Don’t run the risk of running out of pension
Life expectancy and costs of living are rising, and that means it’s increasingly likely that you could run the risk of running out of pension. So what can you do to make sure that you have a big enough pension to meet your needs for the whole of your retirement?
Retirement is supposed to be a reward for a life of hard work. But recent headlines about pension poverty and dwindling pension funds have warned of an emerging risk for the UK’s future retirees: the risk of running out of pension.
Pension poverty is an extreme example of what can go wrong when you haven’t planned properly for your retirement. But as the cost of living rises and life expectancy increases, all pensioners will have to make their savings go further and last longer.
How much will you need in your retirement?
A recent study by the investment house Schroders discovered a huge disparity between pension expectations and the reality. Savers who are aged 55 and over predict that they will need an income equivalent to two—thirds of their current salary to afford to live comfortably in later life. But those who have already retired found that their average income is just over half of their final salary.
Furthermore, pre—retirees are drastically underestimating the amount of money they will need to cover their living expenses. While pension savers believe that expenses will make up 38% of their annual retirement income, existing pensioners claim that it is closer to 53%.
Are you saving enough to meet your expectations?
Attitudes towards pension savings are changing, albeit slowly. In 2012, auto—enrolment was introduced as a way to help workers supplement their pension savings by encouraging employers to match employee contributions. The scheme has upended the pension savings landscape, and it has been estimated that by 2019/20, an extra £20 billion a year will be saved into workplace pensions as a direct result of the scheme.
However, according to the government’s most recent Automatic Enrolment Review, around 12 million people in the UK are still not saving enough into their pension funds.
Plan for your retirement well in advance
So how do you plan for your pension and reduce the risk of running out of money in your retirement?
Save as much as you can, as early as you can
There is no substitution for early, regular pension saving. Even a small weekly or monthly contribution can add up over time, thanks to the effect of compound interest.
It is never too early to start planning your pension, either by making the most of your workplace’s auto—enrolment scheme or by setting up a tax—free savings account such as a Lifetime ISA or a self—invested personal pension (SIPP) plan.
Work out how much you can afford to put aside for your retirement, then set up a direct debit on pay day so that you aren’t tempted to spend your spare cash. When you get a pay rise or a windfall, increase your pension payments accordingly. This will help you to become more disciplined about your pension savings so that you can get into the habit of saving as much as you can.
Know what you need
According to a Prudential study released earlier this year, 2018’s retirees can expect to have an annual income of £19,900, which includes income from the state pension and private pension funds. However, the average income varies considerably from county to county, and the same survey found that 27% of people retiring in 2018 believe that they will not have enough money to sustain them in their old age.
Use IG’s pension calculator to calculate your annual or final pension and how much you’ll need to save in total or per month.
In reality, there is no ‘ideal’ pension income, as everyone has a different idea of what sort of lifestyle they want — and what they need — in retirement. For some people, ongoing expenses such as mortgage payments and tuition fees have to be factored in to any pension calculations. For others, retirement funds must be able to stretch to cover annual holidays and a new car every few years.
When planning for your pension, be realistic about your annual expenses and your desired lifestyle and review your funds on a regular basis to ensure that you are still able to afford the retirement that you want.
Switch up your investment portfolio
Most pension funds have suffered in recent years due to a toxic combination of low interest rates, the weak pound, and stock market volatility. Yet many pension savers forget that they can switch pension providers at any time.
If your investment portfolio is not delivering the returns that you anticipated, ask why. It may simply be that the markets have forced a temporary dip in your returns, or you may feel that your portfolio is simply under—performing.
Many pension savers also find that high management fees are reducing their annual earnings over time. If this is the case, consider switching to a low—fee portfolio of exchange traded funds (ETFs) and index trackers, both of which can be held within an ISA or SIPP wrapper.
Finally, be sure to diversify your portfolio so that you have a shield against sectoral volatility. Markets move, and you could be vulnerable to big losses if you have invested all or most of your pension money in just one or two sectors. Instead, spread your pension funds across a variety of industries, companies and geographies to reduce risk and improve your chances of steady portfolio growth.
Prepare for taxation
Pensioners are not exempt from income tax and capital gains tax, so it is important to plan properly for taxation. The current income tax threshold is £11,600, so after state pension payments (which amount to £6549.40 per year at present) you can earn just £5050.60 per year from your personal pension savings before becoming liable for income tax.
This means that a pensioner earning the Prudential—calculated average of £19,900 per year would have to pay the 20% rate of income tax on £8300 of their annual earnings — £1660 in total. This would bring actual annual earnings down from £19,900 to £18,240.
Similarly, any profits made from selling shares or property will be taxed at the usual rate, regardless of your employment status. However, most pensioners find that the post—work drop in their annual income brings them down a tax band, so these tax bills should be lower in retirement than they would have been before.