Keys to contributing to a pension plan

Establish the best savings strategy for your pension plan.
The future of pensions in Spain is rather uncertain. There are several challenges ahead, mostly demographic, and all the evidence suggests that workers will have to pay more attention to making plans for their future retirement. For this reason, pension plans are a good tool for guaranteeing an additional source of income during retirement. In order to make the very most of this financial product, it is essential to have thorough knowledge about its characteristics and, first and foremost, to know when and how to invest in one. Below, we set out all the key considerations for making contributions to a pension plan.
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Maximum and minimum contribution

As is the case with most investment funds, pension plans are quite flexible when it comes to the contributions they require. Generally speaking, there is no minimum contribution limit, although it is possible that some particular financial institutions or funds might require a minimum initial contribution.

On the other hand, the maximum contribution has been set by law at 8,000 euros a year. Moreover, it is possible to make an additional contribution of up to 2,500 euros a year to your spouse's pension plan if their income from work or business activities does not exceed 8,000 euros a year.

People with a physical disability of at least 65%, or with a mental disability of at least 33%, can also contribute more than this limit. In this case, their maximum contribution can be as much as 24,250 euros, and contributions made by third parties to their pension fund can reach 10,000 euros a year. It should be noted that, in order for them to have the right to these increased limits, they must be registered under the special social security scheme for members with a disability.

Therefore, investors have quite a lot of freedom when it comes to deciding how much they wish to contribute to their pension plan. So, how much should you save for retirement? Experts recommend saving consistently between 7% and 10% of your monthly income.

Regular or one-off annual contribution

The flexibility that exists relating to the amount you can contribute also applies to the manner in which you can make that contribution. Pension plan members can choose whether to concentrate their contribution into a single payment or spread it throughout the year. Moreover, the investment method does not have to remain constant and you are not even required to make contributions every year.

Studies show that savers usually leave their contributions for the end of the year, when they realize that time is running out and they want to take advantage of the tax relief offered by their fund. However, most experts recommend opting to make contributions on a regular basis, ideally monthly, and treating it as simply another item in your monthly budget. The reason for this recommendation is that contributions made on a regular basis guarantee greater diversification of the investment and, therefore, allow you to absorb the volatility of the markets. since a single investment made at a bad time can lead to greater losses. Moreover, this approach helps the individual to get accustomed to saving, turning their contributions into an ingrained habit.

Tax relief on annual contributions

Contributions to a pension plan provide tax relief in your annual personal income tax return. Those who hold a pension plan can qualify for tax relief on their contributions, up to a limit, which will be the lower of the following amounts:

  • 8,000 euros.
  • 30% of the net income from employment and/or business activities.
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A member of a pension plan who pays tax at a marginal rate of 30% and has made contributions totaling 4,000 euros would qualify for tax relief amounting to 1,200 euros. Moreover, the ideal scenario is to use the amount saved each year through the tax relief to reinvest in the pension plan. The results of this strategy in the long term are quite surprising.

However, depending on how the funds are withdrawn, this deduction can end up being simply a deferral of the payment of these taxes. If the funds are withdrawn in the form of capital, i.e. in a one-off lump sum payment, the increased income produced in that year can result in a considerable increase in the marginal rate and, therefore, in the person's tax bill. If, on the other hand, the funds are withdrawn in the form of income, the increase to the person's annual income is not so significant and the saver can remain within the same tax band, or at least in a tax band with not such a high rate. For example, if a person with an annual income of 21,000 euros has accumulated 120,000 euros in their pension fund, withdrawing these savings in the form of capital would place the saver in the upper tax band for personal income tax purposes, with a marginal rate of 45%. A monthly income of 1,000 euros, on the other hand, would result in a total income of 33,000 euros at the end of the year, keeping that person in the same personal income tax band as they are already in based on their annual income.

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