Category Archives for Pensions

Help! I’ve ignored my pension – Part 3 – Working out how much you need

Depending on how old you are, retirement might seem like a very distant prospect. How on earth can you predict what you’ll want to do or what that’ll cost? This is why many people delay starting a pension. Will you be sitting in front of Countdown with a cup of tea or scampering around the world having adventures? Spending some time thinking through your likely expenditure makes it much easier to plan for the future.

In this post, I’ll talk you through some exercises to help you decide what you’ll need. Please note, the content below requires you to contemplate old age, infirmity, and death, so perhaps save it for a sunny day.

Working Out Your Expenditure

Popular advice holds that you need two-thirds of your current income when you retire. This might give you a target to aim for, but it’s based on a number of potentially unhelpful assumptions, for example, that you’ll have paid off your mortgage.

  • If you rent your home, your housing costs (which are usually the largest expense) won’t change.
  • If you walk to work or are based at home, you won’t save the cost of a season ticket or parking charges.
  • If you have children, your expenditure drops when they leave home, but perhaps you’ll be spending on grandchildren or helping out with loans.

So, depending on your situation, your income might need to remain fairly static after retirement. Here are three steps to achieve a more accurate prediction:

  1. If you haven’t done so already, download the MoneySavingExpert budget planner and enter your current outgoings
  2. Make a copy of the budget, then tweak it for early retirement. This is hopefully the period where you’re still active and taking advantage of your freedom. You might be reducing some costs, e.g. mortgage, pension contributions, season ticket or petrol, but increasing others, such as holidays.
  3. Now make another copy and think about late retirement – when you slow down and spend more time at home. This stage can be depressing, as it forces you to consider the less active part of your life. It’s possible you’ll be going on fewer holidays, but spending more on services, such as gardeners and taxis. Your heating costs could rise significantly, too.

Of course, you can’t predict the future. However, even a rough calculation makes planning easier.

Comparing Income with Expenditure

Now you know how much you need, it’s time to compare this with your projected income (head over to Part 1 of this series for tips on how to discover your pension entitlements). If you have a final salary (or Defined Benefit) pension scheme, this is easy. Your statement should show your guaranteed annual income, based on the specified retirement age. Retire earlier and you’ll receive a lower amount. Don’t forget that your pension is also subject to income tax. If you receive £20,000 pa, you’ll pay £1,628 in tax.1 Assuming you’ve reached the state pension age, you no longer need to pay National Insurance.

Those of you who have a Defined Contribution (or Money Purchase) pension or other retirement savings need to do some sums. Essentially, you’re trying to work out how to make a pot of money last throughout your retirement. This is straightforward if you know three things:

  • How long you’ll live
  • How the stock market will perform
  • What will happen to inflation

That’s right, it’s an almost impossible task. Take too much too soon and you could spend your final years in penury; take too little and you’ll deny yourself some fun and potentially leave the taxman with a large windfall. To get an idea of how long you’ll live, try this life expectancy calculator from the Office for National Statistics.

My life expectancy is 86, but there’s a 1 in 4 chance that I’ll make it to 94, and a 1 in 10 ‘risk’ of becoming a centenarian. As I don’t have a final salary pension, I’ve planned a fund that’ll stretch more than 30 years.

The Which? Income Draw Down Calculator helps you work out how much money you might need, and it’ll also factor in inflation and stock market performance. For example, if you had a pension pot of £300K invested in a mix of funds and bonds, then withdrew £30K pa, you’d run out of money in year 12 of your retirement.

Screenshot of income drawdown calculator

Errk. Reducing your income to £24K gives you another 4 years of funded retirement. Experiment with your own figures to discover the implications of different scenarios. You might find that the retirement income you hoped for is difficult to achieve.

One way of avoiding these risks is to buy an annuity from an insurance company, some of which give you a guaranteed inflation-linked income for life. The downside is that you pay a high price for that security. The cost depends on factors including your age, health, and even your postcode. Purchasing an annuity is a major decision, as you can’t change your mind afterwards. For more information, visit the Money Advice Service guide. You’ll also find a questionnaire that’ll estimate how much you could receive from an annuity.

