The death of generous defined benefit pension schemes, pressure on the government’s finances, and the increasing longevity of a growing population have combined to create a worrying backdrop for the retirees of the future.
Deloitte figures suggest the UK’s savings gap could reach £350 billion by 2050, meaning savers will have to find an average £10,000 extra every year until they retire if they are to plug the hole.
Because we are living longer, we could end up spending 30 years or more in retirement. During this time, most people will expect to maintain the lifestyle they have been used to, and perhaps spend more on travel or hobbies. They may want to offer financial support to their family, whether it’s helping fund tuition fees or a house deposit, or contributing to a Junior ISA. They will also need to think about funding their own long-term healthcare needs.
True Potential estimates most of us need an income of at least £23,000 a year to live comfortably in retirement, but notes the average person is only on track to receive a paltry £6,000.
This is why it’s so important to start saving a good percentage of your earnings into a pension as early as you can. A good rule of thumb is to pay in half your age – so if you start your pension pot at 30, pay in 15% of your salary.
‘My property is my pension’
It’s quite common to hear people say their property is their pension provision. A recent survey by Schroders revealed 19% of UK investors who say they aren’t worried about funding their retirement instead plan to use property investments, and 12% are relying on downsizing their home.
But if the house you live in or a buy-to-let property is your nest egg, you are trusting your future to the vagaries of the property market. When you need to sell in order to release equity, how can you be sure the market will be at the right level to get you a decent price? And, in a low-return environment, how will you use the proceeds to generate an adequate income stream?
Yes, there is risk inherent in any investment, but a diversified portfolio of shares and bonds spreads the risk and also gives you the benefit of compound interest to grow your money. Saving in to a pension also allows you to scale-back risk the closer you get to retirement by changing the balance of your investments.
When you choose property over a pension, you are missing out on the major advantage of tax relief on your pension contributions, and the ability to take out a 25% lump sum tax-free when you reach the age of 55. As a buy-to-let landlord, instead you get hit with stamp duty on your purchase, income tax on rental profits, and capital gains tax when you sell.
What about the Lifetime ISA?
With the Lifetime ISA (LISA) launching in April 2017, many savers are wondering if this will be a better option for pension savings. A LISA lets people save towards buying their first home and /or retirement, with the benefit of a £1 government bonus for every £4 they save.
LISAs are not designed to replace pensions, but to complement them. True Potential’s research reveals 32% of Britons plan to save into both a pension and a Lifetime ISA, which seems a sensible option for those who can afford it.
Pensions are a more generous source of tax relief for higher-rate taxpayers than the LISA, and they allow access to your money at age 55, versus 60 for the LISA (if you want to keep the bonus and avoid exit charges). More importantly, if you have a company pension, your employer pays in, but they cannot contribute to a LISA.
Auto-enrolment is now starting to come in to force in the UK, with employees automatically signed up to contribute 0.8% of their salary unless they opt out. It is generally a good idea to take advantage of your workplace pension as your employer must also contribute (at least 1%, although this will rise in future years) so you get ‘free money’ and gain a savings habit.
The sooner you start saving in to a pension, the bigger the investment you make in your future.