George Osborne, just before the election, waved his golden wand to give the over-55s access to their pension cash at long last. Lucky them. How wonderful it must be to have a tax-free lump sum with which to treat yourself to a luxury holiday or a flash new car. In fact, it’s enough to make most young workers sick.
Final-salary pension schemes are long gone. The best most of us thirtysomethings can hope for is a decent employer offering a defined-contribution scheme. If we’re lucky, our taskmasters may be so good as to top up our measly pots with a few per cent of our salaries. So for those of us only just starting on our pension-saving journey, how can we get ahead and ensure that we too can one day retire in style?
You probably think this is going to be a rather complicated area of financial planning, but the good news is that there’s a simple answer: start saving now and whack your cash into equities. Of course, there’s slightly more to it than that. But there’s really not that much to fret over, so let’s get started.
Don’t just start saving now: save as much as you can. The longer your money is invested in a pension — or anything else — the more time it has to grow. And over the long term, the stock market has always outperformed cash. You’ll also benefit from the effects of compound interest, reinvested dividends and pension relief (if all the governments to come before you retire don’t steal it away).
But how much should you be putting away? Figures from Legal & General show that to amass a pot big enough to pay you an annual income of just £5,000 from the age of 65 (excluding state pension) requires monthly contributions from a 25-year-old of £238 in today’s money. Leave it until you turn 35 and you’ll have to find £308 a month. The older you get, the harder it will be to get started: if you live in a cave until you turn 55, you’ll have to make monthly contributions of £840 a month. All that for an eventual return of less than £417 a month on top of the state pension, which today pays just over £500 a month at best.
If you want a more comfortable retirement income, you’ll have to put away a lot more. Precisely how much depends on many factors, including your current income and your personal retirement goals. But a good rule of thumb is to divide your age by two and tuck away that percentage of your net earnings each month. So thirtysomethings should save between 15 and 20 per cent.
Once you’ve worked out how much you can afford to save, the next question is where to put it. As already mentioned, an employer’s defined contribution scheme is most likely to be your best bet. Turn it down and you’re effectively doing yourself out of a pay rise — or free money — in the form of your employer’s contributions. Such schemes tend to match employee contributions, or even exceed them, up to a set proportion. The average employer contribution was 6.1 per cent of gross salary in 2013, down from 6.6 per cent in 2012, according to the Office for National Statistics. On a salary of £30,000, that equates to an annual injection into your pension pot of £1,830, or £152.50 a month.
There’s tax relief too, at 20 per cent for basic-rate taxpayers and 40 or 45 per cent for higher and additional-rate payers. That means a £10,000 pension contribution effectively costs a higher-rate taxpayer just £6,000, and a 45 per cent taxpayer £5,500. However, with all the main political parties threatening to cut pension tax relief for the wealthy, the sensible advice is to get saving even faster if you’re lucky enough to be well paid, and don’t rely on the tax perks.
It’s also worth noting that by April 2017, all employers will be required automatically to enrol staff aged 22 and above, earning £10,000-plus, into a company pension scheme. Neil Collins challenges the merits of auto-enrolment in this issue, but here are the facts. The minimum an employee must contribute is currently 0.8 per cent of qualifying earnings, but this will rise to 4 per cent by 2018. Employers must contribute at least 1 per cent, rising to 3 per cent in three years’ time, while the government pays 0.2 per cent rising to 1 per cent (see gov.uk/workplace-pensions). You don’t have to join the scheme — but you will have to opt out if you don’t want to join, and every three years you will automatically be opted back in.
If you leave your employer, you can choose to keep your company scheme (whether or not you were auto-enrolled) but it’s up to you whether you continue to make contributions. Your ex-employer obviously won’t. The alternative is usually to move your pension to your new employer’s company scheme. There will be a cost of moving your money but it will be easier to monitor if you do, and keeping all your pension cash in a single pot avoids multiple fees, which in turn helps your money grow more over the long run.
Maike Currie, associate investment director at Fidelity Personal Investing, says the next option worth considering for pension savers is a Sipp (self-invested personal pension). These are nothing to do with your employer, and you can open one online from any good fund platform, such as Hargreaves Lansdown, Bestinvest, Fidelity or Interactive Investor.
With standard personal pension schemes your investments are managed for you within the pooled fund you have chosen. Sipps, by contrast, give you the freedom to choose and manage your own investments, and Maike Currie says they are suitable for most investors who want ‘more control over where their pension money is invested, its future growth and the eventual income they receive in retirement’.
You can choose to invest in all manner of things from individual shares to government bonds, investment trusts and commercial property. ‘But don’t forget about costs,’ Currie continues. ‘Sipps come with a multitude of different charging structures, so make sure your provider has a transparent and simple one.’ Unlike employer schemes, you will usually have to pay a set-up fee of £100 upwards, and you’ll be charged to buy and sell your investments.
Of course, however you invest your pension, you should always find out exactly what fees you will be charged, because over the long run they can take a significant bite out of any gains. When Steve Webb, the pensions minister in the last government, announced that charges on auto-enrolled pension schemes would be capped at 0.75 per cent, he claimed that this would save the average earner who was previously paying charges of 1.5 per cent around £100,000 over the course of their working life.
The last piece of advice for thirtysomethings starting out on their pension journey is this — diversify your portfolio. This will ‘reduce risk and give much more consistent performance’, according to Danny Cox of Hargreaves Lansdown. Patrick Connolly at Chase de Vere adds: ‘The best approach is usually to hold a combination of different asset classes including equities, fixed interest and property. A portfolio of this type has growth potential through equities but the other asset classes provide some protection if stock markets fall.’
He also points out that pension investors can often afford to take more risk while they are many years from their likely retirement date, because they have time to claw back short-term losses and can ride out market ups and downs. ‘This is particularly the case for those investing regular premiums into their pensions, as most thirtysomethings will do, because this approach helps negate the risk of market timing. Indeed, if prices fall, then investments can simply be bought cheaper the following month. If thirtysomethings are happy to accept the risks, it can be perfectly sensible for them to invest most, or even all, of their pension into equities.’
Canny investors should, however, plan to increase their weighting in other risk-diversifying asset classes as their pension grows and they come nearer to retirement.
Pension planning really doesn’t have to be complicated when you have three or four decades of working and earning still ahead of you. Just remember the simple mantra: start saving now and save as much as you can.
Laura Whitcombe is deputy editor of Moneywise and co-author of Money Made Easy 2015-16, published by Harriman House.