How much should I pay into my pension each month?
I am 35 years old and I am conscious that I need to start to contributing to a personal pension. At the moment I have no retirement plan in place am not currently contributing to a pension. The problem is I just don't know where to start when it comes to building up a pension pot. When you I start paying into a pension? How much should I contribute to my pension each month? How much pension will that equate to in retirement? When can I retire? I am always reading about the need to for a sustainable retirement income but I have no idea of how to go about it. Also what about using an ISA rather than a pension to save for retirement?
Sorry for all the questions but I am completely confused. Any help would be appreciated.
The classic problem with retirement planning is that people put off dealing with it until it is looming on the horizon. By that point it is extremely difficult to build a pension pot sufficient enough to give you the retirement you want – especially if you are starting from scratch. Like you say people are told to build a sustainable pension income but how can you do it realistically? For the rest of this article I will ignore your possible state pension until the very end as there is no guarantee that it will be around by the time you retire.
Before we start, you may also be interested in our articles "How much income could I get from a £100,000 pension pot?", "How much do you need to retire and what will your pension be worth?" and "How to get £30,000 a year pension by saving just £55 a month".
Start with a realistic expectation
Most people do not have a realistic concept of how much money they need to have saved in order to have a decent retirement income.
A male retiring at 65 with a £50,000 pension pot would get around £2,500 income a year from it whether he took an annuity or provided a sustainable income via income drawdown. That's not exactly much.
Only you can decide how much of a retirement income you want. But using the figures above you can get a sense of how much of a pension fund you would need to produce that income as well as the size of the savings task ahead. Yet you shouldn’t get too downhearted as you can stack the odds of achieving your desired retirement income in your favour. I show you how in the rest of this article.
Ditch the idea of raiding your pension
Let's say you want to a retirement pension of £25,000, then a man of 65 will need a pension pot of £500,000. That is a lot and that’s assuming he doesn’t take 25% of that pension pot as a tax-free lump sum and blow it. If you want an income of £25k a year and a tax-free lump sum you’d need a pension pot of around £666,666!
Yet 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.
Start paying into a pension early
Now the power of compound returns mean that the earlier you start putting money into a pension the less you have to save a month.
To get a pension pot worth around £330,000 by age 65 you would need to save
- £720 a month if you are aged 30
- £1,020 a month if you are aged 40
- £1,720 a month if you are aged 50
These are big numbers but by starting early you can more than halve your required monthly contributions. Given your age (35) that is good news for you.
Keep charges low
Now the above figures are assuming that you pay an annual charge on your pension (be a personal pension or a SIPP) of around 1.5%. Yet these days it is possible with passive funds to get the annual charge much lower. Charges have a huge impact on the size of your pension fund over time.
If in my example above the 30 year old cut their charges then rather than their pension pot being worth around £330,000 when they hit 65, it would be worth £422,000, which could provide a much bigger income. Alternatively it could mean that they could reduce their pension contributions to £590 a month to achieve the original objective of £16,666 a year.
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. If that 30 year old took more risk and the average annual return was say 8% a year, then it would mean he would only need to save £200 a month and still achieve the required retirement income of £16.6k a year, as mentioned earlier.
Of course there is no certainty of achieving 8% a year return, but if your investment timeline is 35 years (as it is for the 30 year old in my example) you can take more risk. Older savers can’t do this.
Save via a pension
Retirement saving doesn’t have to be done via a pension it can be done using Stocks and Shares ISAs. The downside of ISAs is that you don’t get tax relief on the way in, but the plus side is that you don’t get taxed on the way out and you can access it at any time.
Yet with a relatively modest pension income requirement most of it will be tax free anyway when you come to draw it. To save for retirement using a pension you have to be happy that you won’t have access to the fund until you retire.
Yet the big plus of saving via a pension is that you get tax relief on the contributions. So for that 30 year old that £200 a month pension contribution will only cost him £160 a month.
Join your company scheme
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.
Lets say an employer matched an employees pension contributions then that 30 year old would pay just £80 a month net and get it topped up to £200 by his employer and HMRC (pension contributions receive tax relief).
So suddenly that unachievable retirement income has got a whole lot more realistic. Other than saving lots of money there is no simple answer to pension saving. The secret lies in doing a number of things mentioned above to stack the odds in your favour. But while you may say that the 8% return is pretty punchy the figures above don’t take into account the fact that you will likely increase your pension contributions as your earnings increase. That would mean you wouldn't need to make 8% a year return on the money invested.
Of course the final choice is to delay retirement, for example until age 70. For a lot of older people who have neglected their pension funding this is an inevitability. But it significantly reduces the the amount you need to save for retirement
Pension vs ISAs
Before the new pension freedoms, ISAs offered the most flexible way to save for retirement. Now the pension versus ISA debate is less clear cut. Using a stocks and shares ISA to save for retirement has the flexibility of allowing you to access the funds in an emergency. So it is a sensible approach to save via ISAs to start with and then when you are sure you don’t need access to the funds move them into a pension to get the tax relief, assuming you have paid sufficient income tax that year.
Yet whichever route you go down, pensions and ISAs are just tax wrappers and the underlying investments can be the same.
If you follow the advice and the example above you could retire comfortably with an income equivalent to £25,000 in today's money by putting away just £80 a month. That is before you add in a state pension which currently is just shy of £8,000 a year.
So take action today and start saving into a pension. I strongly suggest that having come this far that you download this excellent FREE SIPP guide from the UK's leading SIPP provider. It's one of the best guides I've seen on the subject and tells you everything that you need to know to start saving for your retirement.