Retire on Time

When do you want to retire? 60? 55? Tomorrow? If so, you will have to start planning pretty soon – someone has to pay for that long holiday at the end of your life we call retirement. And the way things are going the person paying for most of it will be you.

The pensions crisis, if there is one, is caused by one simple fact. We are living longer. Between 1960 and 2050 life expectancy for a man aged 65 is expected to grow from just over 12 years to a shade under 22 years. So retirement will be nine and a half years longer – an increase of 77% and you will need a lot more in your pension pot to pay for it.

One answer is to retire later – recent suggestions range from 67 to 70, even 72 in the USA. But many people want to retire younger than 65 not older. That means spending a lot less and saving a lot more. And spending less does not mean using your plastic more – that is spending later, not less.

How much?
No-one really knows how much we have to save to have a decent pension in retirement. But a good clue is given by the schemes that the better companies operate and which promise a pension of around half your pay after 40 years service. The total contribution into those pension schemes is roughly a fifth of the amount paid in wages. If you are with one of those employers then join the pension scheme. If not, and you and your employer between you are paying less than 20% of your gross pay into a pension of one sort or another, then your retirement will not be that wealthy. And remember, even that amount will only let you retire on half the income you enjoy now and usually at 65 not 60.

If you are paying into a pension fund, every £100,000 saved up will currently produce a pension at 65 of less than £5000 a year. So to have a pension of £25,000 which rises with inflation you will need to have saved up half a million pounds. The average pension fund today is around £30,000 representing a pension at 65 of just £1400 a year.

From 6 April next year we will be free to save a lot more towards our pension when fifty years of rules and restrictions will be swept away on ‘A-Day’. We will be able to save as much as we earn – with an upper limit of £215,000 a year – and we will be able to enjoy a pension of up to £75,000 a year without any restrictions. There will also be a new freedom to invest the money saved for a pension where we want – even in things like houses or art – and when we do retire much more freedom about how we turn the our retirement savings into an income.

Join your work scheme
If your employer has a proper occupational pension scheme then you should join it. Staying out of it is like taking a pay cut. Because for every tenner you put in, your employer will normally put in at least another £10 and the Chancellor will chip in with £2.82 – or £6.67 if you are a higher rate taxpayer. A growing proportion of new employees fail to join their company scheme. They are throwing away free money from their employer and the Chancellor.

Some occupational schemes let you choose how much you put in. Always choose the amount which maximises your employer’s contribution. That will maximise the free money going into your retirement savings fund.

Salary sacrifice
Although money paid into your pension scheme is free of income tax it is not free of National Insurance contributions – either for you or your employer. So one way to boost your pension even more is to use what is called ‘salary sacrifice’. You give up some of your pay. You and your employer save money on National Insurance contributions. Your employer pays the salary given up into your pension fund together with all, some or, if they’re really mean, none of the National Insurance contributions they have saved.

Put in more
Many people put extra money into their pension either through what are called AVCs (additional voluntary contributions) or a stakeholder scheme. At the moment there are strict limits about how much you can put in – and you cannot put extra into a stakeholder if you earn more than £30,000 a year. But from next April these rules are being swept away. If your employer doesn’t offer an occupational scheme – or if you are self-employed – then you are on your own. And it is of course much harder to put a fifth of your gross income into it. But you should try.

Which scheme?
Most people do not know – and honestly do not want to know – about the ins and outs of investment. How much risk they want to take, where their money will be invested, who will look after it – all these things are complicated and for most of us not very interesting. As important as any of these are the charges that come off your money – not least because they come off whether your pension savings go up or down. So no matter how much your money may grow charges drag it back each year. Nowadays the charge on a new pension contract is normally at least 1.5% a year. On contracts begun in the recent past it will be more like 1% and in much older contracts it could be 2% or more.

The simplest way to hitch your retirement savings to the growth in UK businesses is to put it into a tracker fund which follows the ups and downs of the whole UK stock market and, because that job is quite easy, should have low costs. Aim to pay charges of 1% a year or less, put in as much as you can, and forget about it until you are 60.

Alternatives
Pension savings are yours but you cannot use them until you retire. No matter if you have a wedding, your roof blows off, or you need cash for a great business idea, your pension fund is tied up until you are 55 (50 until 2010). There are other ways to top up your retirement savings which gives you access to your money.

You can save tax-free in what is called an ISA – an individual savings account. You can put £3000 each year into a cash ISA – basically a savings account with tax-free interest. And you can put another £4000 into an investment ISA which will also grow tax-free. Alternatively you can put all £7000 a year into an investment ISA. You can take the money out of an ISA whenever you want and it is completely tax free. But remember you cannot put in more than the maximum amounts each year so you may not be able to put it straight back.

Some people say their house is their pension fund. What they mean is that when they retire they will use the growing value of their home to release capital and boost their income either by trading down or taking out a loan with the interest to be paid off when you die. Neither is likely to produce an adequate pension.

One alternative from April is to put domestic property into your pension fund using what is called a SIPP (Self-Invested Personal Pension). But it is not possible unless you have a very large fund already. You must use the money in your fund to buy the property and the fund can only borrow an extra 50%. So if you want to buy a property for £150,000 you will need a fund which is already worth at least £100,000 and borrow another £50,000. Your fund will then have to let out the property to produce a return. If you live there you will have to pay a commercial rent to the fund. So it is more likely to be a tax break for wealthy people to invest in property rather than a practical way to boost the pension savings of most people.

September 2005