In this example, choosing an inflation-linked annuity for a pension pot of £300K generates a secure, guaranteed annual income of almost £10,000.2 But managing it yourself could result in £16,000, assuming you don’t live too long. You’re possibly paying £6K pa for that security. The exact figures depend on your personal circumstances and when you retire. The questionnaire – which includes helpful videos to explain every step – does give you an idea of the compromises, though.

What if there’s a shortfall?

Perhaps you’ve played with the calculators and the numbers aren’t stacking up. If you’re close to retirement, it’s a good idea to get advice from a Certified Financial Planner. Although expensive, they can perform far more sophisticated calculations and also advise you on how to invest your money. Otherwise, there are several options to consider:

  • Decrease your projected retirement income. Are there any areas of expenditure you could reconsider? This might include downsizing and/or moving to an area where you no longer need a car.
  • Retire later. This gives your pension pot longer to grow and reduces the number of years you’re drawing on it. If you don’t enjoy your current job, ponder what else you might do. Take a look at my post on Finding Your Ikigai for some tips on identifying a career that’s right for you.
  • Build your assets. In my previous post, I explained some options on saving for retirement. You could possibly boost your income by starting a side hustle or renting a room. Also, review your outgoings with a critical eye. Small savings across multiple expenses could add up to a significant sum.

In future posts, I’ll explain more about savings and investments, and also demonstrate the impact of inflation on long-term financial planning.

Conclusion

Confronting old age is sometimes a frightening experience, especially if you discover a gap in your finances. But it’s best to deal with the problem as soon as possible. There are always options, but you need to face the facts first. Taking action now could mean a long and happy retirement.

As a financial coach, I can guide you through the process of your pension healthcheck. By explaining the options available and using forecasting tools, I support you in making an informed decision that’s suitable for your situation.  I never recommend a specific product or course of action. If you require advice rather than coaching, you need to see a qualified financial advisor. They’ll either recommend products on which they receive commission, or you’ll pay a fee for independent advice. Please contact me if you’d like a free 15-minute chat about pensions or any other aspect of financial wellbeing.

  1. Based on the 2018/19 rates. []
  2. Based on a 65-year-old non-smoking woman starting an annuity in November 2019. []

Help! I’ve ignored my pension – Part 2 – Building your assets

As financial folk are fond of saying, the best time to start a pension is when you’re in your twenties. The second best time is now. Many people don’t start thinking about retirement until they reach middle age, when saving for a pension becomes a priority. In my last post, I guided you through a Pension Healthcheck to see what funds you already have available. This time, we’ll look at a few ways of building your assets.

Company Pension

Photo of pension potIf you’re an employee, you almost certainly have the option of joining a pension scheme. In fact, you’re probably already part of one. By law, employers are obliged to provide and pay into a pension scheme for their employees (unless they’re very low paid). Enrolment is automatic, and you have to opt out if you don’t want to be part of it. You’ll be automatically enrolled again after three years. Yes, the Government is very keen to get everyone saving for retirement.

In schemes like these, a percentage of your salary is deducted from payroll before you even see it. In return, your employer also makes a contribution – so you get free money. The Government provides tax relief, too.  Here’s an illustration:

You earn a salary of £32,000; you and your employer each contribute 5% into the pension scheme. Your monthly contribution from take-home pay is £133.33, which becomes £166.66 with tax relief. Your employer also adds £133.33. So, for a £133.33 deduction in your pay packet, £300 lands in your pension pot.

As I mentioned in my last post, there are two main types of company pension:

  • Defined Benefit/Final Salary – you’ll receive a guaranteed amount after the specified retirement age
  • Defined Contribution/Money Purchase – the size of your eventual pension pot is based on how the underlying investments have performed

Most company pensions these days are Defined Contribution, so there’s absolutely no guaranteed income. In the worst-case scenario, you might actually receive less than you put in. When you start drawing a pension, the income you receive is subject to tax, although you can take 25% of your pension pot as a tax-free lump sum.

