If you don't already save into a pension don't worry about it. It's probably refreshing to hear that right? After all every other financial expert out there will be scathing about your lack of planning. Other money experts and financial advisers like to paint themselves as the picture of superhero perfection so they can charge people a fortune to be let in on their secret. But don't listen to them. When it comes to financial planning it's never too late. Also while these 'superheros' ignore the fact that reality gets in the way of our best laid plans I don't.
Who can realistically contribute several hundred pounds a month to a pension when they have children, for example? That is why I produced this article at the request of a UK national newspaper and why I've reproduced it here. In this article you will:
- find out how you can get a £25,000 a year pension (more than the national average wage) from £32 a month, even if you are starting from scratch, versus the superheros' claims that it will cost you at least several hundred pounds a month
- find out how much you should start paying into your pension each month
- put a plan into action
- finally stop worrying about what's going to happen to you in retirement
Remember, you need to plan for your retirement otherwise it will never happen. No one is going to do it for you.
Start by breaking down your goal
Yes it is possible to retire on £25,000 a year (which is a bit more than the national average wage) by saving just £32 a month. Everyone who reads this article is surprised that it is possible but I want to assure you it is. All I am doing is using financial planning techniques, from a career spent in financial planning, that a financial adviser would want to charge thousands of pounds to tell you.
Typically an adviser (or indeed the press) will use current annuity rates and an assumption that you will take 25% of your pension pot as a tax free cash lump sum to calculate the size of pension pot you need to provide an equivalent income of £25,000 a year. If we assumed a male was to retire at age 65 with an income of £25,000 a year he would need a pension pot of £666,666!
That is an eye watering amount for you to have to pay into your pension throughout your working life. For many it would equate to saving £500+ a month. But don't worry I will tell you why that is an unnecessary amount. For starters most people will have paid off their mortgage by the time they retire bringing their required income down i.e you won't need money to pay your mortgage each month once you retire. Therefore most people need a retirement income of around 2/3 of their salary to maintain their standard of living. So that brings down the required gross pension to £16,666, from £25k.
If we also ditch the idea of raiding your pension and taking a massive lump sum, instead using it to just produce an income in retirement, the required pension pot now drops down to around £330,000 which is a bit more sensible. Not everyone needs to have a tax free lump sum especially if they have cleared their mortgage.
Your boost from the state pension
When planning your retirement you next need to take account of all of your retirement income. Assuming that will receive a full state pension (as most people do) this amount under the new rules equates to £8,093 a year. Not bad at all.
So deducting that from the £16,666 income from above leaves us with needing to generate £8,573 a year gross income. To generate this income you now only need £171,460 in your pension pot when you retire. Already that is far more achievable. But I've not finished yet. As you can see momentum is building!
Start paying into a pension today
Now the power of compound returns mean that the sooner you start putting money into a pension the less you have to save a month.
To get a pension pot worth around £171,460 by age 65 you would need to save
- £374 a month if you are aged 30
- £530 a month if you are aged 40
- £894 a month if you are aged 50
These are big numbers but don't worry I'm going to reduce them further.
Keep charges low
Now the above figures are assuming that you pay an annual charge on your pension (such as a SIPP) of around 1.5%. Yet these days it is possible with Exchange Traded Funds (ETFs) and tracker funds to get the annual charge much lower. Charges have a huge impact on the size of your pension fund over time. Or in other words it means your pension pot grows quicker which means you can contribute less each month.
If in my example above the 30 year old cut their charges by investing their pension fund into etfs or tracker funds then they would need to save just £305 a month. We are getting there!
Your boost from investment risk
Now one of the benefits of starting to save for retirement early is that you can take a little more risk. The above figures assume an average return of 5% a year in excess of inflation. If that 30 year old took more risk and the average annual return was say 8% a year above inflation then it would mean he would only need to save £105 a month and still achieve the required retirement income. Of course there is no certainty of achieving 8% a year return but it is not unrealistic.
