when needed. This article should not be considered as investment or tax advice specific to your circumstances but is intended to be educational and explain from a high level how the workplace pension system in the UK works for the vast majority of working people.