Notwithstanding these risks, the tax relief and employer contributions make company pensions a good wheeze for most people. The three main problems with company pensions are:

  • Your money is locked away until you reach retirement. This could be either the state pension age (65,66,67 or 68, depending on how old you are now), or an age set by the company or pension scheme. Accessing it earlier means a lower income or smaller pot. This is generally a Good Thing, as it means that those funds are protected for when you’re no longer able to work. However, if you were ill or unemployed for an extended period, you would be unable to access your money. Most schemes will give you early access if you’re diagnosed with a terminal illness.
  • If you switch jobs frequently, as many of us do these days, you can end up with lots of small pension pots. Some are portable, but others will be frozen. It can be difficult to keep track of multiple pots and it means remembering to update numerous companies every time you move house. The new Pensions Dashboard is supposed to make this easier, but it’s not tremendously helpful in its current form.
  • If you’re in a Final Salary scheme, it might not be possible to bequeath your pension to a spouse or family member, or they could receive a much smaller amount. In return for that guaranteed income, you cede some control over your money. Given the scheme is assuming the risk and responsibility for maintaining regular payments, this is an understandable compromise. However, some employees are unhappy with this arrangement and would rather receive a lump sum they can manage themselves. This is a big decision that could have serious implications for your retirement. A pot of £400K sounds appealing, but it’s hard to make it last unless you know three things: how long you’ll live, the future rate of inflation, and what they stock market will do.

If you’re uncomfortable with the idea of a company pension, there are some other options.

Personal Pensions

As you might expect, you get much more control with a personal pension scheme. And more responsibility. You’ll have to decide where to invest the money and what level of risk is tolerable. I’ll be discussing risk in a future blog post, but essentially the more risk you take, the higher your potential returns and the more your pot could grow. Equally, your potential for losses is greater. Opt for a cautious approach, though, and your pension pot might not grow enough. This is a difficult call and one of the biggest challenges in retirement planning.

As with company pensions, you’ll receive basic-rate tax relief on your contributions to any approved scheme.1 However, not all employers will pay into a personal pension, so you might be sacrificing those benefits. You can set up a personal pension with many financial companies. Head over to MoneySavingExpert for more information and suggestions.

Roboadvisers

Image of robotYou can reduce some of your pension stress by signing up with a Roboadviser.  These are online investment services that manage everything for you. Over a couple of simple screens, you decide how much you want to invest and the level of risk with which you feel comfortable. The robots create a basket of investments for you and send updates on performance.

The advantages of Roboadvisers are:

  • It’s simple
  • You can set it and leave it
  • In some cases, it’s cheaper than managing your own investments

The potential disadvantages are:

  • The fees can be high, which eats into your future pension
  • You don’t have any control over where your money is invested. This might be important if you’re an ethical investor or keen to invest in specific sectors or assets
  • There’s little human interaction and no personalised advice

For sensible advice and a review of Roboadvisers, check out the Boring Money guide.

SIPPs

A SIPP is a Self-Invested Personal Pension. There’s a lot of confusion around this product, so I’ll try to keep this simple. A SIPP a pension wrapper – this means your investment is ‘wrapped’ in certain benefits. You get to decide exactly what’s included in your portfolio – index funds, shares, bonds, etc – and you can buy or sell them at any time. As with the other types of pension, you get tax relief from the Government, too. Any gains aren’t subject to tax, either. Theoretically, an employer could pay into your SIPP, but they’re unlikely to do so if they have a company scheme.

SIPPs are popular with self-employed people who run limited companies. They can make employer contributions as the company, which then reduces their corporation tax bill. If you’re an employee or a sole trader, most SIPPs will automatically apply for basic-rate tax relief on your contributions. Higher- and additional-rate taxpayers need to claim the extra through their tax return.

There is a different type of SIPP that allows you to hold commercial property and other assets. These are much more expensive and usually suitable only for very wealthy investors.

The advantages of standard SIPPs are:

  • You have complete control over the investments
  • They’re tax efficient if you run a limited company
  • Depending on where you invest, the charges are relatively low

The disadvantages are:

  • You’ll have to make a lot of decisions about how and when to invest your money
  • The charges can mount up if you’re buying and selling investments frequently
  • Some schemes have steep minimum contributions

The Best Buys page over at Boring Money provides ratings and reviews of SIPPs.

