It’s all too easy to reach your fifties and find your pension falls short of expectations. Here are six ideas to give it a late boost.
The general rule of thumb in order to maintain a comfortable lifestyle in retirement is to aim for two-thirds of your salary, so if you earn £60,000 a year, you should target £40,000 a year in pension income. The exceptions are high earners, who may find that as little as 50% of their salary is adequate for their needs.
Someone aiming to build up a pension pot sufficient to generate a replacement income of two-thirds of salary needs to put aside a percentage of their earnings equal to half their age. For example, if you have reached the age of 40 and have saved little so far, then you should start investing 20% of your earnings, and if you have reached 50, you should invest 25%. Over an entire career, 15% of your salary should be put aside.
However, the typical pension contribution falls woefully short of these goals. Although the minimum contribution to a workplace pension rose to 8% last April (5% paid by the employee and 3% paid by the employer), in the previous few years the average total contribution was just 4.7%. In fact, the average pension pot of UK ‘Generation X’ workers aged 39-54 is worth just shy of £160,000 and will generate an annual income of around £5,500 in retirement, according to a study commissioned by consultancy Dunstan Thomas.
The survey further revealed an uneven split between the sexes, with average pension savings of £186,611 for Generation X men, compared with just £117,854 for women of the same age. Family pressures were blamed as the reason why 19% of people could not save more, while 38% thought little about retirement “because it worries me so much”. Around 42% were hoping to receive an inheritance before they retire – which could be foolhardy given that nursing care costs average £47,320 a year, according to charity Paying for Care, and could rapidly deplete an inheritance.
The average £160,000 Generation X pension pot has been built by monthly contributions of around £200, but people on average incomes need to set aside £799 a month to afford a moderate retirement lifestyle, according to the Institute and Faculty of Actuaries. Even those who have saved the full £1.073 million lifetime allowance ( the maximum pension savings that attract tax relief) will not have enough annual income to pay for one year’s social care. After taking account of the option to withdraw 25% tax-free cash (which would take it down to £804,825) and assuming 4% annuity rates, a pot of £1.073 million would generate an annual income of around £32,200.
The UK’s growing army of self-employed are making even less pension provision. Only 24% of self-employed people are actively saving into a pension, and about five million are not saving at all, according to government-backed provider National Employment Savings Trust (Nest). So what can be done?
1) Delay taking your pension
An obvious way to boost your pension is to work on and delay taking it, particularly at times like the present when stock markets have posted heavy falls. As well as enabling you to earn an income for longer, deferring retirement allows you to maximise your investments for a few extra years, allowing them to grow and compound when your pension pot is at its largest. You might also consider a slower transition into retirement – reducing the number of hours worked or looking at other ways to make an income, such as harnessing a hobby. (Do check, however, whether your pension is one of the few that impose restrictions or charges if you change your retirement date.)
Nonetheless, you will still need to put in a good few more years to make up a significant pension contribution shortfall. For example, a person who joined a workplace pension at 22 and contributed 8%, the statutory minimum level, would need to work to age 77 for a replacement income of two thirds of salary, with inflation protection and provision for a surviving partner. If a person doesn’t start pension contributions until later in life, that age rises sharply – someone who first joined a pension at age 35 would need to work to 79, and someone who started pension saving at 45 would need to work to nearly 81.
Pension pot needed for a pension income of £20,000 a year, to last until age 100
taken to age 100 (£)
Note: Assumes 5% investment returns post charges, income inflation linked at 2% a year, pension fund runs out at age 100. Source: AJ Bell
2) Freeze your state pension
You can also boost your pension by delaying your state pension, and you can stop claiming even if you have already started to draw it. If you reached state pension age on or after 6 April 2016, you will receive an extra 1% for every nine weeks you delay or stop taking it, which equates to 5.8% boost for every full year of deferment.
If you reached state pension age before 6 April 2016, delaying or stopping your state pension yields even more: an additional 1% for every five weeks you don’t claim. This works out as a 10.4% boost for every full year of deferment.
Furthermore, if you reached state pension age before 6 April 2016 and delay taking your pension for a minimum of 12 months, you can take a lump sum in lieu. Housing benefit or pension credit is usually affected by any additional income, but not this type of lump sum.
3) Filling NI gaps provides boost
People need 35 ‘qualifying years’ of national insurance (NI) contributions to receive the full state pension, and at least 10 years to receive any at all; but all is not lost if your record has gaps, because you can top it up by making voluntary NI contributions.
