Saving for retirement can seem daunting, with so many different types of pension and savings accounts to choose from. To help get you started, let’s work out what you might need, so you can decide how and when to invest for your retirement.
Charlene Young, AJ Bell’s Senior Pensions and Savings Expert discusses how much you might need in your pension to fund the retirement you want.
Pensions help you save more towards your retirement, but how do you know if your savings are on track? I’m Charlene Young, senior pensions and savings expert at AJ Bell, and in this short video, we’ll look at how much you might need in your pensions to fund the retirement you want.
Let’s start by working out how much your retirement might cost; this will largely depend on how much you will want to spend It is personal to you which can make it tricky to pin down. Some people like to target a fraction of what they spend now after tax. But there are handy resources out there that can help you.
Research by the Pensions and Lifetime Savings Association – or the PLSA for short – look at the amounts needed to fund three different standards of living in retirement. They produce figures for people living alone, as well as for those living together.
The minimum or basic standard covers the essentials, and then different amounts are assumed to be spent on goods and services, like food, holidays, household maintenance and clothing to get to the moderate and comfortable standard of living.
It’s important to note that all the living standards assume no rental or mortgage costs, but they do attempt to give a realistic estimate by assuming that everyone, including those targeting a ‘minimum’ standard of living, will want to enjoy a social life and the odd takeaway as well as paying essential bills. Most people in the UK will have some income from the State Pension. To get the full new State Pension, you’ll need to have built up 35 full qualifying years of national insurance contributions. This covers most, but not all, of the basic standard of living for a single person. If you’re aiming for a moderate lifestyle, the State Pension could cover nearly 40%.
For a two-person household, your combined State Pensions could cover a basic standard of living, but only around 50% of that moderate lifestyle. It’s likely that you might want to wind down or even fully retire before you reach your state pension age. You’ll need to make sure your personal savings can cover you entirely until the State Pension kicks in, and leave enough to make up for any shortfalls once it does. You can go to the gov.uk website to get a state pension forecast and see if you’re on track for the full amount.
Here’s where your own savings come in – whether that’s a workplace scheme, a personal pension, or investments in other types of accounts. Figures from consumer site Which? show that people aiming for a moderate retirement lifestyle will need between £300,000 and £400,000 in their own pot by the time they reach State Pension age. For the comfortable standard, it jumps to £500,000 to £600,000. If you’re in a couple and able to pool resources, this should mean a much lower target pension pot size between both of you. Of course, these are just estimates. Investment returns, inflation, and how long you live will all make a difference.
Being told you need to build a large pension pot to enjoy a decent standard of living in retirement might feel intimidating. While automatic enrolment has been successful in getting more employees saving into pensions, those on the minimum contribution levels are at risk of falling well short of their retirement expectations. The key is to focus on saving what you can afford, whilst taking advantage of incentives like employer contributions, tax relief and tax-free investment growth on the investments in your pot. Check with your employer whether they offer to match your contributions.
For example, if you pay in 6%, they also pay in 6%, and so on. This valuable perk can give an extra boost to your savings. The earlier you can start, the more time your savings will have to grow. Someone saving £400 a month from age 30 could end up with over £400,000 by age 67. Wait until you’re age 50 to start, and you’d need around £1,350 a month to get there. This assumes a 4% annual growth rate after charges. You should also find out where your current pensions are. If you have had several different jobs, chances are that you’ve got pots spread across different pension providers.
Tracking them down and combining them gives the chance to reduce charges and the benefit of having all your savings under one roof, making it easier to see if you are on track. Thank you for watching this video. If you’re interested in learning more about pensions, we’ve got other videos and guides online to help. For example, we look at how to claim tax relief on the money you pay into pensions and how you can access your pot when you’re think of retiring. See you soon!
How much do you need to retire?
It all depends on what you want your retirement to look like, and how much that might cost.
A good place to start is with what you spend now. What are your ’must haves’ in retirement; things you want to keep up or maybe even increase, such as holidays abroad or hobbies? And what expenses are likely to reduce or even disappear when you stop working? Examples might include commuting costs or educational support for your children. Some people find it easier to simply to take a percentage or proportion of their spending figure in today’s money.
