I am 30 years-old and earn £50,000 a year. My employer matches pension contributions up to 10 per cent.
I want to retire at age 60 on an annual income of £30,000 – which will be topped up by the state pension whenever I am eligible for it.
How much do I need to be saving per month into my company pension to achieve this, assuming that my fund achieves returns of 7 per cent a year and that I live until 85 years old?
Early retirement dream: With 30 years to go, keeping the value of your savings growing above inflation is key to achieving your goal
Kay Ingram, chartered financial planner at LEBC Group, replies: Your goal is unachievable unless you also pay in extra to the pension.
A 10 per cent contribution will only get you halfway there based on long term growth assumptions.
Ideally you would need to triple your own savings to be likely to meet your target, but following the tips below will also help you maximise your chances of hitting it.
Looking at what you are putting in now, a matching employer's contribution of up to 10 per cent on a £50,000 annual salary gives £416.66 per month saved into a pension.
But this will only cost you £166.66 per month, because you also receive government tax relief on your contributions at your income tax rate. So, for basic-rate taxpayers, £8 saved becomes £10 invested.
What about in Scotland?
For Scottish resident taxpayers earning more than £43,431, tax relief at 41 per cent is available reducing the monthly cost of each £10 invested to £5.90 and where salary sacrifice is used to £4.70.
As a £50,000 earner you are on the cusp of becoming a 40 per cent taxpayer, meaning taxable income over £50,000 will give your pension savings a further 20 per cent tax break.
When looking at what kind of pot you might build up by retirement, it's important to take account of the effects of inflation.
If inflation is 2 per cent, an annualised return of 7 per cent is only worth 5 per cent in real terms.
To put this in perspective, UK equities have averaged a return of 4.9 per cent above inflation since 1899, according to the Barclays Equity and Gilt Study 2019, an influential report analysing long-term returns.
Pension saving cannot be on a set and forget basis. Regular reviews are advisable, taking account of changes in personal circumstances, taxation and investment returns.
What can you do to boost your pension and improve your finances?
- If your employer operates a salary sacrifice scheme, then use it to bump up your pension contributions.
If your pension savings are made by salary sacrifice, a further 12 per cent National Insurance is saved, bringing the net cost of your current contributions down to £141.66 per month.
It also saves your employer 13.8 per cent in NI, which it might add to your pension.
- For graduates with student debt, paying more into a pension will reduce the repayment you must make by 9 per cent. This means the debt takes longer to pay off, but it is written off after 30 years.
Kay Ingram: 'Ideally you would need to triple your own savings to be likely to meet your target'
Bear in mind though that high earners who expect to be significantly over the threshold earnings at which the 9 per cent applies and not have gaps in earnings during their careers should pay back student loans sooner.
This reduces the roll up effect of the interest, which otherwise increases the overall amount you pay.
- Basic rate taxpayers can earn up to £1,000 of interest from savings tax free, falling to £500 once taxable income is over £50,000.
Putting more into your pension means that more of the interest you earn on other savings will remain tax free.
- If you have children, you can claim tax free child benefit of up to £20.70 per week for the first child and £13.70 for younger ones.
Once income exceeds £50,100 this is taxed, but pension savings reduce income counted. So, by putting more into your retirement pot you can retain the child benefit tax free.
How should you invest to meet your retirement target?
With 30 years to go, keeping the value of your savings growing above inflation is key to achieving your goal.
They could be invested in a low-cost index tracker fund with a high level of exposure to shares.
Your employer's 'default' fund is probably one of these, but it's worth researching any others it offers to see if they might do better, and then deciding whether you want to switch or split your pot across several funds.
If 20 per cent of salary is invested continuously in a fund growing at 5 per cent after adjusting for 2 per cent inflation, with charges of around 0.3 per cent per year, you could expect to build up a pot of £835,000 in real terms by age 60.
Closer to retirement, switch a proportion of the fund into lower risk fixed interest investments - government and corporate bonds - if you intend to use your pot to buy a guaranteed income for life via an annuity.
However, you might want to stick with higher risk equities if you prefer to keep your pension invested in retirement.
What can you do with your pension to achieve a £30k income in retirement?
An annuity could produce the income you need on a guaranteed basis. If you stay invested and draw down an income instead, that will give you more flexibility but mean ongoing investment risk and the chance that you may outlive the pension fund.
Annuity: You could use your fund to secure a guaranteed lifetime annual income of £30,000.
If taxed at current tax rates, £34,500 before tax requires annuity rates of 4.13 per cent.
This is a low-risk solution but does not offer flexibility to change the income paid out after it has been bought.
Income drawdown: Alternatively, income could be drawn down from the fund.
If you don't take a 25 per cent lump sum upfront, then 25 per cent of each income instalment will be tax free.
So, each £33,176 withdrawn would provide £30,000 net of tax.
With growth in the fund matching inflation, withdrawals could last for over 25 years but this isn't guaranteed.
Lower investment growth and living longer risks a shortfall. Higher returns or a shorter lifespan could create a surplus for others.