Something is always better than nothing, but if you want to be able to have a comfortable retirement it is worth giving the size of your contributions more than a passing thought.
“People very often see what they have at the end of the month and save that,” says Fiona Tait, pensions specialist at Royal London. “However, there are two problems with that – very often there is nothing left at the end of the month and second there is no end goal or target to aim for.”
How much you should be paying into your pension will depend on a number of factors – most significant is the age at which you start saving. The longer you leave it before you start saving, the more you’ll have to put away.
The sooner you start the more you save
Jonathan Watts Lay, a director of Wealth at Work, which provides financial education in the workplace says: “There is an old adage with pensions and that is that you save, as a proportion of your salary, half your age when you start. So if you start at age 30, you’ll need to save 15%.” If you leave it until you are 40, you’ll have to put away 20%, or 25% if you don’t start your pension until you are 50.
This is because the money that you invest first, while you are young has the longest time invested and more chance to grow. Take the example from Chase De Vere. If you invest £100 and it grows at a rate of 6% a year after char ges it will be worth £179 after 10 years. After 20 years it is worth £321 and by the time it has been left for 30 years it has racked up to £574. Leave it invested for 40 years and it will be worth £1,029, 10 times the original amount.
Most advisers agree ‘saving half your age’ is a good rule of thumb to work with. However, there are other factors that you will need to think about too. Mr Watts-Lay says it is important to think about the lifestyle you will want to lead when you retire.
“Do you want to spend your retirement fishing or travelling the world? Also think about when you’ll finish work,” he says.
Clearly the more lavish your plans, or the earlier you want to retire, the harder you’ll have to save. You might feel like you are getting ahead of yourself, planning your retirement, when you’ve barely started your pension. However, your aspirations can be a very powerful motivator.
“Think about what you want to achieve with your money and then you’ll find it easier to make the necessary sacrifices to meet that goal,” he adds.
Rather than thinking of your pension as a lump sum, it can also be helpful to think about the income it will need to deliver. ‘Think of it as a replacement salary, based on your existing one,” says Miss Tait.
“Aiming for two-thirds of your earnings would be considered the gold standard, silver would be half.”
By searching online you can find numerous pension savings calculators (such as those provided by the Money Advice Service) which can help you work out just how much you need to have saved to deliver the income you want.
How much will £100,000 deliver in income?
Bear in mind that a pot of £100,000 would deliver a healthy 65 year old an income of around £5,370 a year with an annuity (with no guarantees, inflation or spouse protection included). However, your capital – the original £100,000 from the pension pot – would be gone.
Alternatively, if you left the money invested via income drawdown you could expect an income of around £3,000, or 3% with a balanced portfolio of investments and without surrendering your capital. (You could of course take a higher income but the risk of running out of money or suffering a drop in income become greater). You could also draw down on your capital as a last resort, if needed.
Whether your plans are modest or grand, the figures will invariably be daunting, but it is important to remember that you don’t have to save all this money yourself.
If you are a member of your workplace scheme your employer should also be making contributions on your behalf and , depending on your deal, could encourage you to pay in more.
Mr Watts-Lay says: “If your employer is matching your contributions that’s essentially free money.”
Coupling that contribution with the tax relief on contributions at your own marginal rate of income tax, means that a small deduction from your salary can be transformed into a sizeable investment into your pension.
“Take a £100 a month payment, for a basic rate taxpayer that will be grossed up to £125, then if you’ve got employer matching that could be taken up to £250. You have spent £100, but got £250 in value,” he explains.
You may not, however, receive such generous help from your employer. Under auto-enrolment rules employers have to pay money into your pension on your behalf.
Currently the minimum contribution on an auto-enrolment scheme is 2% with 1% coming from the employer.
However, it is important to note that this isn’t a percentage of your whole salary, rather it is a percentage of your ‘qualifying’ earnings which is currently the money you earn between £5,824 and £43,000 a year. Kate Smith, head of pensions at Aegon says: “Some employers will pay it on your full salary but you do need to check.”
From April 2018 minimum contribution levels will at least rise to 5%, with 2% coming from the employer and from April 2019 it will rise again to 8% with bosses needing to pay in 3%.
However, in spite of these increases there is still widespread concern that this isn’t enough for a comfortable retirement and workers are being urged to save more than the minimum.
Analysis from Royal London shows that if somebody spent their whole working life paying in the minimum statutory amount to get a pension equivalent to two-thirds of their income, with inflation protection and provision for a partner, they would need to work until age 77. To get half their salary with the same benefits they would need to work until they were just over 71.
Don’t pay the minimum
This means, unless you want to work into old age, you must engage with your pension and not just assume that because a scheme has been set up on your behalf, you are saving enough.
This is particularly tough when there are so many other drains on your finances, like mortgages, childcare and credit card bills through to gym memberships and TV subscriptions. But experts agree savers need to not get bogged down in the now and give some thought to how they will get by in the future. “It’s a balancing act between short term consumption and a need to live a longer, fuller life,” says Ms Smith. “People don’t want to carry on working too long or to retire in poverty.”
But Mr Watts-Lay says upping your pension contributions doesn’t always mean having to make sacrifices to your current lifestyle. “Think about all things you are spending your money on that you have no emotional attachment to. Do you have the best deals for example on your utilities and insurance? That can all free up more money for your pension.”
Alternatively you may want to siphon off a portion of every pay rise that you get – the saving won’t feel like too much of a sacrifice if you haven’t had the opportunity to spend it. Miss Tait says you should do the same whenever you manage to drop a regular outgoing. “Look at the things you are spending money on now that are finite like childcare for example. Once you stop paying it, redirect it your pension before you are tempted to spend it.”