When you are working, planning your lifestyle is straightforward. You usually have a good idea of what is coming into your bank account and the standard of living you can afford. Retirement, on the other hand, is much more difficult to plan for. It can be really hard to know what you need to put aside to ensure you have enough to enjoy it.
How can you know you will have enough income in the future?
The pensions landscape has changed a lot over the years, reducing the predictability of income in retirement, and shifting responsibility for providing for yourself in retirement rather than the state or your employer.
Rarity of salary-based benefits
While the public sector still offers income in retirement based on your salary, in the private sector these are few and far between, with many companies offering employees a pension based on what you and they contribute, rather than your salary. This means that you are dependent on investment returns and need to keep an eye on the investments in your pension, as well as need to decide how you want to take the income when you retire.
Introduction of auto-enrolment
Employers are now legally required to offer (almost) all employees a pension, with a minimum of 8% of salary going in. At least 3% must be paid in by the employer, with the balance contributed by the employee. This is from pre-tax income, so there is a tax saving on the contributions.
This scheme has been very successful, with many people starting a pension for the first time and increasing pension savings, making many people better placed to retire well.
Employers are now legally required to offer (almost) all employees a pension, with a minimum 8% of salary going into the pension.
But you can’t take it for granted that this will provide enough income for you when you retire. Using a pension calculator to make an estimation (using certain assumptions) can provide a clearer picture.
State pension moving later
Depending on your age, this can now be 66, 67, or 68. This will be reviewed in the future.
What this means for you at different stages of your life
Starting out in your career
You will be auto-enrolled in your company pension. It is very unlikely that it will be a good idea to opt-out if you are tempted to stop making contributions. Your early investments have the longest to grow and make a big difference. You will also get full tax relief on your contributions. You can even consider increasing the amount you contribute if this is affordable. If you are a self-employed contractor, you will need to make your own plans.
Now you will need to think about what you want and how to get there. Are you on track to the retirement you want? If not, you can start to contribute more to your pensions. This is more likely to be affordable at this stage of your career and is especially attractive to higher-rate taxpayers to be able to maximise tax relief and give pension pots a real boost.
This is the time to start to pull it all together. You may have a trail of pensions left behind as you moved jobs. Make sure you know where all of them are, and how they are invested. You should consider whether you should bring them all together in one pot as you may save some cost, hassle, and get better investment performance. Get an idea of what income your pensions will provide and plan accordingly.
Getting retirement right
Approaching and moving into retirement often means taking some important and sometimes complex decisions regarding your financial affairs. The most significant for many people is how best to generate an income from a pension pot having given up work. There are many other considerations involved such as providing benefits to your family in the event of your death, how tax-efficient your arrangements are and, very importantly, taking the right level of risk for your circumstances.
There are lots of options, many more than there used to be as there was a raft of changes to pension legislation in 2015.
For personal pensions, options include leaving your pot invested while taking an income (known as drawdown), buying a guaranteed income in the form of an annuity, taking lump sums, or a combination of these. Pensions have never been so flexible. They can even have an important role in relation to your estate and inheritance tax.
Yet with flexibility comes responsibility. Pensions have valuable tax incentives, but there is a need to use their powers wisely. Once in retirement taking too much from your pension too early could mean you risk it running out later on.
Significant changes to the landscape
In addition to the many rule changes there have been over the years, the nature of what retirement actually means has changed too. For many people retirement used to mean stop working completely at a certain age and starting to live off pensions and other savings. This is changing with more people opting for a long stage of semi-retirement, earning less and perhaps topping up their income from other sources.
People are living longer too, which means retirement savings need to go further. In 1908, when the State Pension was first introduced for those aged 70 and over, pensions needed to last around nine years on average. In 2021, men at age 65 are expected to live for approximately 20 more years, and women 22 more years, meaning people need to make their pensions last more than twice as long*.
With the full State Pension from the government providing little more than £9,000 per year – assuming you have paid or been credited for national insurance for 35 years – it is unlikely to represent more than a subsistence level of income, so it makes sense to start planning as soon as possible to maximise your resources. Rules can also change. Already, the State Pension is set to rise for certain age groups – to as high as 68.
What does your retirement journey look like?
Retirement can last several decades. Early on, when still fit and healthy, retirees often want to travel and do things with their new-found free time. Expenditure can then often dip due to becoming less active but rise again in later life due to the cost of care – though everyone is different.
Changes in circumstances may require different levels of expenditure and the need to build flexibility into affairs, but to provide a rough guide in 2019 Loughborough University published some figures to help people understand the annual spending needed to support different lifestyles. Here is what they estimated, though costs will be higher in the South East for instance, and the analysis makes some assumptions such as a home owned mortgage free.
Table: Retirement living standards
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Source: Loughborough University (lboro.ac.uk)
Get it right first time
Decisions made at retirement, and during, can make a big difference to the income you can expect. For pensions in particular, decisions can often be irreversible and making the wrong choices can be costly. If you are uncertain about which pension options are suitable for your circumstances, take appropriate regulated advice or guidance. Pension Wise, the Government’s pension guidance service, provides free, impartial information to help you understand your options at retirement or discover more about our Foundation Planning Services by visiting our hub.
How has life expectancy changed over time? - Office for National Statistics (ons.gov.uk).
Life expectancy calculator - Office for National Statistics (ons.gov.uk).
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.