Pensions: how much should I pay in?
19th Mar 2024 Pensions & Retirement
6 min read
A pension is a tax-efficient way of saving for your retirement, but it can often be difficult to figure out how much you should pay throughout your life. In this article, we explore how much pension you may need.
What is a good pension amount to aim for?
Some advisers recommend saving up to 10 times
your average salary by the time you retire.
For
example, if your average
salary is £40,000, you should aim for a
pension pot of around £400,000.
Another useful tip is that you
should aim to save 12.5% of your monthly salary.
With a workplace pension,
this is more likely if your employer matches your contributions..
So, if you
earn £30,000 a year and pay £125 per month (5% of your salary), your employer
would contribute £75 (3%).
Some
employers offer a higher contribution if you increase the amount you pay into
your pension.
What’s my target income in retirement?
First, you
need to decide your desired retirement income.
So, you’ll
need to figure out how much pension you need to live comfortably.
One of the
quickest ways to figure this out is with the '50-70' rule, which is when you
aim for an annual income between 50% and 70% of your working income.
For
example, if you earn £50,000, you will
want to save between £25,000 and £35,000 a year. a year.
Want a more
accurate figure? Then you’ll have to do a few calculations, using the below.
How to calculate your retirement income needs
- First, you need to figure out your current monthly expenditure.
- Deduct any recurring costs that may no longer apply after retirement. This may include mortgage repayments (if you expect to have paid it off), commuting costs, pension contributions, and regular savings.
- Make deductions for reduced housekeeping costs (for example, if you have children who will move out). A smaller household can mean lower bills for food, energy, transport, entertainment, and holidays.
- You should also consider other savings, such as running fewer cars, getting a cheaper vehicle, or taking holidays at cheaper times.
This will
give you a monthly income figure on which you could, in theory, live
comfortably.
You can find
out how much retirement income you may receive from your pension and how to
boost it using Unbiased’s pension calculator.
What extra money might I need in retirement?
By working
out your target income, you’ve assumed your needs and spending stay around the
same, but in reality, that won’t be the case.
You’ll want
to treat yourself occasionally, and will face one-off expenses.
Extra costs
might include:
- Luxury holidays
- Home repairs and improvements
- Healthcare expenses
- Vet bills (if you have pets)
- Helping your children financially
- Saving for care costs
So, it’s wise to aim for a
decent safety margin when saving for retirement, instead of the bare minimum.
This may mean a higher income,
or a larger pension pot (depending on how you access your pension).
Also, your costs may
increase significantly by the time you retire.
The cost of living tends to double
every 25 years, so work out what it may be by the time you retire and by the
end of it.
How long will my retirement last?
To work out
how much you need to save, you need an idea of how long your retirement could last.
This means
estimating your retirement age and how long you will live.
A typical retirement age might be 65. You may wish to retire sooner, but need to factor this
into your calculations as it means less time saving and more time living off
your pension.
If you
retire later than 65, you may not need to save as much and may be able to save
more.
Your
lifespan is less easy to guess, but you can get a rough idea, based on your
health and lifestyle, by using a life
expectancy calculator.
An average
65-year-old today who retires at this age could expect to live to around the
age of 84 if they are a man or 89 if they are a woman.
Those who
keep fit and have a healthier lifestyle could live longer, but you’ll need more
savings.
Image source:
Photo by Julius Yls on Unsplash
How much state pension will I receive?
If you
qualify for the full new state pension, you’ll receive £203.85 per week (£10,600 annually in the
2023/24 tax year) from the state pension age, which is 66, but is due to rise
to 67 from 2026.
The amount
you get will increase over time, so will maintain its buying power – and
if inflation or wage growth is below 2.5%, it will outgrow both of them, thanks
to the 'triple lock.'
On its own,
the state pension is not enough to live on, but may help you achieve a sustainable retirement income from your private
pensions.
Do I have any final salary pensions?
Some
workplace pensions are known as final
salary or defined benefit, which offer a guaranteed
income for life.
If you have
one, or think you might, find out how much it will pay and when payments will
start (known as your ‘pensionable
age’).
