How to fund retirement

Low interest rates are making it ever harder to fund a decent retirement income (see below). And you can't rely on the future generosity of the state particularly given our ageing population and fragile public sector finances. So how can you give yourself a decent chance of retiring in comfort, rather than penury?

1. Take charge of your finances

A great way to identify wasteful spending that could be diverted into paying off debt is to draw up a spreadsheet (or just use paper and pen) and record your monthly spending habits for a few months. Once your credit card and any other non-mortgage debt is paid off, then saving via direct debit so that a set amount of money goes out of your account and towards your pension each month is a great way to ensure you save consistently.

2. Start early

3. Buy shares

In the US the gap is even more pronounced 6.4% versus 0.8%. So while the ride might be bumpy, in the long run it should pay off. Fund manager David Dreman found that, between 1946 and 2010, stocks beat bonds only 63% of the time over one year, but 94% of the time over 15 years.

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4. Keep fees to a minimum

What is an annuity?

However, as rising life expectancies (which mean the annuity provider has to pay out for longer) and falling interest rates (which make it harder to generate the investment returns to fund the payouts) have driven annuity payouts down, they have become increasingly unpopular, and last March the government made it easier for all pensioners to keep their pension pots invested, rather than annuitising them. That said, an annuity is still worth considering for at least part of a pension pot, to provide a reliable, guaranteed base-line income.

There are several types of annuity. The simplest pay out a fixed annual amount. However, because the "real" value of this payout would gradually decline over time due to inflation, many annuity purchasers opt for index-linked annuities, where the annual payments rise in line with a price index such as the consumer prices index (CPI).

You can also buy annuities that will continue paying out a sum to your spouse should you die before them, or an enhanced annuity that pays out larger sums to smokers or others with lower-than-average life expectancy. But the more bells and whistles you add to your annuity, the more expensive it gets. According to Hargreaves Lansdown, £100,000 would get a 65-year-old a £4,624 annual income. If you want an index-linked payment that will pay out for at least five years (even if you die) then that same £100,000 only buys £2,680.