We all know that we should be planning for retirement. The State Pension is a useful starting point, but would fall short of providing a comfortable retirement for most people.
Workplace pensions can partially bridge this gap. These require a minimum level of contribution from both the employee and the employer. But over the course of a working life, it’s possible to build up multiple pensions, and to lose track of the amount you have accumulated. There may even be gaps in your contribution history.
Without a cohesive plan, it’s difficult to work out if your retirement plans are on track, and if you are contributing enough.
There are a number of factors you should consider when deciding how much to save for retirement:
Your Goals
The first step of any financial plan is understanding what you are trying to achieve. What does a comfortable retirement mean to you? For some people, this can involve travelling the world and taking up new hobbies. Others are happy with a simpler lifestyle and spending more time with family.
When planning for your retirement, consider:
- How much you will need to pay your essential bills and expenses.
- The cost of hobbies, travel, and luxury items.
- Any lump sum expenditure, for example home improvements or gifts.
Once you know how much you would like to spend in retirement, we can help you work out how much you will need to have in your retirement fund to achieve this.
Investment and Risk
Your retirement income will depend on the pension pot you build up. This, in turn, will depend on the amount you save and the investment growth you achieve.
Over 25 years, if we assume that you contribute £500 per month to your pension, you could build up a fund of around £250,000 if your investments grow at a rate of 4% per year.
However, at a growth rate of 7%, your retirement fund could be worth closer to £400,000.
Nobody can predict investment growth, and returns are unlikely to accrue in a steady pattern. Your fund will go up and down, and you may even lose money in the short term.
But if history is any indication, a diversified basket of shares or a multi-asset fund will usually grow in value over the longer term. The more risk you take (i.e. the more you invest in volatile assets such as shares), the greater the potential reward.
The longer you invest, the more likely it is that you will benefit from the upside and smooth out the short-term volatility. This is particularly true if you make regular contributions.
The less risk you take with your pension, the more you will need to contribute, particularly over a longer timescale.
A diversified investment plan which takes an appropriate amount of risk relative to your retirement plans, timescale, and contribution level will give you the best chance of achieving your goals.
Your Life Stage and Priorities
The earlier you start planning for retirement, the easier it will be.
Let’s assume that you want to build up a retirement fund of £500,000, and expect to achieve investment returns of 5% per year. With 40 years of working life ahead of you, you would need to save £337 every month.
However, if you wait 10 or 15 years to start planning, you will need to save a lot more. With 25 years to build up your retirement fund, you would need to contribute £854 per month.
The problem is that earlier in life, you will probably have other priorities, such as getting on the property ladder or providing for a family. This takes up mental energy as well as money, and retirement can seem a long way off.
Our tips for getting started are:
- Make sure that you have an emergency fund in place and that you are not spending more than you earn.
- Aim to clear consumer debts as soon as possible, as these are expensive and don’t add value. Mortgages and student loans are a lower priority.
- If you are employed, make sure you join your workplace pension scheme. Your employer will need to contribute and you will also receive tax relief.
- Start with a modest contribution but commit to increasing this, for example by 5% per year. You will barely notice the increase, but it will make a huge difference to your pension pot at retirement.
Tax Efficiency
Pensions are an extremely tax-efficient way of saving for retirement.
For every £80 you contribute personally, a further £20 will be credited in the form of tax relief. This takes the gross contribution to £100.
Higher and additional rate taxpayers can claim further relief through Self-Assessment.
Pension contributions can also effectively reduce your taxable income, taking you into a lower tax band.
Employer contributions are an allowable expense for Corporate Tax purposes, which can make funding your pension through your business an effective option.
However, there are some limits on contributions and exceeding these can result in tax penalties:
- You can receive tax relief on personal contributions of up to £3,600 per year (gross) or your annual earnings if higher.
- Personal and employer contributions are further limited by the annual allowance, which is currently £40,000. If you don’t use your full annual allowance, it can be carried forward by up to three tax years.
- Anyone earning over £240,000 will have a reduced annual allowance.
- Your annual allowance will be reduced to £4,000 if you have taken income from a money purchase pension. The carry forward option is also removed.
- Your total pension pot will be measured against the Lifetime Allowance. This is currently £1,073,100, with tax of up to 55% payable on any excess.
If your pension savings are limited by taxation restrictions, remember there are other options. You can also save for retirement using ISAs, investment accounts, and bonds.
Income and Spending Patterns
Your income and expenditure may vary throughout retirement. For example:
- Many people retire gradually, and require their pension income to supplement a reducing salary.
- It’s usual to spend more in the earlier years of retirement when you are still fit and well.
- Spending often slows down later in life, although may increase again if care is needed.
- You may have a company pension scheme with a specified retirement age and fixed income amount. If you want to retire earlier, or need to vary your income, you will need to plan for the additional flexibility.
- Depending on your age, you may receive the State Pension as late as age 68 under current proposals. Most people want to retire earlier than this, in which case further planning is required.
