With rising rent and the average student in England graduating with £50,000 of debt, the last consideration for some might be pension contributions. However, recent research has found the average person will need to accumulate £260,000 to enjoy a basic retirement income. Worse still, the report from Royal London suggests that for the estimated one in three retirees living in private rented accommodation, the amount needed is an astonishing £445,000.
The reality is that people are living longer and costs in later life are increasing. Couple this with historically low interest rates, and the sum needed to support later life increases exponentially.
Assuming retirement at 65 years old, to meet the £260,000 target will require a significant level of commitment, exactly how much isn’t necessarily easy to calculate given the effects of interest rates, investment returns and inflation. So, how much should you be paying in to your pension? Over time, different rules of thumb have developed. We thought we’d analyse a few:
Broadly speaking, considering pension planning, there are three rules of thumb:
‘Half your age’
The concept is straightforward; save half your age as a percentage of gross income. i.e. if you are 44 years old you should be saving 22% of your salary. This may sound a lot, but bear in mind that figure includes tax relief and employer contributions, assuming you are employed. If you run your own business or are self-employed, unfortunately you don’t enjoy that luxury.
According to the Office for National Statistics pre-tax average weekly earnings in the UK are £516, which is just under £27,000 a year. Using the average income as a rudimentary figure between 18 and 65 years old, the ‘half your age’ method provides a pension pot of over £267,000, without considering any investment gains or charges. The logic of the principle seems sound. With a modest investment return after charges compounding over as many years, the impact on the ultimate value will be significant.
How does this rule of thumb stack up? Naturally, the sooner you start saving the better.
However, it’s also important to consider that increasing age doesn’t always mean an increasing income, you are also unlikely to be starting on the national average wage at 18 years old. You might change careers mid-way through life or wind down working hours nearing retirement. The amount you are saving is consequently less, at one of your last opportunities.
You will also need to carefully manage lifetime milestones; house purchases, getting married, having children, grandchildren… all significant outlays making a dent in the amount you can save towards retirement.
Twice your salary when you’re 35
When it was recently reported by Fidelity Investments that by 35, you should have twice your salary saved millennials were in uproar, with aforementioned student debt and the housing crisis often cited as reasons why it was unrealistic. Quickly “by 35 you should have [insert wildly optimistic claim]” began trending on Twitter ridiculing the assertion, ultimately making headline news.
Fidelity proposed the savings factor system: Aim to save the equivalent of your salary by age 30, twice it at 35, seven times by 55, and ten times by 67.
How appropriate is this rule of thumb? Well, whilst having a regular savings target is undoubtably beneficial, if unrealistic, it’s irrelevant. During a period in life where you may be planning a family or (especially in London) saving hard to buy your first house, an idealistic pension target can only dishearten people. The likelihood is that money is better spent eradicating debt and fulfilling shorter-term goals.
The most important point is to start saving, at any level.
The best thing about auto enrolment is that it actually nudges you to make a start.
Figures from The Pensions Regulator reveal that in 2017 £5.4 billion was invested in defined contribution (DC) pension schemes, an increase of more than 21% on 2016. The total invested in DC schemes is around £48 billion to-date and membership is up to 12.6 million people, an increase of over 400% since 2010. This is predominantly thanks to auto enrolment, now making it compulsory for employers to automatically enrol eligible employees into a pension.
Currently the auto enrolment minimum contribution is 5% of a band of your earnings (between £6,032 and £46,350 in 2018/19); 3% paid by you, the rest by your employer. This amount is set to increase to 8% in 2019, but as discussed, it is simply not enough. The figures speak for themselves; as more people start saving for the first time, the average asset per member has reduced from £4,700 in 2016 to £3,900 in 2017.
The issue is, auto enrolment may give you a false sense of security that your retirement planning is on track, when in reality, you are paying a much lower percentage of your salary than is really needed.
How can I properly plan for retirement?
Rules of thumb are a start, at the very least it’s a conscious start to retirement planning. The real answer is professional, considered, financial planning. A bespoke financial plan, incorporating lifetime cash flow forecasting, will identify your objectives and clearly map how to best achieve them. Importantly, it will be in the most tax efficient way, with appropriate investments aligned to the level of risk you are comfortable taking. Regular, incredibly valuable, reviews will realign your plan with your evolving circumstances.
The value of your investment can go down as well as up and you may not get back the full amount invested.