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Retirement:
How much should I save for my pension?

The maximum an individual can save for retirement, and still receive tax relief, is the greater of £3,600 or 100% of earnings up to the annual allowance. The annual allowance is currently £215,000 and rises to £255,000 in steps of £10,000 each tax year until 2010-2011, when the levels for the following 5 years will be set.

There is, however, also the Lifetime Allowance to consider. If an individual's pension fund exceeds this, a penal tax charge of, effectively, 500% is applied when a crystallisation event occurs. The exception to this is that there is a concession whereby the contribution may be unlimited in any year that the member wholly crystallises the benefits in that scheme.

If you are lucky enough to be a member of a defined benefit scheme you will know what pension you will receive, or at least what proportion of your income you will receive as a pension at the normal retirement age.

If you are in a money purchase arrangement, the benefit you receive at retirement depends on the value of the fund at that time. There your ultimate pension will be based on the amount you contribute and the investment performance of your fund. The one factor you don't have any control over is the annuity rates when you retire. These ultimately govern the level of income it is possible to achieve from your pension fund. It is therefore necessary to regularly review your contribution levels and investments to ensure that you will be achieving somewhere near the level of retirement income you require.

The contributions can take a big chunk out of your disposable income. For most people it is matter of achieving a balance between what they can afford to pay each month to their pension scheme and what will give them a reasonable pension.

A financial adviser can advise you on how much to contribute a month to achieve your desired pension at your chosen retirement age. This advice is based on standard assumptions for future interest rates and inflation as to how your pension fund will grow and what it is likely to give you at retirement. It is important to review your pension planning regularly as the actual growth of your pension fund will depend on the investment decisions made by the trustees managing the fund and on the economic climate.


Example

Mr C, age 43, has already built up a pension fund of £100,000. He currently earns £30,000 a year and would like to retire with a pension of £20,000 a year when he is 65 together with the maximum lump sum he is allowed. He would need to contribute around £150 a month gross (£1,800 per annum) from now until age 65 to achieve this annual pension with an estimated (tax free) lump sum of around £100,000. Mr C’s desired pension is therefore relatively easy to achieve as he has already built up a reasonable pension fund. Note that this does not take into account the effects of inflation, nor any salary increases Mr C may have in the 22 years to his retirement.

The later you leave it to start saving for your pension the more you will have to save as your fund will have a shorter period to benefit from investment growth.


Example

Mr D is aged 43 but has not yet started saving for a pension. He currently earns £30,000 a year and would like to retire with a pension of £20,000 a year when he is 65 together with the maximum lump sum he is allowed. He would need to contribute over £800 per month gross (£9,600 per annum) from age 43 to age 65 to get this level of pension and the maximum lump sum at age 65. This equates to nearly a third of his gross income! Whether these levels are affordable is debatable and illustrates the importance of starting to save for your pension as early as possible. Note that this does not take into account the effects of inflation, nor any salary increases Mr D has in the 22 years to his retirement.

The effect of delay in starting a pension

Consider a 20 year old male who wishes to retire at age 65 and can put £100 a month gross into his stakeholder pension plan. At age 65, based on an assumed growth rate of 7% per annum, this will give him:

(Note this does not take into account the effect of inflation.)

Over the 45 years he pays in to the pension plan he will pay in a total of £54,000 (£100 × 12 months × 45 years) to get these pension benefits.

Consider now the effect of leaving it until age 30, 40 or 50 to start his pension but with the same monthly contribution. His pension will be drastically reduced:


Age at start of pension plan20304050
Monthly contribution£100£100£100 £100
Contributions to age 65£54,000£42,000£30,000£18,000
Pension lump sum at age 65£64,600£34,000£16,800£7,200
Annual pension at age 65*£12,500£6,650£3,300£1,400

To get an equivalent pension when starting contributions at a later age, the monthly contributions must be increased significantly. As the fund has less time to benefit from investment growth, the total contributions made by the individual must be greater in total:


Age at start of pension plan20304050
Monthly contribution£100£190£375 £900
Contributions to age 65£54,000£79,800£112,500£162,000
Pension lump sum at age 65£64,600£64,600£63,100£64,500
Annual pension at age 65*£12,500£12,600£12,400£12,900

These figures are based on quotes for a stakeholder pension where £100 per month gross is paid for a male, assuming 7% annual growth, 1% annual management charge, and the annuity is based upon a male aged 65, single life, level payments paid monthly in advance with a 5 year guarantee. Note that no account for the effect of inflation has been taken in these figures and that these are estimates. The pension income will depend on how the investment grows and interest rates at the time of retirement.

Your pension plan

A financial adviser will be able to provide you with illustrations of your total pension from existing pension plans and how much you need to contribute in future to try and achieve the level of pension you want to retire on. Remember when thinking about how much pension you will need that your expenses are likely to be less in retirement:

When meeting with a financial adviser to discuss your pension it will be useful to have collated or considered:


Where next?

Within Your pension questions answered…

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