First, check your NI record with the Department for Work and Pensions. You can obtain a forecast either online at tax.service.gov.uk/check-your-statepension, by ringing the pensions service on 0800 731 0175. If your forecast does not show an expected pension of £168.60 per week then it is worth looking at the top-up options.
Do not take the DWP’s record as written in stone, either. DWP record-keeping can be patchy, particularly for women who have stayed at home to look after young children and who should receive a credit, and for people who contracted out of the state system via an employer’s final salary scheme in the 1980s and 1990s and are therefore not entitled to ‘qualifying years’ during that period.
Voluntary NI contributions will usually be Class 3, but can be Class 2, depending on your work circumstances. For example, if you were employed but earning less than £118 per week and not eligible for any credits such as through illness, they will be Class 3. If you are self-employed with profits under £6,365 then they will be Class 2. They are also Class 2 if you lived and worked abroad but lived in the UK for three consecutive years immediately before leaving, or paid at least three years of contributions.
The rates for the 2019/20 tax year are: for Class 2, £3 a week or £156 a year; and for Class 3, £15 a week or £780 a year. Topping up NI contributions is excellent value for money. Even for Class 3, which is more expensive, your outlay of £780 for a full year will generate 1/35 of the state pension throughout your retirement. In the 2019/20 tax year, this equates to 1/35 of £168.60 per week, or £4.82 per week, or £250.49 per year, so assuming you live another 20 years from state pension age, this £780 will generate £5009.80 of income.
If you want to fill in any gaps in your NI record, normally you must make the top-up payment within six years of the original missing payment. However, if you’re a man born after 5 April 1951 or a woman born after 5 April 1953, you have until 5 April 2023 to pay voluntary contributions to make up for gaps between April 2006 and April 2016.
For those with part-year gaps in their NI records, the cost will be adjusted accordingly; those will be the cheapest gaps to fill.
4) Boost your contributions
There may be other ways to boost your pension contributions, such as paying in all or part of your bonus, or forgoing a pay rise. For the last few tax years employees have been able to claim tax relief on pension contributions up to £40,000 or 100% of their annual earnings.
You can continue to receive tax relief on pension contributions until age 75, even if you’ve finished working. Even if you are not earning anything, you can contribute up to £3,600 each tax year into a pension, and only have to fork out £2,880, because the government automatically adds £720 to bring the total to £3,600. If you retire at 60 and save the full amount each year up to your 75th birthday, you’ll get a whopping £10,800 from the government completely free.
However, if you’ve already accessed a pension, you can only contribute a maximum of £4,000 each year to money purchase pensions, even if you’re still working. Your pension provider should let you know when this starts applying to you. Furthermore, if you have taken out protection to ringfence an earlier Lifetime Allowance, you will lose it if you make new contributions into a pension scheme.
5) Investigate salary sacrifice
Salary sacrifice enables you to forgo some of your salary for a non-cash benefit from your employer, including increased pension contributions. The salary you forgo will not be subject to tax or NI, so there will be a saving, while the NI contributions your employer makes will be reduced too. These savings may be used to further boost your pension contributions.
However, salary sacrifice effectively reduces your salary, which can impact entitlements such as maternity/paternity pay, as well as mortgage and loan applications based on your income. For the lower paid, this may mean you’re able to claim more tax credits, but if you are on a very low income there may be little wiggle room because your take-home salary cannot fall below the national minimum wage.
6) Rev up your investment
Paying into your pension is only one half of the story. The other is to ensure that your investments are working hard. Over 90% of investors are in a ‘default fund’, rather than actively choosing a fund.
Default funds by their nature tend to be cautious, with perhaps a maximum of 60% in equities, and other funds available may offer a better chance of turbo-charging your fund. Usually, your pension provider will explain the different investment options available online. As a general rule, the longer you have until retirement, the more risk you should take, which means holding more in equities which have historically had a higher rate of return than bonds over the long term, although they exhibit greater volatility in the short term.
To demonstrate how helpful the compounding of additional investment returns can be, if a 22-year-old earning £30,000 contributes 8% to a pension with contributions rising in line with inflation, and chooses an investment fund that generates an extra 1% per year, then her pension pot will grow an extra £55,000. In comparison, if she simply paid in 1% more of her salary every year, her pension would be just £23,000 bigger.
If you want to target annualised returns of 8% or more, allocate 80% of your portfolio to stocks and 20% to cash and bonds. With such a hefty equity exposure, at some point you are likely to experience a calendar quarter where your pension pot loses as much as 30%. But hold your nerve, because the down years have occurred 30% of the time while the positive years have occurred 70% of the time.