A slow start can be costly
Planning for retirement is just one area in which, with the benefit of hindsight, many people wish they’d taken action earlier.
How often in life do we look back and wish we had done things differently? According to a recent study, two in five pensioners regret retirement-planning mistakes which have left them struggling financially.1 Nearly one in five say that they didn’t save enough for retirement, and 15% regret not starting to save earlier in their working lives.
Understandably, many of us still have misgivings about locking our money away for decades – especially if we have more immediate calls on our income. Nevertheless, if we’re serious about planning for the future, we need to put away surplus income today, since doing so funds our lifestyles tomorrow.
With that in mind, how should we go about saving for life after work? Putting aside arguments over whether the current government – or a future one – will rein in pension tax privileges, there are some compelling reasons why a pension is still the most obvious answer.
Pension contributions attract tax relief on the way in and they accumulate capital gains free of tax once inside. When you access your pension savings, the first 25% is normally tax-free. While you cannot draw benefits until your 55th birthday, this can also be an advantage as it restricts the temptation to tap into your retirement fund before then.
Getting off the mark
How much pension income you need in retirement will be determined by a number of factors, including your health, your living expenses and your desired lifestyle. Unfortunately, there’s no one-size-fits-all answer. However, the average worker in the UK earns £26,364 a year2, so a pension income of around £20,000 might seem like a reasonable target for most people.
Assuming you qualify for the full single-tier State Pension of £8,094 a year3, you would need to find at least £12,000 a year from your other pensions to achieve an overall income of £20,000 per annum. Achieving this, however, can be very challenging for those on low incomes, or those with unpredictable earnings – but especially for those who delay saving.
For example, someone in their mid-20s who starts saving into a defined contribution (money purchase) pension today would need to save around £250 a month to achieve an income of £12,000 by the time they reach State Pension age. Someone who delays until their mid-30s would need to put away £420 a month; and a 45-year-old who hasn’t started a pension would need to start saving around £850 a month.4
This analysis assumes that the fund would be used to purchase an annuity. Of course, under ‘pension freedoms’, people can draw down their defined contribution pension in a variety of ways; but an annuity remains a widely chosen method of providing a retirement income – and a useful yardstick against which to measure the required saving rates.
Playing catch up
“The sooner we start, the more choices we have later,” says Ian Price, divisional director at St. James’s Place. “The power of compound returns [gains on gains] means that 10 or 20 years can make a big difference.”
“However, you should never think that it’s too late to start saving, or that you can’t catch up. There are significant opportunities to make up lost ground if you have the available means and allowances,” he adds.
You can put as much as you want into your defined contribution pension each year, but you’ll normally only get tax relief on contributions up to £40,000. If your scheme operates what is called a ‘relief at source’ arrangement, your pension provider will add tax relief of 20% to your pension contributions, and then you can claim anything above the basic rate via your annual tax return. A £40,000 contribution could effectively cost a higher rate taxpayer just £24,000.
Moreover, you can make use of allowances from the three previous tax years if these haven’t been utilised. This year is particularly important, especially for higher earners, as it is the final chance for pension savers to use the £50,000 allowance that was in place in 2013/14 – before it was reduced to £40,000. If it is not used before 6 April 2017, it will be lost forever.
However, the fact remains that the best way to secure a comfortable retirement is to save as much as possible as early as possible in your working life, and take financial advice. The longer you delay saving, the harder it will be to build the kind of fund that will see you through retirement.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are dependent on individual circumstances.
1 Prudential, 15 April 2016
2 Office for National Statistics, 15 March 2017
3 www.gov.uk, 17 March 2017
4 Aegon.co.uk, accessed 20 March 2017; the example is based on a male who pays basic rate Income Tax, buying a single life, level annuity, and where pension contributions are invested in a default equity and bond lifestyle fund