Other Investments

You don’t have to put your money in a pension scheme. Other investments are available and might be more suitable for you. Until recently, buy-to-let property has been a popular choice for some investors. However, changes to stamp duty and mortgage tax relief mean it’s unlikely to be a good choice for the average investor. Property is also vulnerable to market downturns, problem tenants, and high costs.

Stocks & Shares ISAs

The Individual Savings Account is a wrapper for savings and investments. There are currently six types of ISA, which I’ll cover in more detail in a future post, but the most popular type for retirement planning is the Stocks and Shares ISA. As with a SIPP, you can choose what investments to include and buy or sell them at any time. All your gains are also tax free. The main difference from a pension is that you won’t receive any tax relief on your contributions. A key advantage, though, is that you don’t have to wait till retirement to access your money – this makes it a good choice for medium-term goals. Also, any money you withdraw won’t be subject to income tax (unlike a pension). You can currently invest up to £20,000 in a Stocks & Shares ISA each year.

The advantages of a stocks and shares ISA are:

  • Flexibility over what you invest and when you withdraw funds
  • Your gains and withdrawals aren’t subject to tax
  • The allowances are currently very generous

The disadvantages are:

  • You don’t get tax relief or employer contributions
  • The flexibility means you might be tempted to spend it before retirement
  • Unlike your pension pot, ISA accounts form part of your estate and are subject to inheritance tax (and might be more vulnerable in a divorce settlement). They’re also included in means-testing for benefits.

There’s also a bewildering choice of ISA providers and potential investments. The Best Buys page over at Boring Money can help you choose.

Conclusion

What’s right for you will depend on your individual circumstances and how close you are to retirement. The solution might be a mix of pension and ISA investments so that you have access to funds in both the medium and long term. None of us knows what the future holds, but it’s almost certain that Future You will be grateful for a pot of money.

In the third and final part of this series, I’ll help you work out how much money you’ll need in retirement.

As a financial coach, I can guide you through the process of building your retirement assets. By explaining the options available and using forecasting tools, I support you in making an informed decision that’s suitable for your situation. I never recommend a specific product or course of action. If you require advice rather than coaching, you need to see a qualified financial advisor. They’ll either recommend products on which they receive commission, or you’ll pay a fee for independent advice. Please contact me if you’d like a free 15-minute chat about pensions or any other aspect of financial wellbeing.

  1. Higher- and additional-rate tax payers need to claim the exra through their tax return. []

Help! I’ve ignored my pension – Part 1

When I hit 40, I was alarmed to realise that my pension was no longer a long-term plan. Given I could theoretically retire at 55,1 suddenly this seemed decidedly medium term. Like many people these days, I’ve had a patchwork career comprising many different employers and a few periods of self-employment. I’d acquired a few pension pots here and there but wasn’t really sure they would keep me in gin and cat food. Although I’m a keen planner and wanted to get started, part of me was afraid. What if there isn’t enough? Will I have to fight the cats for their food?  How on earth could I predict what would happen over the next 50 years?2

From talking to friends and colleagues, this is a common situation. We’re acutely aware that we should be doing something about retirement but feel overwhelmed. After all, pension planning means confronting our own mortality and putting aside large chunks of money for an uncertain future. I’ve spent the last five years learning everything I can about long-term investing and life choices. Although I’d previously worked in finance and also have a PhD, I found much of the information confusing. My motivation in becoming a financial coach was to simplify the process for other people.

In this post, I’m going to talk you through a Pension Healthcheck so you can see what provision you already have in place.

Occupational or Personal Pensions

The first step is to dig out those old pension statements (they’re probably in a carrier bag). This paperwork should give you a predicted income based on the company’s standard pension age (this might differ from the state pension age). It’ll be lower if you decide to retire earlier.

