30-year pension plan: how to improve the odds of retiring early

Five years ago pension auto-enrolment was introduced. Employees and their employers are both now obliged to pay a sum corresponding to a small percentage of the employee’s income into a workplace pension. Initially, the minimum overall contribution, with tax relief added in, was 2 per cent. This is set to increase to 5 per cent after April 2018 and to 8 per cent – 4 per cent from an employee, 3 per cent from their employer and 1 per cent in tax relief – from April 2019.

Auto-enrolment has so far boosted pension saving, as inertia among those auto-enrolled means dropout rates have been very low. However, a 2 per cent pension contribution is far from enough to build an adequate pension. Indeed, one pension expert says a millennial will need to save almost a fifth of their income into a pension to maintain their standard of living in retirement. Consultancy Aon has calculated that a male defined contribution pension scheme member aged 25 with a salary of £22,500 a year will need to save 18 per cent of his salary, or £4,050 a year, to maintain his standard of living if he wants to retire at age 65.

However, for the vast majority of millennials, many of whom are juggling paying off student debt with saving towards a deposit on a house, such figures are pie in the sky rather than realistic goals.

Nonetheless, the need to budget and save regularly should not be ignored. Pension experts emphasise the need for younger people to save into a pension. ‘The scale of contribution necessary to generate a fund that will provide for even a modest retirement is still not understood,’ says Martin Tilley, director of technical services at Dentons Pension Management.

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‘Even the higher levels of contributions to be phased in over the next few years will not provide anything but a bare existence in retirement. Moreover, millennials and others banking on getting an inheritance are in for a shock.

Their parents are likely to live a lot longer than they think, and in their latter years the parents may well require care, reducing any personal wealth they have and their ability to pass it on.’

No time to waste

So what can younger people do to build a decent pension pot in the face of such challenges? It pays to start saving early, as even small amounts compound impressively over the very long term. Tim Gosling, policy lead at the Pensions and Lifetime Savings Association (PLSA), calculates (using the Nest pension calculator) that if someone on a £25,000 salary were to start making employee contributions of £64 a month into a pension aged 21, they would have a pot of £158,000 (including tax relief and employer contributions) if they retired at 68, based on total growth of inflation and charges plus 3 per cent. However, if they delayed until they were 30 and made the same contributions then, they would end up with a pot of just £114,000.

Another way to save more into a pension over time is to commit to boosting your pension contribution in line with any salary increases you receive. Claire Trott, head of pensions strategy at Technical Connection, says: ‘Auto-enrolment is a good start to pension saving, and ensuring you make the most of employer contributions to your pension will boost the value of your pension pot, so if it’s possible to increase your employer’s contributions by raising your own, this option should be seriously considered.’

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It is also worth customising your workplace pension by looking at the funds it invests in. Usually, if employees don’t select their own funds, their pension contributions will be channelled into so-called lifestyle funds, which were developed as an automated pension investment strategy. They were created to free employees from having to actively choose funds for their workplace pensions and manage them as they approach retirement. These funds gradually shift away from equities into assets perceived to be less risky, such as bonds and cash, as the employee approaches retirement. The rationale is that the closer people get to retirement, the less exposed they should be to losing any value in their pension as a result of stock market falls.

Spoilt for choice

However, the combination of poor annuity rates (which are based on gilt yields) and the greater flexibility pension savers now enjoy means investors are less likely than they were to withdraw their whole fund and use it to buy an annuity that will provide a guaranteed income for life.

This begs the question of whether a fund that will automatically de-risk into bonds is a good choice, given that pension savers may want to remain invested in stock markets and draw a retirement income directly from their investments.

The range of alternative fund choices will, of course, be dictated by the pension provider, but someone who is 30 years or more from retirement could sensibly invest their pension fully or largely in the stock market. Younger people can afford to take a relatively high degree of investment risk in the hope of getting better returns, because they will have plenty of time to recover from short-term losses. Indeed, market falls can be beneficial for regular pension savers, as they enable them to buy assets at lower prices. So consider moving to riskier assets in your pension, to make it work harder for you in the long run.

Another suggestion often made by retirement experts is that younger generations reconsider their spending priorities and cut out some ‘luxuries’ to enable them to invest in their pensions instead. Tilley argues that while the generation of baby boomers grew up without the many comforts and technological conveniences available today, these things are often now considered to be essentials. However, they can still be enjoyed at a reduced level.

‘The latest phone contracts at £40 a month and comprehensive television packages can be scaled back, freeing up tens of pounds a month that can be contributed to a retirement savings vehicle to make a huge difference over 40 years of growth,’ says Tilley. ‘Even missing out on two Costa coffees each week could allow £20 a month to be put away. One less takeaway, one less cinema trip: they can all add up.’

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Similarly, Peter Bradshaw, national accounts director at Pension Monster, argues that younger people need to consider the cost of things and ask themselves what they could do without. He advises using a budget planner, and reconsidering the cost of phones, broadband services and gym memberships. Bradshaw says: ‘Let’s say you were to retire tomorrow at age 68 on a £159-a-week state pension alone, your lifestyle would change massively.’

Every little helps

Garry Crackle, director at Opt Pensions, observes that new apps are coming onto the market which allow people to put aside small amounts regularly. One, called Chip, calculates how much you can afford to save based on your spending habits and then transfers that across to your savings account.

Crackle says: ‘Rather than going for a midmorning snack, you can swipe the amount you would have spent into a savings pot. Little things like this can go a long way towards slowly starting to save and developing the discipline of doing so.’ Bradshaw suggests also that by the time millennials retire, there may no longer be a state pension to rely on, so it makes a lot of sense to capitalise on pension tax reliefs while these are available. He says: ‘They are not necessarily forever. The government has already made changes to the lifetime allowance.’

Inequality between generations continues to increase in the UK and life expectancy remains on the rise, so it remains unclear what retirement is going to look like for those reaching retirement age in 30 years’ time. The uncertainties surrounding retirement could undermine the likelihood of any retirement at all for younger people unless they take action, which is why it’s so important to start saving, even small amounts, as early as possible. 

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