Why You Should Save Into a Pension
Simply put, a pension is a savings account that pays you back in a drip format over the months of your retirement.
Imagine not working – that sound glorious. Days on the beach, nights in the warm glow of an open fire with a book and glass of wine, an occasional delve into family life with the grandchildren running around (quietly and without breaking anything) before settling peacefully into bed with a story and some cocoa.
Now imagine not having any money - suddenly that relaxation is ripped away, replaced with cold empty rooms and a lack of food in the fridge.
Retirement without an income can be a very scary prospect. Thankfully, there are schemes in place to make sure that doesn’t happen and a little bit of forethought can prevent it entirely.
Assuming you have been paying your national insurance contributions (which you have if you have been working or signing on) then you will have built up a bit of a government-enforced savings account as you went on.
£164.35 a week is hardly going to afford a wide spread of luxuries but at least it’s not total destitution – and that’s what you can expect from the government once you pass your 66th birthday.
But what are your options if you want to have the retirement you really want?
Pensions and savings are pretty much the same thing. A lifetime ISA offers the best tax-free way to put aside money into an account of your own and release it when you are older, and a personal or private pension plan provides a comprehensive alternative. Both can be added to that default government-sponsored state pension without affecting it – why not look at our guide to retirement saving to see which suits your circumstances the best?
But how much to put into it? Financial experts suggest 15% to 20% of your salary every year from the moment you start work, but if you’re reading this article with your 20s behind you, you might have missed that boat and want to catch up.
The important thing to realise is that the numbers are simple enough – what you put in is what you get out. Of course, there are some clever investments that can be made, or government schemes where they help top it up, but with the cost of inflation and other factors, it’s easy to just look at those bonuses as offsetting financial changes in the interim. So, for some easy maths, we can just take what’s been paid in and work with that.
For many people, by the time they reach retirement, the kids are gone, and the house is paid for. This significantly lowers the amount of money needed to maintain a comfortable lifestyle. Still, there are others who must continue to cover their rent or mortgage and that can make a serious dent in any pension or savings. For this example, however, the assumption is that the mortgage is paid.
If we want to retire at age 66 and expect to live to 85 then that’s a total 19 years that needs to be paid for. What is a good pension amount? For a reasonably relaxed lifestyle, let’s suggest that we’d like an extra £1,000 per month after the amount awarded by the state pension.
The total amount of pension required is: £1,000 x 12 (for a year) x 19 (for all the years) = £228,000.
So that gives us an amount we need in the pension pot. How do we go about building it?
Let’s assume an above average salary that grows over time, but nothing too extreme:
- years 21 to 30: £20,000
- years 31 to 40: £28,000
- years 41 to 50: £36,000
- years 51 to 60: £43,000
- years 61 to 66: £45,000
That represents a full working life with no gaps, so to make it a little more realistic, let’s assume that one year in each ten is spent between jobs (not necessarily at the same time, but that doesn’t affect the maths).
Total earned in lifetime: £1,368,000
This means that the percentage of earnings wanted as retirement fund is: 16.7%
It seems that the general financial advice of between 15% and 20% fits our example perfectly!
What if we don’t start putting money aside for retirement until our 40th birthday? The relevant earning total drops from that £1,233,000 to £936,000 and the percentage needed to be put into savings, or a pension becomes: 24.4%. A little harder to put into a pension, but not impossible.
Living on the state pension is a difficult thing to do. Millions of people manage it, of course, but often must rely on additional benefits to get by – it certainly doesn’t fuel the wine-sipping, beach-tripping lifestyle described at the beginning of this article.
Saving into a pension gives you a stable way to put aside the right amount of money to provide for you in your older years.
The benefits of pensions and different pension plans extend outside the tax relief and into the more difficult-to-pin-down feeling of security that can lead to a healthier and happier life.
Worrying about money is one of the largest causes of depression and other mental health issues in the UK, and fearing the future is a large factor.
There’s no upper limit to the amount you can put into a pension – one of the advantages to saving, whether it’s a standard bank account or a pension savings plan, is that you can put in as much as you like!
However, the tax-free maximum you can put into a pension is limited to £40,000 per year (after which you may be taxed). An ISA has a maximum tax-free allowance of £20,000 per annum, while a lifetime ISA is limited to £4,000.
For a more in-depth look into whether it is worth having a pension and for other ways to save for a pension, read our guide on saving for your retirement.