Retirement Living Standards research from Pensions UK is another handy tool to help you figure out how much you’ll need for retirement. The research estimates three different levels of income most people will fit into when they retire, based on three standards of living: ‘minimum’ (basic), ‘moderate’, or ‘comfortable’.
The standards put a cost on what each level looks like, and what a range of common goods and services would cost for each. For example, the moderate living standard allows for some help with house maintenance, a used car and one two-week holiday abroad every year. It also allows around £103 per week for food (including takeaways), as well as money to spend on clothing and personal items and taking others out to dinner.
| Retirement Living Standard | Annual income needed after tax (according to Pensions UK) | Income needed from your pension savings |
|---|---|---|
| Minimum | £13,900 | £1,684 |
| Moderate | £32,700 | £25,184 |
| Comfortable | £45,400 | £42,172 |
Source: Pensions UK. Income levels shown for a single person living outside London.
How much does the State Pension cover?
At this stage you might be wondering how far the Government’s State Pension can get you? Well, the maximum State Pension is currently £12,548 a year, based on 35 ‘qualifying’ years of National Insurance payments. That means, looking back at the Pensions UK’s figures, even if you can claim the full State Pension, it’s unlikely to give you enough annual income for the lifestyle you want in retirement.
Another important point to bear in mind about the State Pension is you can only start claiming it from age 67, if you were born on or after 6 March 1961. Further increases are currently part of a government review. If you want to retire before then, you’ll need to make sure your personal savings can cover you entirely until the State Pension kicks in, and enough to make up any shortfall once it does.
How much should you save for your pension?
Using the tips and information above, you can work back from how much you’ll need to retire and by when, and what you currently have in your retirement ‘pot’. Then you can figure how much more you’ll need to save to make up the difference.
If you’re employed, it’s likely that you’re already saving for your retirement into a workplace pension. Thanks to auto-enrolment, if you’re 22 or over and earning more than £10,000, a minimum of 8% of your (qualifying) earnings, with at least 3% of this coming from your employer, should be going into your pension. While auto-enrolment has been great at getting more people paying into a pension, it’s unlikely that the minimum contributions will build a substantial pot.
Let’s take the Pensions UK’s moderate retirement living standard for a single person. In today’s money, an income of £32,700 per year is needed for this. After deducting the current full new State Pension, you’d still need between £335,000 and £505,000 saved into a pension by the time you reach State Pension age to plug the shortfall with a pension annuity. Although, this will be more if you want to retire early or could be different if you intend to use your pot to give you an income under a different option, like drawdown. Your workplace pension can help you work towards this figure, but you may need other sources of savings to make sure your retirement is comfortable.
Here are some examples to help put workplace pension savings into context.
A 22-year-old earning £25,000 per year, with 8% of their salary paid into a workplace pension (3% coming from their employer), could achieve a pot of around £290,221 by age 67.
A 33-year-old earning £38,000 with a workplace pot already worth £19,000 could get closer to £290,767 by the time they’re 67, based on the same contribution rates.
Examples illustrate potential total workplace pensions savings built up in today’s money by State Pension age. Both examples assume earnings grow at 3% a year with no career breaks and an annual investment growth of 5%, with adjustment for price inflation.
Still not sure on how much you'd need? Our handy pension calculator tool can give you a better estimate of your potential contributions and income later in life.
What is the best way to save for retirement?
There isn’t a one-size-fits-all solution here. It does all depend on your personal circumstances. The good news is you have options, a couple of which we’ll go on to explain in more detail. Just remember, the best option for you will depend on:
- Your age
- Your tax rate (now and what it might be in retirement)
- Whether you’re employed or self-employed
- When you want to start accessing your retirement savings
Pensions
All pensions are designed specifically to help people who are saving to retire. From workplace pensions set up and supported by your employer, to private or personal pensions, such as Self-invested personal pensions (SIPPs), that you set up and manage yourself.