You can add
this figure to your state pension to have a clear total of your guaranteed income.
Now, you
can work out how much more income you may need from other pension pots.
How big should my pension be?
You can now
decide what size pension pot you need and have the most important figures:
- Your preferred annual retirement income
- Your guaranteed retirement income
Deduct your
guaranteed income from your preferred income to discover how much you’ll need
to generate from other sources.
An example: Steve's pension pot
Steve has
no final salary pensions and anticipates receiving the full new state pension
from the age of 68. In retirement, he is aiming for an annual income of
£25,000.
From 68,
he’ll need to make up around £14,400 a year from his private pensions. If he
retires three years earlier at 65, he’ll need to find £25,000 annually himself.
Assuming
Steve lives until 85, how big would his pension have to be to generate that
income?
Hypothetically,
Steve has saved a pot of £250,000 and a financial adviser finds him a dra that delivers 4% growth.
He draws £25,000 a year for three years, followed by £14,400 for each
subsequent year after he starts receiving his state pension. which
delivers 4% growth. He draws £25,000 a year for three years, followed by £14,400 for each subsequent year after he starts
receiving his state pension.
Assuming
nothing changes, his pension will run out in around 20 years, which is as Steve
expects. But this scenario depends on Steve’s pot growing by 4% annually.
If growth
is lower or Steve takes out more, his pot will run out sooner – and he may live
longer than 85.
How much can I pay into my pension?
So far,
we’ve looked into how you should pay into my pension, but the other big
question is how much you can pay in.
There is an
annual allowance that limits the amount you can save into pensions and get tax
relief.
How much can I pay into my pension if I’m unemployed?
A person usually
cannot pay more into their pensions each year than they earn annually, but what
if you have no earnings, or earn very little?
You can
still pay in a reasonable amount and receive tax relief if you can find the
money to do so.
If you earn less than £3,600,
you can pay up to £2,880 a year into a personal pension such as a stakeholder
pension or a self-invested personal pension (SIP).).
This money
benefits from tax relief to grow to £3,600, which is enough to build up a
decent-sized pension pot.
How can I stop my pension from running out?
If you want a guaranteed income
for life, you may prefer to buy an annuity with your pension pot
rather than use a drawdown scheme.
The
advantage of an annuity is that it never runs out, but the annual income may be
lower than with a drawdown scheme.
In the
above scenario, what if Steve chose an annuity? He could use his £250,000
pension pot to buy a guaranteed income of around £10,600 per year, nearly
£4,000 less than his target.
However, he
would have more security if he were to live a very long time.
Another
option for Steve is to buy an annuity with £100,000 of his pension pot for an
annual income of around £4,200 and drawdown the remaining £150,000.
In this scenario,
assuming 4% growth on his drawdown scheme, his pension would run out in around
20 years – but after that, he would be left with a guaranteed income of roughly
£14,800.
Can I use other sources of income in retirement?
If your
pension pot isn’t enough to meet your needs or you ‘outlive’ it, you may have
to find other sources of retirement income.
These might
include:
- Equity Release
- Downsizing
- Renting out a room in your home
If you
can’t do any of these or don’t own your own home, you may be reliant on the state pension if your private pension runs out.
Am I saving enough for my pension?
The first
thing to do is find out how much is currently in your pension pots.
You may
also have old pension pots from previous jobs – track these down and ask an adviser about combining them into one pot, known as ‘pension consolidation’.
Your
pension provider should be able to give a projection of your expected pension
pot at the age you plan to retire. A financial adviser can also give you an
independent forecast.
Then, you can discuss your retirement income needs with your adviser, who can let you know if your projected pension pot is large enough to meet them.
If not,
they can recommend an affordable increase in your monthly pension
contributions.
Every pension contribution you
make benefits from at least 20% tax relief. If you have
a workplace pension, your employer contributes
to it, making it the most efficient way to save for your future.
Unbiased can quickly connect you to a financial adviser regulated
by the Financial Conduct Authority who can help you build the retirement you
want.
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