Planning for your retirement
It’s Pension Awareness Day this week, a day to learn more about how pensions work and understand what your financial needs might be in the future. Securing a comfortable retirement means making sound choices while you are planning for retirement and when you reach pension age – read on for some help in making those choices…
Income in retirement
Even if retirement is many years ahead, having an idea of how much income you will need in later life will help you to set aside enough savings today. How much income you will need depends on your lifestyle choices and varies from person to person.
Saving for retirement
Retirement can easily last 20 years or more. Saving enough to fund a long period after work is costly. There are many different ways to save for retirement. For example, you could use individual savings accounts (ISAs) – from 1 July 2014 these will be called new ISAs or NISAs – or invest in a second home or buy-to-let property. But saving through a pension scheme has some advantages.
Joining a pension scheme through work makes sense if your employer will help to meet the cost by making contributions to the scheme on your behalf.
Under the new system of auto-enrolment, which is being rolled out between 2012 and 2018, all employers have to contribute something. A workplace scheme could be a company scheme, personal pension plan, or a multi-employer scheme, like the National Employment Savings Trust (NEST) – a national scheme with low charges.
If you are topping up a workplace scheme, you might save through a personal pension plan. This is also an option if you are self-employed – in which case, you must bear the whole cost yourself of saving for retirement – but you are also eligible to join NEST.
Whatever the type of pension plan or scheme, you usually get tax relief on your contributions at least equal to the basic rate of income tax (20% in 2014-15). This means, for every £80 you pay in, the taxman provides another £20. Depending on the scheme, tax relief may be added to your pension plan or given as a reduction in your tax bill.
The table below gives an idea of the amount you would need to save each month in spring 2014 to provide yourself with each £1,000 a year of before-tax pension when you retire.
How much you might need to save to provide each £1,000 a year of pension*
|Your age now||Target retirement age||How much you might need to save each month*|
* Assumptions: investment growth 5% a year; charges of 1% a year; pension contributions increase in line with inflation which is assumed to average 2% a year; pension pot buys an annuity for a single person with income increasing each year with price inflation (rates at 21 March 2014 from Money Advice Service); tax relief at 20% will be added to the monthly amounts shown and paid into your pot. Any employer contribution would reduce the amount you might need to save to less than the amounts shown.
Choosing your pension age
The table above assumes that you will retire at state pension age under the rules as they stood in spring 2014.
If you want to retire earlier, you will have to manage for a while without your state pension. On top of that, starting your pension early makes it more expensive because the pension has less time to build up and longer to be paid out. So you will normally have to save more each month to provide each £1,000 a year of pension that you want.
If you plan to retire later, your pension will have longer to build up and less time to be paid out. This makes it cheaper so that you may be able to save less each month to provide each £1,000 a year of pension. For example, if the 50 year old in the table above puts off retiring for five years to age 72, the amount he or she might need to save each month falls to £49.
These figures all assume that you use your whole pension pot to provide an income. Under current rules you can opt to take a quarter of your pot as a tax-free cash sum. If new Government proposals go ahead (from April 2015) with personal pension schemes and some types of company pension schemes, you will have complete flexibility to take any amount of your pot as one or more cash lump sums – provided you have reached age 55. You can even cash in the whole lot if you want to! If you intend to draw any of your pot as lump sums, you will need to save more than the amounts shown if the pension you want is to stay the same.
Retirement does not have to be a cliff-edge where you are working one day and finished with work the next. Currently, around one in eight people over state pension age are still working, often part-time.
If you plan to carry on working into later life, you will not necessarily need all your pensions or other savings in one go. With phased retirement, you divide your pension savings into chunks and can start drawing a pension from each chunk at a different time. Some other types of savings and investments, such as NISAs also give you this flexibility.
As you cut back on work, you could increase the amount you draw from your pension scheme or other savings and investments so that your overall income is maintained.
A phased approach to retirement also gives you a way of planning to deal with the effect of inflation. You can start retirement on a lower amount of income and gradually increase it later to compensate for rising prices.
The new flexibility expected to be introduced from April 2015 (see above) should make it even easier to phase your retirement.
Drawing a pension
You might have to take the pension from an occupational pension scheme all in one go, but with a personal pension plan you usually can phase in your retirement income. This is because each plan is usually set up as a group of segments. You can start the pension from each segment independently of the others.
When you want to start a pension from a segment, you would typically take part of the pension pot as a tax-free lump sum and use the rest to buy a lifetime annuity. An annuity is an investment where you exchange a lump sum (in this case, some of your pension pot) and in exchange get an income either for a set period or for life.
Alternatively, you could draw your pension from some or all of the segments using income drawdown. This is where you leave your pension savings invested and cash in part of these on either a regular or ad hoc basis to provide yourself with income or lump sums as you need them.
Again, you would typically take a tax-free lump sum but then leave the rest of your pension pot invested and just cash in bits of it as you need to draw off some income.
Income drawdown is especially suitable for phased retirement because you are not committed to receiving a set level of pension at regular intervals. You can choose when and how much to cash in (normally up to a maximum amount each year), but income drawdown is more risky and costly than buying an annuity because the maximum income you can draw may fall. This means it is usually suitable only if you have a large pension pot or other reliable sources of income.
Information supplied by Royal London royallondon.com
For more information visit pensionawarenessday.com