Can I afford my future❓
Tax relief, compounding and employer contributions can help 🤞
Even if you are not aware you have one, if you’re a permanent employee in full time work (that earns above the minimum threshold), you’ll already have a pension pot, the tax efficient savings account you can’t touch until you turn 55, and ideally shouldn't access until you hit retirement. Studies from the last decade showed that far too many people were not saving for their future by choice, so the government had to take action with the Pensions Act of 2008. In 2012 auto enrolment into workplace pensions began to become mandatory for everyone in work, shifting to you having to ‘opt out’ of a pension, instead of having to make the decision to ‘opt in’.
I can’t afford my present, let alone my future 😟
It cannot be ignored that the younger generation have grown up in trying times, entering work at low wages with tragic growth (usually saddled with student debt), facing eye watering housing prices whilst having to battle inflation and record low interest rates, it’s no wonder that some feel like they can’t even afford the minimum contributions into their pension, no matter what incentives the government has introduced. The average salary in the UK is around £27k, the average house price in the UK is over £225k, it’s not rocket science to see that trying to save a whole year’s salary for a house deposit is going to be made even more challenging by having to divert 5% of your salary to a fund you aren't going to see for decades. 😰
With that said, saving is not easy, it requires discipline and willpower, which you might say is why the government introduced the auto enrolment, to help overcome the behavioural biases that get in the way. But the reality is, if you can afford to put money aside now, your future self will be in your debt for it. 💪🏼 Opting out of your workplace pension is technically an option, but remember in doing so you lose all of your employer and government contributions (see below), so make sure you think long and hard before committing to anything, it’s also worth noting that after 3 years, your employer is obligated to re-enrol you into their scheme.
Not easy, but worth it 🙌
Some of you may be feeling disgruntled looking at your payslip, seeing that 3% (increasing to 5% next year) of your annual salary disappears into an invisible and seemingly inaccessible account, but fear not, with auto enrollment comes the gift of free money!
Employers are now required to make additional contributions into your pension, starting at 2%, with some companies increasing their percentage the more that you increase your personal contributions, when you combine this with government contributions (through tax relief at the highest tax rate that you pay, known as your marginal tax rate), increasing the amount you pay in from your salary looks like a much more attractive proposition.
I’ve grown accustomed to the life of luxury… 💰
You need to define for yourself what amount is enough for your retirement, but even if you wanted to receive 50% of what you expect to earn in the year before you finally pack it all in, you’ll need to take action, as this will require approximately 10–15% contributions from the age of 30. So the earlier you start, the easier it will be thanks to compounding. This was highlighted a few years ago when CLSA, a research company, concluded that 10 years of pension contributions through your twenties, before stopping at the age of 30, with expected investment returns of 7% a year, amounted to higher returns than someone investing the same amount between the ages of 30 and 70. If you are thinking of starting as early as possible, aka. building a pot for your child, you’re a smart cookie… If you were to pay just £2,500 a year into a pension for just the first two years of your child’s life, taking advantage of the £2880 government tax relief (as of the time of writing), and the money then remained invested growing at 7% a year with compound interest until they turned 70, a fund worth £551,000 would be the outcome. Sure you need to consider other variables like inflation, charges and market volatility, but you have to admit it’s a great start for your little one. 👶
Aren’t workplace pensions usually in deficit, though? 🤔
You may have read a lot in the news in recent years about large organisations having significant pension deficits, which might fill you with fear, why should you work so hard to put away all that money for your retirement, only for your employer to not pay you what they had committed to? Fear not, as the bulk of these headlines relate to ‘old school’ defined benefit/final salary pension schemes, which used to pay you a set amount, based on things like how long you had worked for the company in question, and what your final salary was when you chose to retire. Unfortunately like most things that sound too good to be true, these were as well, and with people living longer and previous generations all retiring at the same time, a lot of firms realised they could not afford to pay out what they had promised. Nowadays companies operate defined contribution pension schemes, which determine your final pension amount based on the combination of the contributions made by you and your employer.