One way you can increase how much you’re saving for retirement is by increasing your contributions to your workplace pension. It’s also worth checking with your employer if they’ll pay more into your pension to match this – known as ‘matched contributions’. This could mean the extra amount you pay in is boosted even further.
Just like your workplace pension, you’ll get great tax benefits from saving into a SIPP or Ready-made pension. For every £4 you save, the Government will add an extra £1 in tax relief. Find out more about how paying into your pension works, its benefits and annual limits in our contributing to your pension article.
AJ Bell Ready-made pension
The pension that takes the hassle out of managing your investments. Choose a fund, tell us how you want to invest and then sit back. We'll do the rest.
If you work for yourself, you won’t usually be auto-enrolled into a workplace pension scheme, but you can still save for your retirement and earn tax relief with a personal pension. And if you own your business, you could also consider paying part of your salary directly into your pension as an employer contribution. This can have the added benefits of reducing your business’s liability for corporation tax, and your personal liability for income tax. Read more about pensions for the self-employed.
Learn more about how to invest in your pension and boost your retirement savings.
Lifetime ISAs
Lifetime ISAs may not spring to mind when you first think of saving for retirement, but they can also be used for this purpose. A Lifetime ISA gets you a 25% bonus from the government on the amount you pay in, but you’ll need to be under 40 to open one for the first time. As with other ISAs, your investments are sheltered from tax, but you’ll need to wait until you’re age 60 to access a Lifetime ISA or be hit with a 25% government penalty charge.
Lifetime ISAs are particularly useful if you’re self-employed, or you’ve already maxed out your pension saving allowances. Tax benefits will depend on your personal circumstances - but a good rule of thumb is if you’re a higher rate tax payer, you’ll usually be able to claim back more in pension tax relief than the value of the Lifetime ISA bonus.
Both pensions and Lifetime ISAs have restrictions on what you can pay in and when you can access them, so make sure to check these out before you open one. And if you opt to pay into a Lifetime ISA instead of your workplace pension scheme, you’ll miss out on what your employer would pay in too. Read more about what's better for retirement, a Lifetime ISA or a pension.
What age can you start a pension?
You can open and manage your own pension from age 18, but the choice can be bewildering at such a young age, and too often we leave it for another day when we’ll have fewer competing priorities for our money. The thing to bear in mind is, the earlier you start saving for retirement, the longer your pension will have to grow, and the less pressure you’d need to put on your finances in later life.
Case study: Millie is 50 and wants to retire at 60
She is working and has a pension with her employer that will be worth about £300,000 when she retires. She wants to increase that to £400,000 by the time she retires to generate an estimated income of £20,000* in addition to her state pension.
At age 50, she will need to save £6,700** a year into a personal pension or SIPP for 10 years which will equal total payments of £67,000. This could grow in value to £100,000 boosted by the government tax relief and investment growth.
If Millie had started paying into her pension earlier her annual saving would be far lower as there would be more time for investment growth**. So at:
40, she would only have to save £2,700 per annum (total £54,000)
30, she would only have to save £1,430 per annum (total £42,900)
20, she would only have to save £850 per annum (total £34,000)
*Assumes an annuity rate of 5%
**Assumes lump sum contributions at the beginning of each tax year, 20% tax relief and investment growth of 4%
If you’re a parent and want to give your child a head start on saving for their retirement, you might consider opening and contributing to a Junior SIPP. You can open one from the day they’re born, and anyone can pay into it. Plus, they’ll benefit from basic-rate tax relief (20%) from the Government on anything you pay in.
Read more about our Junior SIPP
While we can give you useful information, AJ Bell doesn’t give financial advice. If you need help finding a pension or investments suitable for your needs, please speak to a financial adviser. If you’re 50 and over and want to understand more about your options at retirement, the government also offers a free and impartial guidance service, Pension Wise.
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Disclaimer: These articles are for information purposes only and are not a personal recommendation or advice. You should consider consulting a regulated financial adviser or a tax adviser if you’re in any doubt about what to do. How you're taxed will depend on your circumstances, and tax rules can change. Pension and LISA rules apply.