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How much Pension do you REALLY need?

Introduction

Barely a day passes without yet another doom-laden warning about how little we are saving for our retirement, how our pensions are inadequate, that the state will only offer us a pittance – and we need to do more, so much more than we are doing already.

The danger, with all this negative publicity is that, rather than galvanising us into action, they can have the opposite effect. They can make many people shrug their shoulders and think that if that’s how things are going to be, there is no point in bothering. After all, retirement is many years away, so why worry?

In reality, a much more balanced assessment of how things might look for us in retirement can help us to make sensible choices – without having to divert vast amounts from our current earnings into a pension fund.

So what facts do we really need to know?

We can survive on less money

The most important thing you need to know is that you won’t need as much to live on as you do now.

If you think about it, the minute you stop work, there is no need to spend money on commuting, on suits, dresses and all the other small and large expenses that make the daily grind more tolerable – such as the tall skinny latte on the way into the office.

How is the amount we need calculated?

Many financial advisers tend to give their clients a rough-and-ready figure of between half and two thirds of current take-home income in order to maintain a very similar lifestyle to the one they do now.

But you may need more or, probably, less to live on.

In turn, this means being more precise about your needs. Here are 10 steps to help you do that.

1) Assume an ideal income, after tax, that would allow you to pay all your bills, including council tax. Your current income (combined with your spouse’s income if you are in a relationship) is a useful start.

2) Add at least one annual holiday, a couple of meals out every month or two, new clothes from time to time. Include car maintenance costs, running repairs to the house and so on. You may take up a hobby, so add a reasonable amount for that.

3) By the time you retire, you should no longer have to pay monthly mortgage costs or offer financial support to your children. So deduct those costs.

4) Take off the monthly cost of commuting, the suits and dry-cleaning bills, the takeaway lunches and canteen coffees.

5) Deduct the amount you currently save into a pension or other saving scheme.

6) Deduct the value of any basic state pension, State Earnings Related Pension (Serps) and Second State Pension (S2P) you may be entitled to at age 65. More details on these are available elsewhere. Note that if you intend to retire earlier, you will have to make up this difference. You can get an update of your state pension and other entitlements by filling in form BR19, available at the Pension Service website.

7) Deduct the value of any investments you have already set aside, such as ISAs, company share saving schemes or other lump sums (maturing endowment policies) you might have – as long as they are not earmarked for any immediate spending needs. Assume 3.5 per cent as a rough income from these sums: this is a relatively safe amount that should not put your capital at risk.

8) Calculate the pensions you have so far saved into. All employers and pension providers are required to tell you how much the sums you have saved up with them will buy you. Then deduct this amount from your monthly needs.

9) If you are planning to “downsize”, moving to a smaller/cheaper property and using the spare capital for income, calculate roughly the amount of equity you hope to release by such a step. Assume the same income multiple as for your lump sum investments, although if you were to buy a pension (otherwise known as an “annuity”) with that money, you could expect an income of up to six per cent.

10) If you are likely to receive any inheritances in the next 20-30 years, add those too. Calculate the income form any lump sum in the same way as before.

The above calculations should give you a rough idea of your monthly or annual “savings gap” – the target amount you need to try to achieve.

Obviously, if you were planning to stop work before you reach 65, you will also need to take into account that larger gap before your various state and any other occupational pensions actually kick in.

What you then do is work out how much you need to save each month to achieve that annual target income.

Here is a calculator from the Financial Services Authority – the City watchdog – that helps you work out how much you may need to save.

It’s not as bad as you thought – or is it?

Generally, as you get older, you should find that you have – sometimes inadvertently – managed to put aside surprising amount of money, typically in company pension schemes. They will hopefully provide that little additional sliver of income you need.

Don’t forget either that although your retirement income might be smaller, you are also likely to pay less tax on it – either because you move from a higher rate of tax to a lower one, or because the tax relief on your first slice of earnings is higher for pensioners, subject to an earnings cap.

Plus, you no longer have to pay National Insurance Contributions on your earnings, even if you carry on working.

More pages

Page 1: Introduction

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