Time to start thinking about retirement
However far away retirement might be for you, it’s never too early to start thinking about how you’re going to fund it. It’s one of the most important things you’ll ever have to save for, and the more money you can set aside, the better.
The Retirement Living Standards suggest an individual needs an income of £14,400 a year in retirement simply to reach the minimum living standard. £31,300 a year represents more financial security, but you’d need £43,100 a year to be considered truly ‘comfortable’.
If that seems a lot, consider it this way. When you eventually finish work for the final time, you’ll probably be winning back 8 hours a day, 230 days a year. Over the course of a 20-year retirement, that’s 38,000 extra hours to fill. It’s a wonderful prospect if you have plenty of income to make the most of that time – but an awful lot of jigsaws if you don’t.
That’s why it’s so important to consider the ways to save and invest for retirement, long before your twilight years approach.
Ways of investing for retirement
For most people, the idea of investing for retirement goes hand in hand with a pension. But there are plenty of different types of pensions to choose from, and there are other options for investing for retirement too. Like investment ISAs.
So, which is right for you?
Below you’ll find some general guidance on the options available. For tailored recommendations based on your own financial situation, seek the advice of a Specialist Financial Adviser from Wesleyan Financial Services.
Remember, pensions and investments can go down in value as well as up, and you may get back less than what you put in.
Workplace pension schemes
If you’re currently employed, it’s likely that you’re already investing for retirement, as employers in the UK are now obliged to provide a workplace pension scheme for their staff (although you can choose to opt out).
Broadly speaking, workplace pensions fall into one of two categories – defined benefit schemes or defined contribution schemes:
Defined benefit schemes
In some key professions, workplace pensions operate on a defined benefit basis. The value of your pension is based on how many years you’ve worked for your employer, and the salary you’ve earned.
All of the schemes through government employment are defined benefit schemes, such as the NHS Pension and the Teachers’ Pension.
Defined contribution schemes
Most workplace pension schemes are defined contribution schemes. In these schemes, you can choose how much of your salary you want to contribute to your pension each month, as long as it’s more than 5% of your pay (including tax relief).
Your employer will usually have to contribute at least 3% themselves, but may choose to give more.
All these contributions to your pension pot are invested according to the terms of the scheme you are in. You may sometimes get a say in how it’s invested, and how much risk you want to take.
Drawing your workplace pension
Workplace schemes set out an age at which you can start to take your pension. At the moment, this tends to be between 55 and 65. However, Government policy means the minimum age at which you can take your pension will change to 57 in 2028.
If this change affects you and your plans, it may be worth speaking to a Specialist Financial Adviser from Wesleyan Financial Services..
Bear in mind that while you won’t be able to access your pension before you reach the required age, you can still transfer it to a different provider if you change job or decide to switch to a personal pension instead.
You should always seek financial advice before you transfer.
How pension tax relief works
When you earn tax relief on your pension, some of the money you would normally pay to the government in income tax goes into your pension pot instead. The amount of tax relief you get depends on what income tax band you’re in.
If you’re a basic-rate taxpayer, you get 20% pension tax relief. So, to contribute £100 to your pension pot only costs you £80 – as the government gives you the £20 it would have taken from £100 of your pay packet. If you pay into a pension directly through your employer, the contribution is taken off your pay before tax is taken, so it works out the same.
Please note that tax treatment is based on your individual circumstances and is subject to change in the future.
Personal pensions and SIPPs
While workplace pensions work well for a lot of people, personal pensions or SIPPs (self-invested personal pensions) can often give you more choice and control over how your money is invested.
Personal pensions might be of particular interest to the self-employed, who don’t have the luxury of being enrolled in a workplace scheme. However, even if you do have a workplace pension, you can save into a personal pension pot too.
How a personal pension works
For the most part, a personal pension works the same way as a workplace pension. Tax relief still applies, it’s just claimed back from HMRC on your behalf by the pension provider. If you’re employed, your employer can still contribute to your personal pension too - just bear in mind they are not obliged to do so.
Other people can contribute to your personal pension more easily though. For instance, your partner or family members can pay into your pension pot, or you can pay into theirs to help your loved ones save for the future.
What’s the difference between a personal pension and a SIPP?
Personal pensions will usually allow you to select from the provider’s own range of managed funds, while a SIPP invites you to select a more bespoke portfolio, for instance investing in individual company shares or commercial property.
In many cases, the difference between these two types of pension can be minimal – but there’s often a distinction to be made in the way they charge.
Personal pensions typically charge a management fee based on a percentage of your pot, whereas SIPPs mainly charge fixed fees per trade or transaction. What’s best for you can therefore depend partly on how active you intend to be with your investment.
Using ISAs to save for retirement
If you’re looking for more flexible ways to invest for retirement, a standalone investment plan, a Lifetime ISA or a stocks and shares ISA might be worth considering.
A stocks and shares ISA allows you to save up to £20,000 per year, tax free – and while it’s usually best to leave the investment in place for a minimum of five years, there’s no minimum age at which you can take your money out.
If you don’t like the idea of investing your future retirement fund at all, you can always save in a cash ISA, which can offer flexibility and tax-free interest. Fixed-rate savings accounts are another option, and may provide a better rate if you’re willing to tie your money down for a few years.
The risk with cash savings though is that they struggle to keep pace with inflation. So while your cash balance might rise through the years, your money is actually worth less in real-world terms when it comes to funding your retirement.
Remember, investments can go down in value as well as up, and you may get back less than what you put in.
When to start saving and how much you will need
In an ideal world, we’d all start saving or investing for retirement as early as possible - giving our pension pots or investments time to grow and ride out any dips in the market.
Of course though, there’s always plenty to pay for in the meantime. So it’s a case of balancing short-term and long-term goals, and not locking away more than you can afford.
In terms of how much you’d need to save to maintain your lifestyle in retirement, it’s different for everyone – though a general rule suggests saving at least 15% of your pre-tax income each year throughout your working life.
That’s nearly double the minimum auto-enrolment contributions, suggesting that for many people, the regular workplace pension alone won’t be enough for the kind of retirement they dream of.