Although your workplace pension will be administered centrally, potentially limiting your ability to actively manage the distribution of your capital, you are not restricted to only having one pot if you would like to have greater control over where your money is invested. Your alternatives include a private pension, through a firm like Aviva, who will either control all of your investment decisions for you, or let you choose from funds based on risk profiles and other preferences.
For the more confident, and those that want to pay less in fees (when choosing execution only), you can operate a SIPP (self-invested personal pension), where you are the captain of your fate. SIPPs are still tax wrappers, so you will not forfeit your relief by using them instead of a recognised firm, but unless you know what you are doing with regards to your investment decisions, or consult a financial advisor, you should be very careful, as you could end up spending your retirement much closer to home, as opposed to on an exotic beach in the Caribbean. 🌅
However you intend to manage your pension, you will need to think of the end game, this isn’t day trading, this is long term, well diversified capital management. The money in your pension could be your only source of income in your golden years, save your personal investments for your GIA and keep your retirement secure. The benefits of using a SIPP are worth evaluating though, some employers will make their contributions into it instead of the workplace scheme, for example, giving you more choice over where you would like to invest compared to some workplace pensions, as you have the choice of the whole suite of HMRC approved options.
Don’t forget if you’re planning on managing your own pension for the long term, you should also think about your asset allocation, and how you mean to alter it at various checkpoints as you approach retirement.
I’m insured for alien abduction, can I insure my retirement too? 👽
You’re damn right you can, and it’s called an annuity. These insurance contracts guarantee to pay you a fixed income for the rest of your life, in exchange for you handing over the keys to your pension, you don’t have to purchase one, but they do provide a guaranteed income in your later years and remove all the investment performance risk from the individual — providing peace of mind. Sounds good, but remember, these products are essentially bets by Insurance companies on how long they think you’ll live, and they use all (or part — depending what you buy) of the capital in your pension as the wager. You can probably see pretty quickly how there are winners and losers and there are different products available to choose from, but let’s analyse a couple of scenarios for a lifetime annuity:
- You live a long and prosperous life, despite being overweight, and a smoker. The Insurance company didn’t think you’d live as long as you would, so they had offered you an attractive income aimed at the short term, which has ended up exceeding the value of your pension — consumer wins 💸
- You’re a fit, healthy individual with an equally healthy pension. The insurance company predicts you becoming a centenarian, so offers you a more modest income on the basis you’ll more than likely meet the value of your pot. Unfortunately you don’t make it to 100, so whatever is left in your pension goes into the Insurco coffers, if you don’t build in a feature such as a spouse benefit or capital protection into the contract - Insurco wins ☠️
Another option includes a product linked to investments, referred to as a flexi-access drawdown contract, where changes in the value of your pension investments result in variations to the income you choose to receive
- 📈 Investment strategy does well — more money each month for you 👌
- 📉 Investment strategy does poorly — less money you’ll have for bingo 🙈
I’m glad I have another 50 years to figure this out 🤦
Planning for your retirement is not an easy thing to do, especially when you’re thinking decades in advance, most of us consider it to be an uncomfortable thought, as we have a behavioural trait known as short term bias, which was highlighted last year in MoneyFarm research that revealed 70% of those interviewed had no plans in place for retirement. There will be hundreds of companies vying to sign you up to their products, this is a big money industry after all, the US market alone is estimated at $27 trillion, so this is one of the occasions where it is advised to consult an independent financial advisor, to ensure you get the best deal, or as a minimum do your homework and shop around, it is YOUR retirement after all. If you’re in the UK and over the age of 50 you can receive guidance for free by contacting Pension Wise, who will give you independent and impartial guidance that is backed by the government. Don’t confuse this with regulated financial advice though — which you will pay a fee for — Pension Wise will help you understand your options, but won’t provide you with a personal recommendation. Until then, just remember to review your company benefits to make sure you get the best deal (as some employers may offer you different types of pension plans), maximise your contributions where you can, and most importantly, never take anything out of your retirement funds until you retire! After all that’s really what a retirement fund is for — to replace your salary each month when you decide you want to hang up your corporate boots and start the next phase of your later life.