Your boost from the tax man
This is the crucial bit. Pension contributions enjoy generous tax reliefs. For every £8 a basic rate (20%) tax payer pays into a pension the tax man adds £2. Or in other words every £100 of pension costs them just £80. For higher rate (40%) tax payers the relief is even more generous meaning every £100 in a pension costs them just £60. They would still £80 into the pension each month and the tax man would add £20, while the other £20 tax relief is claimed back via their tax return.
So for the 30 year in our example the cost of the pension is now £63 a month assuming they . are a higher rate tax payer. For other ages and tax bands see the table below.
Your boost from your employer
This is where it gets interesting. Some employers will match employee pension contributions up to a limit if they join the company scheme. If your employer does offer this facility then you would be foolish not to take advantage of it.
Yet this will soon be available to everyone under the Government's auto-enrolment scheme. In a nutshell every employer in the UK will have to contribute to a pension for their employees, as will the employees themselves. So even if your employer doesn't match contributions now they will have to a certain extent in the near future.
So if an employer matched an employees pension contributions then that 30 year old would pay just £32 a month net and get it topped up to £105 by his employer and HMRC.
Below I show you the final minimum amounts, taking account all of the above factors, based on age and income tax rate. You will be amazed how little you need to contribute (less than you probably spend on coffee each month). Plus it is and is a long way from the tens of thousands of pounds a year an adviser would tell you that you have to save. Don't forget the more you pay the more advisers can earn, which can not happen if you plan your retirement yourself.
Your minimum pension contribution based on your age and earnings
Find your approximate age and your tax band in the table below to see the net monthly contribution you need to make to get a £25,000 a year pension. For most people they will spend more on coffee and alcohol a month than the amounts shown below. By just diverting the money to their pension instead they would give themselves a comfortable retirement. The key point is that it is never too late to achieve your retirement dream.
|Age||Net monthly contribution 20% tax payer||Net monthly contribution 40% tax payer|
|30||£42.00||£32.00 (you pay £42 into the pension & claim £10 extra tax relief via you self assessment)|
|35||£57.60||£43.20 (you pay £57.60 into the pension & claim £14.40 extra tax relief via you self assessment)|
|40||£80.00||£60.00 (you pay £80 into the pension & claim £20 extra tax relief via you self assessment)|
|45||£120.00||£90.00 (you pay £120 into the pension & claim £30 extra tax relief via you self assessment)|
|50||£188.00||£141.00 (you pay £188 into the pension & claim £47 extra tax relief via you self assessment)|
Congratulations you have now achieved something most people never do, that is to visualise your retirement plan. What we've done is taken a seemingly Everest sized mountain and reduced it to a more leisurely walk.
Think of your minimum contribution amount that we've worked out as your base camp. It is your contingency plan that will ensure that you have a comfortable retirement. But there's more great news. Even if your employer isn't contributing now, they inevitably will. But more importantly as you start paying the monthly amount into a pension your career will advance. Your children will get older. You will get pay rises. It all means that you will inevitably be able to comfortably increase your monthly contributions when you want meaning that your retirement income will be even higher.
The final piece to the jigsaw
As I said earlier, you need to plan for your retirement or it will never happen. You now know what you need to do to ensure a comfortable retirement. If you don't have a pension plan to contribute to you can start a pension online* with the UK's leading pension provider with a one-off payment of just £80 or with a regular contribution of £20 a month. You don't even have to decide your investment choices to get up and running. Plus it only takes a few minutes to set up. It's popularity stems from its cost effectiveness, wide investment choice (including low cost tracker funds and ETFS), excellent customer service and online functionality. The important thing is to start contributing to a pension as soon as possible
The sooner you start contributing to a pension, no matter how small, the sooner you can retireSecure your retirement*
For those of you who want to know a little bit more about how a pension works then here is an excellent guide to Self Invested Personal Pensions*.
Good luck and please share this article to empower others to start planning for retirement themselves.
This guide will give you a run down on how a self invested personal pension works as well as how to get started.Download the SIPP guide*
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