The gradient is everything when climbing a mountain.
It is much easier to scale great heights if the slope isn’t too steep; this analogy applies when saving towards retirement.
If you are at retirement today, say a male age 65 without any particular medical or lifestyle issues, you will need a pension pot of £460,000 in order to provide you with an index-linked income of £15,000 per annum.
This article is not about annuities or whether or not they offer good value for money. It is true that annuity rates are at, or near to, all time lows, but I am using annuity rates for the sake of making a different point.
The point that this article wants to make concerns the advice for starting saving for retirement earlier rather than later.
You could argue that you may not need as large a lump sum- but you can’t know that for sure. The figure could be considered cautious but we don’t know what inflation will be or how kind investment returns might be.
If you are 65 now, at least you know where you stand. You know how much you have saved and what current annuity rates are and what your other options are – but what if you are only 20 years old? If you could be bothered to consider it at that age, how much would you need to save to fund a retirement from age 70 in 50 years’ time?
Employers are now compelled to automatically enrol staff into a pension scheme, but many employers are currently contributing the absolute minimum of 1% of only part of your earnings into pension, with you as the employee currently obliged to contribute the same if you do not want to opt out. This is possibly only a few hundred pounds a year. You don’t have to be Einstein to work out that this won’t accrue to hundreds of thousands of pounds in time for your retirement.
So if you like the idea of £15,000 per annum on top of your state pension when you are 65, how can you possibly know how much to save and when to start?
If inflation averages only 2% over the next 50 years (the long term average has been higher than that) you will want a pension fund which can support £51,556 per annum for you to feel as well off as you would with £15,000 per annum today.
Using the same annuity rates as are available today, you will need a pension pot of £1,581,050 to provide £51,556 per annum from an annuity.
50 years is a long time to save but these figures show that you have got a lot to save if you want to have a choice in when to retire and the standard of living that you might hope for.
What if you do want to retire earlier than 70? Well you need to save more of your income because annuity rates will be worse when you are younger because you will be drawing it for longer.
For most people pensions are the best way of saving towards retirement because you get tax relief on your contributions and the fund grows tax efficiently. Tax is paid on the income that you draw out at retirement after taking your 25% tax free lump sum.
There are many competing demands on your money. Not to mention the statistic that younger people are earning less on average than they used to. However, If you think that you can afford to wait until you are older before starting to save for retirement, consider this:-
If you save £300 per month from the age of 20 to the age of 70 (50 years) and achieve a constant return of 4% per annum net of charges, you could have a pension fund of £571,585 by the time you are 70.
If you wait until you are 22 the pension fund projection falls to £546,001 – that’s a difference of £25,584 for missing that one year’s contributions of £3,600.