How early do you need to start saving for your retirement?
Whether you're starting out in your career or you've already got 40 years' experience behind you, understanding what you'll need in financial terms for a comfortable retirement can seem a complete mystery. But some attention to the numbers now will help you work towards the retirement lifestyle you desire.
Adding to the confusion is the fact that there are plenty of different numbers bandied around for the ideal retirement income.
For example, while Joseph Rowntree Foundation figures suggest an income of £347.93 a week, equivalent to £18,092.36 a year, is the minimum required by a couple in retirement, research by the automatic enrolment scheme NEST found that a retired individual needs an income of at least £15,000 a year for a comfortable retirement.
Research by adviser Towry pushes the figure higher still. It found that, on average, people thought they'd need an annual income of £29,844 to support their retirement goals, which, assuming an average retirement of 22 years, equates to an investment pot of more than £650,000.
As well as the numbers put forward by research, there are also rule of thumb guides to shape your savings. On the back of final salary schemes, two-thirds of income is regarded as the ultimate retirement income goal, with the government's own report, Framework for the Analysis of Future Pension Incomes, suggesting a target of at least half to two-thirds of working age income.
But, while all of these figures can provide a useful guide, Jason Witcombe, director and certified financial planner at Evolve Financial Planning, recommends taking a more individual approach to determining your retirement requirements.
'How much you need in retirement is really a matter of personal taste,' he explains. 'Some people are happy on £20,000 a year while others want a lot more. You need to think about what you want from retirement, but also what you might be doing when you reach this stage of your life.'
However far off retirement might be, chances are your spending patterns will be different in this phase of your life.
Julia Turney, head of engagement, workplace pensions at Barnett Waddingham, explains: 'Hopefully you'll have cleared your mortgage and you might even be considering downsizing to a smaller property. But while these areas of expenditure are likely to reduce, you'll probably spend more on items such as heating and hobbies.'
The concept of retirement has also changed. With the removal of the default retirement age, it's possible to keep working well into your 70s and beyond. Often this might be on reduced hours or a part-time basis, but it could provide an additional source of income to factor into your retirement planning.
STATE PENSION ENTITLEMENT
On top of this it's also important to consider your state pension entitlement. This is based on your national insurance contributions, with the full new pension, available if you reach state pension age after 6 April 2016, worth no less than £148.40 a week.
Although the figures can seem daunting - or even impossible - there are ways to make saving the necessary funds easier. As well as the tax relief the government adds to your pension contributions, under pensions auto-enrolment you'll also get some help from your employer.
With this, unless you choose to opt out, a percentage of your pay goes into a pension every month alongside a contribution from your employer and tax relief from the government.
Initially the minimum you'll pay in is 0.8 per cent of your salary, with your employer adding 1 per cent and the government 0.2 per cent, but by 2018 these minimum figures will have increased to 4, 3 and 1 per cent respectively.
While this is a helpful starting point, Turney says it's unlikely to be sufficient. 'Even when the total contribution reaches 8 per cent in 2018 it won't be enough. There's a rough rule of thumb that you should pay in half your age as a percentage when you start making pension contributions. Most of us started too late,' she explains.
There are ways to improve your chances. Although the government has set a minimum contribution for employers, many will pay in more or offer to match any contributions you pay in. As this is effectively free money into your pension, it's worth increasing your contributions to take full advantage of this.
Even a small additional contribution can make a significant difference to your final pot. For example, according to Legal & General's pensions calculator, a 35-year-old on basic rate tax paying in £200 a month before tax relief can expect an income of £193 a month if he retires at age 65. If he increases his contribution by £25, this monthly retirement income increases to £217.
GET AN EARLY START
The benefits of compounded returns mean there's also plenty of merit in starting as early as possible. 'The earlier the better,' says Andy James, head of retirement planning at Towry. 'The longer you can leave money invested, the greater the opportunity it will have to grow.'
To illustrate this he uses an annual contribution of £3,600. If this is paid into a pension every year from age 18 to 65, and assuming an annual growth rate of 5 per cent, the fund would be worth £673,291 at age 65.
In comparison, leave starting the plan until age 30, and by age 65 your pension pot would only be worth £362,261. This means that the contributions made in the 12 years between 18 and 30 grew to a whopping £310,030, almost as much as the 35 years' contributions paid in from age 30.
Long-term savings don't need to be just about pensions, however. Witcombe recommends using other vehicles such as Isas, savings accounts and even property to build up a pot for the future. 'Just save,' he says. 'Different vehicles give you more flexibility, but they can also complement your tax status and financial commitments at the time.'
As an example he points to someone in their 20s or 30s, whose key priorities might be clearing student debt and saving for a first home. By saving into an Isa rather than a pension, they would establish a savings habit but still be able to access the money for a mortgage deposit.
And, while an early start is desirable, sometimes delaying a pension could mean it costs less to build up the fund. 'Tax rules can change, but if you wait until you're a higher-rate taxpayer, you'll get additional benefit from the tax relief on pensions,' Witcombe adds.
Thus, while tax relief means it costs a basic-rate taxpayer 80p to put £1 in their pension, it only costs a higher-rate taxpayer 60p as a result of the additional relief they can claim through their self-assessment.
REFINING YOUR STRATEGY
Although a scatter-bomb approach to putting money away for your retirement may be effective when you're first starting out, as your savings build up it can make sense to refine your strategy.
Witcombe says that once you have at least £100,000 in your pension pot, it might be worth considering a self-invested personal pension (Sipp). These offer greater flexibility on investments, but can also be cheaper.
'Sipps often have a fixed charge rather than the percentage-based charges seen on a standard personal pension. Although they can be expensive when you're starting out, as your fund grows they can be more cost-effective,' he explains.
But wherever you put your retirement savings, a regular review is essential to ensure your plans are on track. Mark Brownridge, research and development manager from the accredited financial planning firm Mazars Financial Planning, recommends that you review your plans annually.
'Take time every year to assess your plans,' he explains. 'Your provider will give you details of how much your fund is worth now and in retirement, so you can see if you're on track. It's also a great opportunity to realign your portfolio if necessary and look at whether you can afford to increase your contributions.
'Few people start out with the dream pension but, if you keep track of it through your working life and make the necessary adjustments, you'll have a much better chance of achieving it by the time you retire.'
Use this pension calculator to see what you might end up with and how long your money could last (external link).