Don't let your retirement dreams fall short
What are your retirement dreams? Do you imagine yourself sitting on the deck of an ocean liner with a long, cool drink in your hand? Or spending the summer months touring Europe with a caravan?
These may all be great ideas but the harsh fact is that relatively few of us are on track to turn these dreams into reality due to a pensions shortfall that often only comes to light once we've finally decided to give up work.
A survey by pension provider AEGON illustrates the point. Although 87% of those questioned wanted to retire on an income greater than £10,000 a year, a staggering 40% admitted they had no pension savings at all.
"For an income in retirement of £10,000, including your full state pension, you need to build up a pension pot of around £110,000," says Rachel Vahey, head of pensions development at AEGON UK. "The average pot today is nearer £25,000."
The good news, however, is that you're never too young to start putting money away for your future – nor too old to improve your chances of enjoying a better standard of living in later life. You simply need to assess your situation and take the appropriate action.
First, you need to work out how much you need. According to Tom McPhail, head of pensions research at Hargreaves Lansdown, if your pension plans show you're going to end up with a retirement income of 50% or more of your current earnings, then you can relax a bit.
"The more above that 50% level you go, then the more comfortable you'll be in retirement," he adds. "But if it's less than that figure, it will become a question of how compromised your lifestyle will be in the future."
Of course, this is all relative, depending on your income. For example, someone earning around £12,000 a year will find that state benefits alone will provide just under 50% of this income target, whereas someone on £200,000 could probably live quite well on a quarter of this amount when they retire.
It's also fair to expect your general living expenses to fall in retirement, with most of us no longer having to cover the costs of a mortgage or with only small amounts left to pay, while any children are more than likely to have left home.
However, that needs to be balanced against the fact you will want money to go out and enjoy your free time, as well being able to cope with rising medical and care bills later in life.
Use a pension calculator to get an idea of whether you are on track with your retirement planning. You can find one by going to the Consumer Financial Education Body's website.
The chances are, unless you've been putting away decent amounts over the years, you will find yourself facing a shortfall. So what are the likely reasons for this and how can you best tackle the problem?
PROBLEM: THE CAREER BREAK
A few years away from the workplace will mean missed contributions, which will almost certainly undermine your overall pension savings – and needs to be tackled as soon as possible.
Women taking career breaks to have children are one of the main reasons why there's such a big pension income gender gap – and the figures compiled by Prudential to illustrate the point are quite alarming.
Women planning to retire in 2010 are expected to receive an average annual pension of £12,169, while their male counterparts will be in line for £19,593 – which works out at a significant difference of £7,424.
Karin Brown, director of pensions and annuities at Prudential, believes there's plenty of scope to help reduce the deficit by talking with your employer to find ways of boosting pension savings and maximising the tax advantages.
"You should also try to keep up any company or private pension contributions, even when you're on maternity leave or an extended career break," Brown says.
Another solution is to get a working spouse to pay into a pension on your behalf – it doesn't matter where the money comes from, as long as it goes into the pot.
If you intend to take a career break, you should plan in advance by pre-funding your pension pot. For example, if you're getting married and want to have children, then try to maximise your pension savings ahead of that time.
You could also try to strike a deal with your employer. For example, in exchange for foregoing a pay rise, they may agree to make some contributions to your pension pot while you are on your break.
PROBLEM: NOT ENOUGH NI CONTRIBUTIONS
The amount of state pension you are entitled to depends on the level of national insurance contributions you have made over the course of your working life – from age 16 to state retirement age.
The good news is that the number of NI years needed to qualify for a full state pension is being reduced to 30 years, but it's still worth getting a state pension forecast as soon as you can to ensure you're on track for the full amount.
Gaps in your NI record can occur for reasons as varied as having very low earnings over a period or living abroad for a while. This will mean for each qualifying year, you'll get 1/30th of the full basic state pension.
You can buy additional NI years in order to plug this shortfall and McPhail says this is definitely a solution that is worth considering.
McPhail points out that an extra NI year will cost you about £600 but will buy you an annual £169 worth of income. "You would only need to live five years before it paid for itself," he says.
"Unless you have an extremely gloomy view of your life expectancy, then buying extra NI years is usually a very sensible idea."
However, as the options open to you will depend on factors such as your age, you should get in contact with your local Citizens Advice Bureau or visit direct.gov.uk for further information.
PROBLEM: STARTED TOO LATE
For many people, life gets in the way of pension planning. When you're young most of your money gets spent on socialising. Then along comes marriage, buying a house and having children, all of which tend to swallow up every available penny.
If you're already in your 50s, with very little capacity to save large amounts, then it's probably not worth starting a pension. You should just put as much as you can in an individual savings account and other investments.
For just about everyone else, however, it's time to get started. Basically you have three options: a stakeholder, a personal pension or a self-invested personal pension (SIPP). Which one is best for you will depend on your individual circumstances.
Basically, it will come down to how much you want to be involved in the management of your pension. If you just want to put some money away, without any involvement at all, then a straightforward stakeholder will be best.
If you want a bit more choice, you can opt for a personal pension. But if you're keen on being more actively involved, you may benefit from the flexibility offered by a SIPP.
PROBLEM: NOT SAVING ENOUGH
You may be squirreling money away into a pension – but are you saving enough to make a difference in the long term?
A general rule of thumb is to halve your age, and then put that amount as a percentage of your salary into a pension scheme. For example, if you're 30, you should be tucking away 15%, and if you're in your 40s, at least 20%.
Try to cut down on spending and increase savings. For more on how much you need to save, see the box on page 56.
PROBLEM: YOUR PENSION IS UNSUITABLE
Another problem could be that your pension may not be suitable for your needs. Of course, you may feel cautious about investing, given the recent market falls, but you will need to take some risk.
Investors in their 20s and 30s, can generally look to embrace supposedly riskier assets, such as funds that invest in the fast-growing but volatile emerging markets, in the hope of making significant longer-term gains.
The closer you get to retirement, however, the less inclined you'll be to lose your savings, so while no investment is completely risk-free, putting some of your assets in safer gilts, and even corporate bonds, might be an idea.
Take a look at where and how you're invested – then take advice to see whether such a strategy will meet your investment goals. If not, then consider buying into funds that will give you a better chance of building the size of pension pot you want.
You also need to monitor your pension regularly: revisit your decisions at least once a year to see how your contributions are stacking up and whether you are on track to achieve the kind of income required in retirement.
PROBLEM: YOU STILL HAVE DEBTS
Planning for retirement means not only building assets and savings, but also ensuring that you have enough income to live the lifestyle you want when you stop working.
Tony Catt, financial adviser at Hanson Wealth Management, points out: "Possibly the most important thing is to make sure that your outgoings are as low as possible in retirement."
Try to pay off any debts as far as possible so you don't have any mortgage or other repayments to make from your pension income. Interest rates on debts are usually higher than the amounts you will receive on deposit-based savings.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.