Planning for retirement shouldn’t be something that fills you with dread: it’s all about looking after yourself as you will be the one who benefits from it. While pensions may seem complicated, the basic principles are extremely simple – most people live at least 15 years after retiring, and you need to be able to support yourself financially, despite not earning a salary. Since pensions provide the most forms of tax relief (which basically means that you either get your tax back or that you don’t have to pay it), they are widely seen as the best way to save for your retirement.
It is never too early to start thinking about pensions – the sooner you start putting money aside, the longer you’ll be building up a fund and the longer it has to grow (it is likely to be put into various investments such as those on the stock market). Even if you over save for retirement, you could reduce your pension saving later, you could retire earlier or you could have a better-than-expected lifestyle in retirement.
Whilst saving for retirement early in your career is important, it is also never too late. If you are approaching retirement age without a decent pension pot already saved up, your options may be more limited, but you can still take steps to improve your income in retirement.
It is a good idea to seek expert advice throughout planning for retirement, whether you are thinking about starting a pension fund, monitoring the progress of your pension saving, making a change to your pension, or turning your savings into a regular income when you retire.
Deciding how much income you will need when you retire
When you are planning for retirement, it is important to think about how much money you need to live on once you stop working. For most of us, our living expenses after retirement should be substantially less than when we were working but this should be balanced with what you expect to do with all the free time you’ll have.
For example, you may have paid off all or most of your mortgage, and costs associated with working such as commuting will no longer be incurred – but you may wish to spend more on travel or hobbies.
As a general rule of thumb, expect your expenses in retirement to be between a third and a half less than while you were working. If you have a rough idea of how much income you’re going to need, it will help you work out how much you need to pay into a pension.
Any forecast of the future size of your pension fund will be based on a number of assumptions, such as expected interest, inflation and stock market growth rates, any of which may be under or overestimated. Even small differences can be significant as they are magnified over the very long timescales involved, first in saving for retirement and then actually in retirement.
Even if you have saved nothing yourself for your retirement, you will generally be able to claim the basic state pension.
The amount you actually receive from the Government depends on how many years National Insurance (NI) contributions you have made while you were working. Currently, both men and women have to have made 30 years worth of contributions in order to claim the full benefit.
The DirectGov website is the best place to get a forecast of your entitlement to the State pension. This will give you an indication of how much you might like to top this up by through workplace pensions or, if none is available, with a personal pension scheme.
There are many different types of personal pension, including stakeholder, group personal and self invested personal pensions (SIPPs).
Pensions require the payment of regular contributions, which are then invested throughout the life of the pension plan. They benefit from tax relief, and the risk and potential reward varies between the types of pension. You are not permitted to invest more than your total yearly earnings in a pension, subject to a minimum of £3,600.
As a general rule of thumb, a total pension of £500,000 will buy you an annuity of £25,000 a year, although this will vary with your age, annuity rates (which go up and down over time) and your individual circumstances (for example, if you experience health problems you may receive significantly more).
Annuity or Drawdown?
To convert a pension fund into a regular income when you retire, you’ll most likely need to buy an annuity. Annuities will pay out a set income for the rest of your life. The amount received depends on the size of your pension fund, your age and potentially other factors such as your health and lifestyle. For more information on annuities see our guide.
It is also possible to keep your pension invested (e.g. in the stock market), even after you have retired, and take a regular income from it. This is called income drawdown, and offers increased flexibility when compared with an annuity. However, it does not guarantee your level of income and comes with risks you may not wish or be able to accept. Our guide to drawdown is a great way to start learning about this alternative to annuities.
Tips when planning for retirement
- It is never too early to start planning for retirement, but even if you have left it late, there are still steps you can take to boost your income.
- A pension is one of the biggest financial commitments you will make, so get advice on the options available to you.
- Your living expenses are likely to be lower in retirement than while you are working.
- The Government can tell you how much state pension you are likely to get, and when you will get it.
You should get expert advice on turning your pension into a regular income with an annuity. It is an irreversible decision – you only get one chance to make the right decision. Buying an unsuitable annuity could very easily be the worst financial decision of your life, so give it time and get help.