Pensions and savings: Interactive Investor expert gives her advice
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The new State Pension currently pays a maximum £9,339 a year, which is less than half the amount people are aiming for in retirement. This means savers have to plug the gap by building up company pension and personal savings in their own name while working.
Too many fall short, often because they have no idea how big a nest egg they need to hit their retirement income target, says Becky O’Connor, head of savings and pensions at Interactive Investor.
“If you are going to put away sufficient money, it helps to have a clear goal in mind,” she says.
The over-55s who have pension pots of less than £200,000 say they would like annual income of £20,000 a year in retirement.
This is a relatively modest target, says Nick Flynn, retirement income director at Canada Life, which carried out the research.
“Even if you get the maximum new State Pension of £9,339 a year, you still have to save a further £10,661 to generate income of £20,000 a year.”
There are two ways of working out how much income your savings will generate in retirement.
The first method is to use something called “the four percent rule”, a personal finance yardstick that says if you withdraw four percent of your pension savings each year as income, your money should never run out.
This assumes inflation averages three percent a year, while your pension pot grows at seven percent a year. You take the difference between the two.
The four percent rule would apply to people who leave their pension in income drawdown at retirement, so that it continues to benefit from stock market growth, while they take income or cash lump sums from it.
Using that rule, you would need a total nest egg of £266,525 to safely withdraw income of £10,661 a year, on top of your State Pension.
This includes all your workplace and personal savings, and other savings and investments, including tax-free Isas.
That may look a daunting target, but remember that HM Revenue & Customs gives you tax relief on your pension contributions.
For basic rate 20 percent taxpayers, this means each £100 of pension costs just £80, while higher rate 40 percent taxpayers pay £60 just for each £100 of pension.
Those in company pensions typically get employer contributions worth at least three percent of salary, turbo-charging their pension savings.
The other way of measuring how much income you need is to look at how much you could buy using an annuity.
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Annuities are swinging back into fashion as interest rates rise and the income they pay increases.
Flynn says: “At current standard annuity rates, a pension of £200,000 could deliver income of around £10,000 a year guaranteed for life from age 65.”
Some pensioners could get more, because annuities pay higher income to those with health problems, or heavy drinkers and smokers. They have a lower life expectancy, so the annuity company calculates it won’t have to pay out for so long.
“Buying an annuity is a significant financial step and an adviser or annuity broker will be best placed to help understand the choices available,” Flynn says.
So the basic rule is that everybody should be aiming to save at least £200,000 across all their pensions and investments, to enjoy and moderate lifestyle in retirement.
Don’t stop there, though. If you want a bit of luxury in your life, you will need to save a bit more.
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