Most people have no plans to work throughout old age. We all look forward to retirement, with the possibility of holidays and quality time with grandchildren. Yet, the future is uncertain. People are living longer. Financial planning is essential. Is saving for a pension still the best thing to do?
Financial planning for old age
Think about your future as early as possible.
The earlier you start building your savings and thinking about your pension, the more options you will have available.
If you start at a relatively young age, you can save at a slower pace.
If you leave it too long, you will need to build up your savings far quicker. This will be harder on your disposable income.
It is usually recommended that you start saving for a pension as soon as you start work.
Pensions auto enrolment
Auto enrolment ensures that UK workers are signed up to a pension scheme, through their employer.
All eligible workers will, at least, be saving something for their retirement.
To be eligible for automatic enrolment, you must be at least 22 years old and on a salary of at least £10k.
If your employer chooses to make the smallest contributions, and you are paying the minimum, you can be setting aside 2% of your earnings into a pension pot. From April 2018 this will increase to 5% and from April 2019 it will go up to 9%.
For most people, the minimum contributions will not be enough for a comfortable retirement.
Types of workplace pension
To begin saving for a pension, it is important to know what kind of pension you are offered.
A defined benefit pension
With a defined benefit pension, your employer makes a promise of a specific retirement income. They will tell you how to contribute each month.
This is the easiest pension to understand, from the employee’s point of view.
You do not need to think about how much to pay in because your employer will dictate this figure to you.
A defined contribution pension
A defined contribution pension is more complicated. There are no promises. The more you save, the more you will receive upon retirement.
When you retire, you have two options with your defined pension. You can either draw your pension as an income or use it to buy an annuity.
An annuity is a guaranteed income each month, paid for with your full pension fund. If you instead choose to draw an income, you will slowly deplete your pension savings.
Saving for a pension
The 2016 Scottish Widows Retirement Report found £24,000 is the least annual income needed for a comfortable retirement.
Many people are not saving enough to make this goal their reality.
As of April 2016, there is a state pension of £8,092 per year for anyone that has made all their required NI contributions. This means that people need an extra £16,000 per year to meet their desired minimum.
You can use the Money Advice Service Pension Calculator, for a better understanding of how your pension savings will affect you in the future.
The difference a decade can make
A 30 year old just starting saving for a pension, and setting aside 20% of their income on the UK’s average salary, would be saving £5,500 each year.
On top of their state pension, this would contribute to a total annual income of just over £13,500 upon retirement at 68 years old.
A 20 year old in the same situation would have an extra decade to save. Putting away the same amount each year, they would eventually have an annual retirement income of just under £23,000. This is much closer to the average’s person’s goal for their retirement.
Planning for your old age, and saving for a pension, can provide more financial security through your retirement years.
Relying on the state pension, even topped up with minimum contributions through a workplace pension, is unlikely to give your desired retirement income.
Other ways to save for retirement
As a minimum, it makes sense to be signed up to an offered workplace pension. This ensures that you are saving for retirement, even if you do not build your savings elsewhere.
A workplace pension comes with benefits in the form of employer contributions, which will help you to build a bigger pot than you could on your own.
For most people, this is still not enough. There are other ways to boost your pension savings, giving you more security in old age.
Private pensions, or personal pensions, are usually provided by banks and insurance companies.
In some cases, you can contribute as and when. This makes them a lot like a long-term savings account. In other cases, you will be expected to make a minimum monthly contribution.
You are given basic tax relief on any money that you save. If you contribute £160, the tax man will add an extra 20%.
Money will be taxed on withdrawal, when you retire. Up to 25% of your private pension savings can be taken as a tax-free lump sum.
The LISA, or Lifetime ISA, is being introduced from April 2017. It will be available to all between the ages of 18 and 39.
This is a long-term savings account, with incentives for contributions.
Each year, you will be able to save up to £4,000 in a LISA.
The government will contribute an additional 25% of anything that you save. This means that you can earn an extra £1,000 a year, if you use your full LISA allowance. Bonuses continue until your 50th birthday.
LISA funds can only be withdrawn for a house purchase, or after your 60th birthday.
Whilst pension savings come with tax relief when added, LISA savings do not. However, your pension is taxed on withdrawal whilst your LISA savings can be withdrawn tax-free once you reach your 60th birthday.
Most pension funds cannot be accessed early. You can take money early from your LISA, but will be required to pay a 25% charge for doing so.
Experts recommend that you do not rely only on a Lifetime ISA. It is wise to open one, for the bonus benefits, but not to make it your only method of saving for a pension. It should be used as an addition to your workplace pension, and possibly a private pension as well.
If you are employed, your workplace pension will be boosted by employer contributions. Your employer will not be adding contributions to your LISA.
Your LISA savings can also affect your benefits entitlement.
How much to save for retirement
Your required income goes down during old age, when you have fewer financial commitments and will probably be mortgage-free.
Despite this, many people are not saving enough for a comfortable retirement. You will need a budget for your essentials, such as living costs including food and heating. You will also want money for luxuries, whether those are holidays abroad or more simple pleasures such as a weekly club or activity.
According to NEST, the National Employment Savings Trust, there is a significant difference in quality of life below and above £15,000. As a result, this is the minimum annual income that they would recommend workers to aim for.
£15k is a far more achievable annual income than the £24k that many workers assume they will need. But, it still requires careful financial planning.
Ideally you will start saving for a pension in your 20s.
If you are on the UK’s average salary, you will want to be contributing as close as possible to 20% of your income. By the time you reach your 30th birthday, you will need to save more than 20% for an income of £15,000 per year.
Relying on the state pension, and even on minimum contributions to your workplace pension, will not be enough.
When planning for old age, save as much as you can comfortably save in a variety of different locations. You will ideally use a personal pension, a LISA, or both, on top of your existing workplace pension.
Many people feel negative about their retirement prospects. In uncertain times, it can be tempting to avoid saving. Some people feel that their savings will be worthless, or that they are due to be ripped off in years to come. Instead, recognise this as an important chance to prepare ahead of time.
By setting aside as much money as possible, you can build a buffer that will give you security through your retirement years. Leave it too late, or save too little, and your quality of life may be greatly reduced.