How to finance the perfect pension pot
Tuesday, 13 September 2011 12:46
By Kate Saines
There is nothing which marks our entry into proper adulthood more than having a pension.
Along with realising we are too old to go clubbing, hankering after a pair of comfy slippers and finding Gardeners’ World vaguely interesting, opening a pension plan is one of those landmarks which proves we are ‘grown up’ in every sense of the word.
But instead of putting your pension planning off until you discover the delights of Monty Don – the smart ones among us should really be thinking about it as soon as it is viable.
That is at least according to a horde of pension experts who are all urging us if we don’t start putting money away for our retirement as early as possible, we could face an urgent panic to make up the gaping financial shortfall in later life.
But how much do we need to save to achieve this enigma that is the perfect pension pot? And what happens if we’ve missed the boat?
And what sort of pensions should we be taking out? There is talk of occupational schemes, private pensions even something called Sipps – but what do they mean?
We’ve lined up some pension experts to help you piece together the many sections of the pension puzzle.
When to start thinking about your pension
You should ideally start saving for a pension as soon as possible. In fact, the earlier you start saving the better. Why? Well, it’s all down to something called compound interest.
In other words, when you start saving for a pension you’ll earn interest. Soon this interest will also earn interest and so on.
Alan Carey of Alexander Forbes, a firm of consultants and actuaries, said: “Albert Einstein called compound interest the eighth wonder of the world.”
He added: “Certainly with a long-term savings plan such as retirement pensions, an early start will lighten the load and spread the cashflow pain.”
Mr Carey, along with many other pension experts, also thinks starting a pension gets us into the savings mind set, which is a healthy place to be when we are young.
The problem is one person’s “early” could be 18 while another’s could be 35. After all, many under-35s will be squirrelling all their spare cash into saving a deposit for a home or paying off debts.
Mr Carey believes, for anyone hoping to get on the housing ladder, saving for a home should be a priority before focussing on their pension in isolation.
He added: “It can be extremely difficult to save for a deposit without making matters even more stretching by saving for a pension at the same time.
“Once, however, the individual has that foothold and built up a rainy day fund to cover unexpected costs or periods of reduced income – such as redundancy – the time is right to commence on the long path to retirement saving.”
While many commentators suggest you clear your debts before putting cash into a pension pot, there are others who disagree.
John Lawson, head of pensions policy at Standard Life, said: “This could prove to be fatal advice because you are likely to have debt for most of your adult life.”
Meanwhile there are the lucky few whose parents or families have clubbed together to get their pension funds up and running at their birth. Indeed, with Child Trust Funds, Junior ISAs and other savings schemes, this is a realistic option for the very young and future generations.
But, whoever you are and however big your bank balance, the key to getting on to the pension saving road is to start the moment you have enough money to do so – with no procrastinating. For most of us, this time comes when we start work.
David Millar, marketing communications manager for Friends Life Corporate Benefits said it is never too late or too early.
He added: “I once met someone who had a real sense of security about his future because his grandfather had started a pension for him when he was born.
“That’s not a realistic ambition for most people, but a general rule is the best time to start saving is when you can afford to make contributions which don’t push you into debt.”
He did point out, however, this might mean reprioritising your current expenditure.
What type of pension plan do I invest in?
Once you’ve made the decision to start your pension you’ll need to find a pension plan.
Most people tend to start with their employer’s occupational scheme and most independent financial experts believe this is the best place to begin.
David Millar, of Friends Corporate Benefits, agrees. He added: “One of the biggest boosts to saving for retirement is the contribution that’s made by your employer.
“Other things to consider are whether the scheme has low charges – and employer schemes tend to be very competitive.”
He suggests, however, ensuring the scheme is offered by a reputable firm before signing up. If your employer doesn’t offer a company pension or you are self-employed you can opt for a stakeholder pension plan.
By law all employers who have five or more members of staff must offer a stakeholder pension scheme at the very least. Unlike company pension schemes not all include employer contributions but they do have certain advantages because they are cheap and simple.
Chris Holloway, a chartered financial planner for Dennehy Weller & Co, said: “Start with a stakeholder pension plan to keep charges to a minimum.”
He added: “There is nothing to be gained by paying for features you will not need – keep it simple and maximise the amount of each contribution that is invested for your benefit.”
Once you have accumulated a reasonable size fund, say £5,000 to £100,000, Mr Holloway suggests you might want to consider an arrangement with wider investment choices such as a Sipp (more on this shortly).
John Lawson of Standard Life said if you are planning on opening a stakeholder pension to beware of providers offering 1.5 per cent charges. This is too high.
Many people opt for a personal pension, which is independent of your employer and therefore provides you with more control over the investment. You need to be looking for one which offers full flexibility and value for money charges.
John Lawson says there are many personal pensions out there with charges as small as 0.5 per cent so it’s worth shopping around for a good deal.
A self invested personal pension (Sipp) is another option, ideal for those who have some experience of investment and already own a pension pot of £100,000 or more.
How much do I need to pay in?
There are various calculations and formula used to pin down the ultimate sum of money to be paid into a pension pot.
Some experts suggest you should be looking to achieve a pension pot that will provide you with two-thirds of your salary while other say you’ll need just half your salary.
Although, at retirement, most people will have fewer financial commitments (if they have paid off the mortgage and their children have left home) the amount required to maintain a decent standard of living will vary from person to person.
It’s important therefore, when deciding how much you want to pay into a scheme, to look at how much you can afford as well as how much you think you’ll eventually need.
Most people start off paying three per cent into a company pension plan, with their employer matching with an equal contribution. But as your salary increases so too should your pension contributions.
John Lawson of Standard Life said, ideally, you should save between ten and 15 per cent of your salary throughout your whole working life.
However, if you cannot afford this straight away because of commitments such as mortgage payments, you can always increase contributions later in life to make up for the shortfall in the early years.
Mr Lawson added: “Another way of planning is to save half your age throughout your working life to get an index-linked pension of two-thirds of your final pay.
“So, at age 20, you should save ten per cent, at age 30, 15 per cent and so on.”
He added: “Two-thirds is the gold-standard, but saving a third of your age – for example 10 per cent at age 30 and so on would give you a final pension not far off half your final pay.
“And, remember, you will get the state pension on top of this.”
If you want a more specific idea of how much you need to save, Scott Wakelin, a consultant at pensions and wealth management consultancy, Mattioli Woods, has provided a breakdown.
He said, to achieve a gross annual pension of £10,000 (in today’s money) at age 65, you would need to save just £1,377 per year if you start your pension at the age of 20.
Start at 30 and you’ll need to be contributing a gross annual amount of £2,263. If you begin pension planning at 40 you will have to contribute £4,002 per year. But leave it until your 50s and the gross annual contribution will be £8,323.
Mr Wakeling said we should all try to increase contributions when it’s affordable to do so, as a general rule of thumb this should be one per cent of our earnings every year.
Meanwhile, Richard Harwood, divisional director of financial planning at Brewin Dolphin said anyone wanting the ‘magical’ 50 per cent of their salary at age 65 would need to save 16.7 per cent of their salary for the whole of their working life.
These calculations are based on a fund with a low charging structure of seven per cent and with annual growth of seven per cent.
“This may seem quite manageable,” said Mr Harwood, “except of course the need to fund a mortgage, the cost of having children and possibly the repayment of a student debt is likely to affect the ability to make such a commitment.”
Standard Life has an online pension calculator you can use to find out how much you need to save.
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