MAKING sure that we have enough money at the end of our working days is perhaps the biggest financial challenge most of us ever face. As we live longer and retirement years increase, the provision of solid retirement benefits becomes ever more important.
In this article I will look at how anyone can make a positive impact on their retirement benefits – no matter what their age.
Start early – under 40s
“I am only now sitting in the shade because I planted a tree a long time ago.” – Warren Buffet, investment guru.
Don’t delay. If you are in your 20s or 30s then the benefits of early retirement saving cannot be underestimated. For example, if you started saving £150 per month into a pension plan at age 25, then you could end up with a fund worth £395,000 (based on an annual growth rate of 7%). Remember that all income and gains within a pension plan are tax-free.
But if you left it five years and then started saving, your fund would be worth only £270,000 (that’s a £125,000 reduction in fund value, but only a £9,000 saving in total premiums paid). It is a difference, in the total fund value, of more than 30% and really hits home as to what a powerful effect compound interest can have over time.
I understand that for most young people there are a multitude of more pressing concerns such as paying for an education, repaying a mortgage or going out for a few beers every weekend! Also, a major disincentive for many thinking of starting pension contributions early is that your pension fund cannot be touched until you are 55, although it should be recognised that pension contributions do attract tax relief (at 20% or 40%, depending on your tax rate) which will help your savings grow even more over the long-term.
However, if you cannot yet afford to put money away without being able to access it until age 55, then other vehicles such as individual savings accounts (ISAs) are more flexible and could be a more appropriate savings scheme.
ISA income and gains are tax free. Also, they can be considered a good basis for longer-term pension planning: ISA funds can be paid as lump sum pension contributions at a later date if required.
Under current pension legislation you can contribute 100% of your income into your pension each year and still benefit from tax relief, although this is capped at £245,000 per annum for really high earners. So, in simple terms, let’s say you build up an ISA fund over the next few years to, say, £30,000 (you are still able to dip in to the fund for emergencies, etc.). Then, when you are financially able to invest it long-term, you can transfer it to a pension fund. If at that point you are a basic rate taxpayer, the £30,000 will attract an automatic 20% tax credit, which makes the actual contribution to the pension fund a healthy £37,500. Higher rate taxpayers will also be able to claim an additional 20% tax relief through their self-assessment tax return.
With regards to choosing your investments, if you are younger, you may wish to be more adventurous in choosing your investments – things could go well and your fund value will grow more quickly. If things don’t go so well, the fund will grow more slowly, but you have more time to recover the position and take a more cautious route.
Maximise your savings – in your 40s
This tends to be the decade in which retirement savings are maximised as people’s earnings tend to peak when they are in their 40s. This is coupled with the fact that the costs of mortgages and children are also beginning to fall away. As a result, many advisers suggest that you should put as much as possible into your pension at this stage.
As a general rule of thumb, we would suggest halving your age and using this figure as an indication of the percentage of your salary you should be paying as a pension contribution. For example, for a 40-year-old we would recommend placing as much as 20% of your salary into your pension.
Reconsider investment strategy – in your 50s
This is the time to reconsider your investment strategy. Short-term market volatility can be difficult to recover from, so it is important that you build more diversification into your funds, with about half of your money in stocks and shares. The rest should be comprised of cash deposits, corporate bonds, fixed interest funds and gilts.
Most people will also be entitled to a state pension so we would recommend requesting a state pension forecast from www.direct.gov.uk. If your national insurance contribution record is incomplete, then you will have the chance to rectify this by making additional contributions.
Taking your benefits – post age 60
Once you are into your 60s, you should start to consider reducing the risk of your pension funds to take into account your proximity to retirement. We would tend to recommend that, at this stage, no more than 40% is allocated to stocks and shares type investments.
With regards to accessing your benefits, then you will need to consider your individual financial requirements. For example, can you stand an element of investment volatility after retirement? Or do you need a fixed income?
If you are put off by low annuity rates, one option is to use an income drawdown facility. The benefits of this are considered below. However, if you need a guaranteed income, then it is usual to look at purchasing an annuity instead. An annuity is usually bought from a large insurer and, basically, they agree to pay you an amount for life, in return for you paying your pension fund value to them. Annuities are considered further below. In either case, you are entitled to take up to 25% of your pension benefits as a tax-free cash lump sum.
■ Income drawdown: you leave your pension invested, but have the option of receiving an income from the fund at the same time. The amounts you are entitled to take are set by the Government Actuary’s Department (GAD) and are reviewed on a five-yearly basis. However, the amount of income you can take is also governed by the size of your fund which will be subject to investment volatility.
If the value of your investment goes up, then you can take a higher level of income as a result; but if it goes down, then you will be left with a reduced level of income. It is therefore imperative that you are happy with the risks involved with an income drawdown arrangement before proceeding.
■ Annuity: Purchasing an annuity can be quite complicated, because there is a vast array of options from which to choose. You can choose to inflation-proof your annuity (by adding automatic increases each year – usually linked to the retail prices index – which would have brought a drop over the last year!) or purchase a guarantee that means your annuity will continue to be paid for at least five years after your death.
In addition, you may want an income to be provided for your spouse if you were to die first – often 50% or 66% of your annuity. However, all of these options will reduce the income you receive initially. Generally, the older you are, the higher the income, but even the best rate is unlikely to exceed 6-7% – therefore just £6,000 to £7,000 a year for every £100,000 in your pension.
You should also make sure that you search for the best annuity rate on the open market – i.e. do not just take the rate offered by your pension provider. For those with underlying health issues, then they are likely to qualify for an enhanced annuity rate or impaired life annuity which can pay considerably more than normal.
The author can be contacted at: Allchurch Bailey Wealth, 93 High Street, Evesham, Worcestershire WR11 4DU; telephone 01386 442597, e-mail andrew.neale@abwealth.co.uk; website www.abwealth.co.uk
