Coronavirus and the economic fallout that has followed will have had a severe impact on swathes of retirement plans. Some have lost their jobs and been forced into an early retirement, while others may have to delay their retirement as a period out of work or with lower pay will lessen their pension contributions.
Pandemic aside, best practice retirement planning has been gradually evolving – and so should your approach. Gone are the days when people can simply plan to retire at 65 and walk into the sunshine with a company pension scheme. Over the last two decades pension schemes based on an individual's contribution rather than final salary have become much more common, meaning people have had to take more responsibility for their pot. And as we can expect to live longer and in better health, the amount needed for our retirement is growing.
Younger people may feel financially insecure and argue that their pension is something they can worry about later. But even small contributions now can make a large difference over time, so it is definitely a habit to get into if at all possible. If you work for a company with a workplace pension scheme, auto enrolment rules have made this easier as you pay 8 per cent of your salary into your pension by default, at least 3 per cent of which is paid by your employer.
Those close to or in retirement may want to consider succession planning as part of their pension plan. Pensions are exempt from your inheritance tax estate, making them an efficient way to pass wealth on to children. Alan Harvey, assistant director at Brewin Dolphin, notes that people close to or at retirement have benefited from assets going up significantly over their lifetime, and they may be looking to help children or grandchildren facing tougher financial conditions.
How to approach pension planning
To work out how much you should be saving for retirement, start by thinking about how much you would like to live off. This should be split between essential and discretionary spending. Gary Smith, financial planner at Tilney, says anything between £1,200 and £1,800 per month should be enough to cover someone’s basic needs and food assuming they don’t have to pay a mortgage. You may wish to have another £1,000 per month or so to cover fun activities.
The Pensions and Lifetime Savings Association, the trade body for pension providers, advises that individuals need £10,000 per year for minimum living standards, £20,000 per year for moderate standards and £30,000 for a comfortable retirement. For couples, the corresponding amounts are £15,000, £30,000 and £45,000 respectively.
Mr Smith notes that you should compartmentalise your retirement, and this is likely to leave you thinking about it in three phases. For the first 10 years or so you might have higher income requirements than in subsequent years, as you are likely to be at your most active. This means you might choose to draw down on your pension more heavily than would be suitable for your entire retirement.
Ian Browne, retirement planning expert at Quilter, notes that one quarter of people who retire end up needing long-term care, which is the final stage of retirement you should be preparing for. Mr Harvey says the amount needed for care costs ranges enormously across different parts of the UK and it is impossible to forecast what you will need, but it could be as much as £200,000. Family properties are often used to cover care costs, either by selling the house or releasing capital from it via a mortgage.
Experts agree you probably need to build up a pot of at least £500,000 to give you a good standard of living in retirement, assuming you are not paying a large mortgage. Mr Browne recommends working out the income level you need to maintain the standard of living you want in retirement and then looking at multiplying that number by “somewhere between 25 and 30” to get a lump sum figure.
If you want to live off the income from your pot, you will need a larger amount than if you are happy to erode the capital over time. Mr Harvey says a 3 per cent yield is realistic for income expectations without selling down investments. To withdraw £20,000 from your pension at a 3 per cent yield, your pot would have to be as much as £800,000 if you were paying income tax at 20 per cent and had used up your personal allowance elsewhere (for example, on your state pension).
You then need to think about what age you want to retire at, and work out if you can afford to based on salary expectations and any other assets you may have or expect to inherit. If you can’t, you are likely to have to expect to work longer, possibly part time, or reduce your expected retirement expenditure. You can also consider increasing your risk appetite, but you have to be prepared for the fact this strategy may not pay off and you may end up having to work longer.
Benefit from multiple income sources
Your workplace or personal pension is unlikely to be your only source of income in retirement. The state pension is a valuable part of most people’s retirement spending, which can often be overlooked as you have to claim it from the Department for Work and Pensions, rather than it being paid automatically. To get the full state pension, which is currently £175.20 per week for those who reach state pension age after 6 April 2016, you need a total of 35 qualifying years of National Insurance (NI) contributions or credits. The state pension age is gradually increasing, but will be 67 for both men and women by April 2028.
You can also bring down your tax bill by having money in different pots. You will pay tax on your pension at your marginal rate, but money withdrawn from your individual savings account (Isa) is free of tax. This means that under the current tax rules you could take £12,500 from your pension free of tax as part of your personal allowance, and draw the rest from your Isa, and not pay any income tax.
Also, if you want flexibility, building up your Isa means you can access it before the age of 55 if you need to. Young savers should think carefully about how much they are likely to want to access before they are 55 when deciding how much to save into their Isa, and how much into their pension.
That said, in terms of building up your pension, the pension is currently the most generous tax vehicle available as you don’t pay tax on money paid into your pot, so you benefit from compound growth over years. The rules may change so make use of the tax relief while you can. You need to balance flexibility and availability versus tax relief and compounding benefit.
In terms of how pension tax benefits might change, there has also been talk of a Pisa – a pensions investment savings account – replacing the current system, Mr Harvey says. This would mean you pay tax on money going into your pension, rather than when you draw down. This would save the government money in the short term as it would not have to bear the cost of pensions tax relief on contributions.
If you have a spouse you should look at yourselves as a family unit when pension planning. You can use up allowances between you and consider each other's marginal tax rate to ensure you can draw down as tax efficiently as possible.
Manage your risk profile
If you have a workplace pension you should pay as much as you can into it. This will maximise the amount of employer contributions you should get and is not included in the sum your NI is based on. If you pay into a self-invested personal pension (Sipp) you will get income tax relief but you will still pay NI. You may choose to pay into both a workplace pension and a Sipp, to get benefit from full company contributions in the former while enjoying a broader range of investment options within your Sipp.
For company pension schemes check the asset allocation suits your risk appetite. Mr Harvey notes that for many young pension savers the portfolios are likely to be run too conservatively. People in their 30s should have a high enough risk appetite to have their pension savings with a very high equity allocation, which may not be the case in the scheme you are automatically enrolled in.
Analysis from Aviva in September last year showed that an average earner could miss out on between £4,000 and £10,000 by sticking with an incorrect retirement date. If your plan’s default pension age has been set too early you will be moved out of high-growth investments years before you need to be.
Wealthy individuals who may not rely on their pension for retirement income should keep an eye on their pension risk profile. Your company scheme will automatically de-risk your pot as you get close to retirement date. You will have to get in touch with your plan managers and ask them to keep you within the higher risk profile bracket.
Mr Smith says a typical life strategy might automatically place 75 per cent of your pension in fixed income and 25 per cent in cash when you are 10 years from retirement. While this might be suitable for someone who is looking to buy an annuity, which is increasingly rare, most people would benefit from taking on slightly more risk.
Mr Browne recommends that you check your pension once a year to make sure you are happy with your asset allocation and that you are still on track to meet your financial goals. You should also think about your ethical preferences, to make sure your money is invested in assets you are comfortable with.