There are a few things to look out for:

  • Final salary schemes – also known as Defined Benefit. You receive a guaranteed amount until you hop the twig. There might be additional perks, too, such as a widow’s pension for your spouse (usually much smaller than what you’d receive) and life insurance cover. If you weren’t in the scheme for long, the predicted income is likely to be tiny. However, it’s guaranteed and paid until death.
  • Defined contribution schemes – sometimes referred to as Money Purchase. Your money sits in an investment pot that grows and shrinks according to the whims of the stock market. On reaching retirement, you can withdraw 25% tax free, then you need to decide what to do with the rest of it. There are no guarantees this time – it’s your responsibility to make it last throughout your retirement. This is why Final Salary schemes are highly prized.

If you can’t find any statements or letters, try the Government’s Pension Tracker. You’ll need the name of your previous employer or provider to use it. The tool won’t tell you whether you have a pension pot, but you’ll get the contact details of the company’s pension administrators.  Personal pensions are trickier to trace as you’ll probably have forgotten the details. Have another look for any paperwork or locate a bank statement that shows the provider’s name.

State Pension

Opinion is divided on the state pension (and on everything else at the moment). Some believe it’s unlikely to survive the next decade, while others insist the Government wouldn’t be foolish enough to take it away. Those in the latter camp are usually the people who are depending most on the state pension. I think it’s unlikely to disappear altogether – that might provoke civil unrest and cause widespread poverty – but there’s a palpable risk that its value won’t keep pace with the rising cost of living. The pension age has already been subject to well-publicised and poorly received increases.3 and the Government makes no guarantees that they won’t be bumped up again.

The state pension is further complicated by the fact that not everybody gets the same. It depends on a number of factors:

If you were born after 5 April 1953, you need 35 years’ worth of NI contributions to receive the full state pension – currently £164.35. Anyone who has experienced unemployment for any reason and didn’t sign on for benefits might not receive the full pension. This also applies if you were self-employed and missed some NI contributions.

You can easily check your state pension entitlement through the Government Gateway. Enter your details and you’ll see a prediction based on your continuing to make contributions.

Screenshot of state pension summary

Any gaps are flagged, and you also get the opportunity to make a retrospective contribution to ‘buy’ extra years’ pension.

Screenshot of state pension shortfall

If you can’t afford to plug the gaps, you’ll have to settle for a lower pension. There is currently a means-tested pension credit for those on very low incomes, but it’s vulnerable to changes.

It’s too complicated to unravel the complexities of the state pension system here. If you have any concerns or questions, you can receive free impartial advice from The Pensions Advisory Service.

Other Assets

Retirement isn’t just about pensions. You might have other assets that’ll provide you with an income: ISAs, stocks and shares, or a buy-to-let property. The advantage of these assets is that you can usually access them whenever you want, unlike a pension pot. And income from your ISA is tax-free.

Many people view their main residence as a pension pot. There are a few problems with this approach:

  • If there’s a downturn in the housing market, you’ll find it difficult to release your capital
  • Equity release schemes aren’t right for everyone. See the Money Advice Service guide for sensible advice on the potential pitfalls.
  • You might not want to move house. We often overestimate our willingness to make big changes in the distant future.
  • You’ll still need someone to live!

So, focus on the assets that you can easily sell or access without causing major disruption.

Conclusion

Hopefully, you’ve now got a clearer sense of the funds available to you on retirement. Perhaps you’re pleasantly surprised? If not, don’t worry. In future posts, we’ll explore some ways of boosting your assets. We’ll also consider how much money you’ll actually need in retirement.  You might not be swanning around the world in your own yacht, but taking action now could ensure that you’re comfortable and secure.

As a financial coach, I can guide you through the process of your pension healthcheck. By explaining the options available and using forecasting tools, I support you in making an informed decision that’s suitable for your situation.  I never recommend a specific product or course of action. If you require advice rather than coaching, you need to see a qualified financial advisor. They’ll either recommend products on which they receive commission, or you’ll pay a fee for independent advice. Please contact me if you’d like a free 15-minute chat about pensions or any other aspect of financial wellbeing.

  1. The Government is currently toying with the idea of increasing the minimum retirement age to 57 []
  2. My life expectancy is 88, with a 1 in 4 chance of reaching 96. Blimey. []
  3. Depending on your age, it’s currently  65, 66, 67 or 68. You can find out on the State Pension Age Checker []