How much do you need in your pension to be able to retire comfortably?
A question that will clearly depend upon your lifestyle and requirements, however based upon the fact that the government has frozen the current Lifetime Allowance at £1,073,100 until April 2026, it would appear that the government at least believes that this will be sufficient.
The “safe withdrawal rate” which has been identified by many pensions advisers in the past has been considered to be 4%. Where 4% of savings are withdrawn in the first year of retirement and adjusted for inflation in subsequent years, should ensure the pot does not run dry for at least 30 years. If you want a secure income through buying an annuity, £1m would currently buy a 65-year-old in reasonably good health a pension of £44,653 per annum. This is on the basis that the pension remains level throughout life and provides a widow(er)’s pension to a surviving partner of the same age, at half the original income in the event of the pensioner’s death. If you want the income to keep pace with inflation then the income generated would fall to £23,351 at outset.
Looking at the above figures it is easy to see why conventional annuities are out of favour at the present time, but they do still provide peace of mind and comfort for those either not willing, or just as importantly not in a financial position to accept the risk of drawdown.
Whilst you may feel that the income figures quoted above sound reasonably generous, these do not take account of the fact that a client can take a tax-free lump sum of up to 25% and make use of pension freedoms for further access. A pot can quickly become depleted.
How, then, do you decide how much you need in your pension pot? To some extent, £1m should be the target, but just as importantly is how to fund pension contributions to achieve a fund of £1m. The government have introduced an annual allowance, limiting the amount that can be paid into pension, whilst being afforded tax relief, to no more than £40,000 per annum, which seems more than most savers will be able to put into pension in a year in any event.
High earners, who may be the only individuals who have the ability to pay substantial pension contributions, are restricted still further, with contributions reduced to a maximum of £4,000 in some circumstances. It will take a combination of a long time and an extraordinary rate of return to get anywhere close to £1m of pension based upon this level of contribution!
So if you were to begin funding a pension when you are 30 years old, assuming a rate of investment return of 5% per annum, you would need to contribute £900 per month (gross) to generate a fund of £1m by the time you were 65. If you leave matters until you are 40 the required contribution increases to £1,700 per month (gross) and at 50 to £3,800 per month (gross), a contribution well above the annual allowance in any event, so perhaps the question should be how much can I pay into pension, both from an affordability perspective and from the perspective of what the rules will allow me to contribute. The answer to pension funding, is always to start as soon as you can and to pay as much as you can in as early as you can, something that often goes against the grain when considering all the other competing causes for us to spend our hard-earned funds.
One thing that we see quite a number of, is grandparents and parents considering funding a pension for their grandchild or child. It is possible to put £2,880 per annum net into a pension which with tax relief means £3,600 is invested. Starting a pension at birth may sound odd but if these contributions were maintained, then at 65 a pot of £1.73 million would have been created, something that sounds eminently affordable for many. You would not expect the Lifetime Allowance to still be at £1,073,100 by then!
Pensions are still the most tax efficient way of saving for later life and also offer an extremely tax efficient way of passing assets down to the next generation, under pension freedom rules, pensions can be passed on to beneficiaries after death. And if the retiree dies before age 75, there is no tax to pay by the beneficiary on any level of income taken.
However, reaching 100 is increasingly common, and a client could quite easily spend 40 years or more in retirement. Therefore, the answer to how much we need to save may not easily be answered by looking at pensions alone. Those who are fortunate enough to be able to build a pension up at or near the lifetime allowance, may well still need to look at other vehicles and approaches to generate the income they will need to meet their lifestyles. Those who are at a stage in their lives where they have the resources to pay greater contributions to try to catch up, may also need to look elsewhere due to the regulatory restrictions that will stop them using pensions as a main planning source.
As always, consideration to the individuals circumstances and objectives, will provide for the best solution, and we would be happy to discuss any requirements you may have in this regard.
As no two situations are alike, we recommend having a no obligation initial chat with one of our Directors and Chartered Financial Planners – Grant Farnell or David Torkington to see if we can help.