For anyone suffering back-to-work blues this week, even the next holiday will feel a long way off – let alone retirement. But if you want to look forward to being able to step off the treadmill as soon as possible, pension planning should be high up on your list of new year resolutions. Unless you’re planning your retirement savings carefully now, your chances of being able to stop work for good when you want to are slim.
Start by being ambitious. Under the lifetime allowance rules, the maximum you are allowed to build up in tax-free private pension plans, including all investment growth, is now £1m. This therefore gives you a simple target for the retirement fund you should aim to build up, at least through your pension scheme. That sum isn’t as outlandish as it sounds. For one thing, in today’s money, £1m of savings would buy you a guaranteed annual pension income of between £25,000 and £45,000 a year, depending on how much protection from inflation and for dependants you need – a decent amount, but not a king’s ransom.
The savings you’ll need to hit this target are demanding, but if you start early enough they’re not impossible. A 30-year-old who makes an annual return on their savings of 5% after charges would need to put £1,145 a month into their pension to get to £1m some 35 years later. Some of that money could come from an employer’s contribution, if you’re a member of a pension scheme at work. Tax relief on pension contributions will also reduce the sums you need to find.
For older savers with less time to benefit from compounding investment returns, the numbers look more intimidating. For a 40-year-old, the monthly sum required rises to £1,925, and then to around £3,800 for a 50-year-old. In fact, that latter contribution rate would breach the annual allowance rules, which limit contributions to pension plans to £40,000 a year (£3,333 per month) for most people.
If these sums are out of the question, try thinking about pension planning in another way. Many financial advisers still use a simple formula for working out how much their clients should be contributing to their pensions: the right amount, expressed as a percentage of salary, is half the age of the saver at the time they begin saving. So, for example, a 40-year-old pension saver should aim to contribute around 20% of their salary to their pension plan.
Above all, the key is not to put off pension planning simply because you don’t feel you can spare as much as you should – saving even a small amount sooner rather than later will pay off thanks to the power of compound interest (this means that the earlier you make an investment, the more time you have to earn interest not just on the capital, but interest on each previous year’s interest). Keep your finances under regular review – at least annually – and look at whether you’re on track to hit your savings targets. Raise your contributions as soon as possible when your budget allows, and monitor charges closely: check whether your pension is still good value, or whether you should transfer to a new provider.
Finally, remember that pension plans aren’t the only way to save for the future. Tax-free individual savings accounts (Isas) can also be excellent long-term savings vehicles and may be useful if you’re close to your pension contribution allowances or if you’re looking for additional diversification and flexibility. From April, if you’re under 40, your options will include the new lifetime Isa, or Lisa. It pays an up-front government bonus of £1 for each £4 invested, up to a maximum of £4,000 a year, a similar level of up-front tax relief to what’s available from private pension plans.
Want to retire in your 30s? Here’s how you do it
The Early Retirement Extreme (ERE) movement, which takes its name from a book by Jacob Lund Fisker, a blogger who retired at 33, consists of a disparate group of people who aim to be financially independent very early on in life. Many no longer need to work full-time by their 30s or 40s; some have been able to retire completely by this time. That probably sounds very appealing right now – but to achieve it, you will almost certainly need to change your lifestyle radically.
ERE aficionados employ a variety of techniques to achieve their aims. Above all, they try to live within their means, in the cheapest possible accommodation close to work so they don’t have to pay transport costs or keep a car; they eat simply, cooking from scratch with basic ingredients and avoid all unnecessary purchases. In addition, many in the ERE movement have embraced hobbies and lifelong learning that enable them to enhance their day-job earnings – anything from bicycle maintenance to plumbing. They often pool their resources through online communities, leveraging each other’s expertise in order to avoid paying for help.
Using all the money saved by living this way, it’s possible to invest significantly more in savings much earlier on in life. The idea is rapidly to build up a pot of money large enough to generate an income you can live off, so that you no longer need to work full-time. You probably won’t use pension plans, since these can’t be accessed until you’re 55, although Isas would still be a very tax-efficient option.
The sacrifices required for ERE aren’t for most people, but there is still plenty to learn from the movement. Most people could save money by cutting down on unnecessary purchases, working harder to get the cheapest deals on the expenses they do have to incur, and learning new skills to reduce the cost of professional help, even if that just means some basic DIY or car maintenance.
The potential long-term impact of even very small changes to your lifestyle can be huge. For more ideas, see Lund’s book and blog and other popular websites in the movement such as Mr Money Mustache. The Monevator blog is a more UK-focused site that tackles similar ideas for cost-cutting, saving and financial planning in a less radical way.