Bill-pruning and increasing my pension contribution

Despite all my recent efforts to cut down regular bills - as part of which we've saved considerably on home and contents insurance, joined an oil-buying group, and changed our AA cover to save £137 a year, and made various other changes, there was one insurance policy that I had not thought about cancelling.  It suddenly occurred to me, a few days ago, that it was something I no longer needed, and so I decided to cancel the plan, and divert the money saved on the monthly premium to my pension.  While I was about it, I also made a change to my clothes and spending allowance which I had been contemplating for a little while, cutting it by a quarter and adding that extra money to my pension as well.  

So today I rang the pension company and informed them of my increased contributions.  The young woman I spoke to congratulated me on making the change, wondering if I had had a pay rise.   

I am pleased to have taken this action; it feels good to have immediately diverted the money saved into something specific, particularly into the pension.  It does not feel very helpful to save money, if the difference is then swallowed up in general spending.

However, as I have mentioned before, I do like spending money on clothes, so the cut in spending money may be a bit of a challenge for me. I will see it as a test of my ingenuity....We will see how I get on.

What to do with a lump sum?

I talked recently to someone who had come into a chunk of money, and asked me what I thought it was best to do with it. This is of course a good question to have to answer. I think it makes sense to do some planning and to try and strike a balance between enjoying your bit of good luck now, and benefiting from it in the future. My suggestion would be to do something along the following lines:

1) Pay off any high-interest debts, with the highest interest ones - almost certain to be any credit cards - first, then any other loans, apart from mortgage and student loans.
2) Once that is done, set up an emergency fund if you do not have one already, or top it up if you do. (As mentioned elsewhere, it is a good idea to have about six months' living expenses tucked away if possible.)
3) If you have done both of these and have some money left, I would designate some of the money for fun; a holiday, really nice meal out, home improvements, presents for your family, or whatever. The amount depends somewhat on how much money you have received, what your general financial situation is, and what you would like to do as a treat.
4) Next, you may want to look at your pension. For instance, if you are not paying the maximum into your pension to benefit from your employer's maximum contributions, it would be worth considering doing this for the future, and back-dating these contributions if you are allowed to do so. (If you work in the public sector you may be able to make additional contributions to your final salary scheme, which would be worth looking into, as this could make quite a difference to your final pension.) The advantage of doing this is that it should improve your pension situation in the long term. Because of the tax position of pensions, pension contributions are quite an efficient use of the money.
5) Another option, either as alternative or in addition to 4, is to consider paying off a chunk of your mortgage, although you should check first that you won't incur fees for doing so; this will probably depend on the amount of the planned overpayment, and the terms of your mortgage. Although interest rates are fairly low at the moment, paying off your mortgage will still reduce your outgoings and commitments generally, and will involve a greater monthly saving once interest rates go back up.
6) If that still hasn't used up your windfall then you are very lucky indeed! You may want to look at other investments such as stockmarket-based unit and investment trusts, and you may benefit from specialist investment advice at this point.

Savings - different purposes - retirement

I've tackled emergency funds, paying annual bills, and saving up for large purchases, and this time am going to begin the subject of saving for retirement. (Remember - I am not an expert, so deal in these questions in fairly broad terms...)

In summary, while most of us working now may receive some kind of state pension on retirement, it seems likely that the vast majority of the money we need to live on in retirement will have to come from our own resources.

There are various possible sources for this income, the most obvious and generally applicable being a pension, to which we will have contributed while working.

There are essentially two kinds of pension; one, a 'final salary' pension which is based on receiving a proportion of the salary you are earning just before retirement, for the rest of your life, and often involves a lump sum being paid on retirement as well. The proportion of your salary which you will receive will depend on how many years you have been a member of the scheme. Final salary schemes are currently available to those working in the public sector, as well as in a very small, and declining, number of large corporations. The advantages are obvious, and the contribution you will have to pay as an employee relatively small compared to the benefit of a decent, guaranteed income in retirement. It may be worth making additional contributions in order to get the maximum benefit from these schemes, if you join late and can afford to do so.

The second type of pension is a 'money purchase' scheme. Under this scheme, employee and employer will usually each contribute a percentage of the employee's salary into a pension fund, which will build up into a sum that can be used to buy an income for the rest of the employee's life when he or she retires. Usually the pension will be held with a financial institution chosen by the employer, but the employee will often have a choice about which funds they invest in, and which are most appropriate will depend on your age, and how much risk you are prepared to take.

The pension contribution offered by different companies will vary, and companies generally match the employee's contribution up to a certain maximum, normally around 5%, maybe up to 10% if you are lucky. It is worthwhile thinking about making the maximum contributions in order to get the greatest benefit from the employer contributions, if you can afford to do so. On retirement, the money in your fund, which will hopefully have grown considerably over the years, will be used to buy an income for the rest of your life, called an annuity. There are various factors which will influence the value of your money purchase pension, including how much you have managed to contribute, which funds your money has been invested in, how much these have grown, and annuity rates - the rate at which it is possible to buy an income - at the time you retire.