The 50% pension rule: how to use it to reach your retirement goals

The amount you pay into your pension while you’re working can make a big difference to the eventual size of your nest egg and how comfortable your retirement is. But how much should you be saving?

Under auto-enrolment rules, employees currently pay a minimum of 3% of their earnings per month into a workplace pension scheme, with at least 5% from their employer, giving a total of 8%.

That may not be enough if you want to make the most of your golden years though. And if you’re self-employed, you won’t benefit from these employer contributions.

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Your retirement income, including your workplace pension, state pension and other sources such as investments or a buy-to-let portfolio, need to cover bills and replace earnings when you have stopped working, while also ensuring that you can enjoy your golden years.

Researchers at the Pension and Lifetime Savings Association (PLSA) estimate that for a comfortable retirement – including theatre trips, regular beauty treatments, and two foreign holidays a year - a retired person would need an annual income of £37,300, or £54,500 for a couple.

To achieve this level, a couple sharing costs with each in receipt of the full new state pension would need a retirement pot of £328,000 each, based on an annuity rate of £6,200 per £100,000, according to the PLSA.

It will be difficult - if not impossible - to build up such a large nest egg by following the 8% auto-enrolment rule for your entire career.

So, rather than contributing just 8% of your earnings to your pension pot, another option is to follow the so-called 50% rule, especially if you are young.

The maxim suggests that you should aim to contribute half the age you start saving for retirement as a percentage of your salary when you first put money into a pension.

HOW THE 50% RULE WORKS

The 50% rule benefits pension savers who start early.

The idea is that when opening a pension, you should save a percentage of your pre-tax salary equal to half your age.

So, if you started contributing to a pension at age 22, you would need to save 11% per year into your pension for the rest of your working life.

This demonstrates that the later you start saving in a pension, the harder it will become to build up a decent retirement pot - and therefore the more you need to pay in if you start later in life.

“It suggests someone who starts saving at age 20, for example, will need to contribute 10% in total to their pension, while someone who delays until age 30 needs to contribute 15% in total, and so on,” says Tom Selby, head of retirement policy at the investment platform AJ Bell.

These figures can look scary but they do include your employer contributions and tax relief as well, says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.

“It’s worth checking how your workplace pension scheme works as some employers will boost their contribution if you boost yours, so you may find it easier to hit these numbers than you first think,” she adds.

PROS AND CONS OF THE 50% RULE 

Saving for your retirement can feel overwhelming, so the 50% rule provides a useful starting point when thinking about what you might need to set aside for later life. 

“It is a simple rule and it’s a decent one as you have to start somewhere,” says Ben Yearsley, investment director at the financial planners Shore Financial Planning.

“The more you can put in earlier, the better, as it gives it more time to grow and compound.”

However, it shouldn’t be seen as a hard-and-fast rule to follow that will guarantee you a dream retirement, notes Selby.

“It is also important not to be intimidated by rules like this, particularly if other priorities like saving for a house or having kids mean you have been unable to save as much as you might have wanted in your 20s and 30s,” he says.

“The key for anyone saving for retirement at any age is to get a realistic plan in place and consider your savings priorities and goals for the short, medium and long-term. You then need to consider your monthly budget, your outgoings and how much you can afford to save in a pension. Any money you save in a pension should be a sound investment as it benefits from upfront tax relief and tax-free investment growth.”

It may also be tricky for certain groups to have a specific contribution level, such as the self-employed, who can have fluctuating income.

“The most important thing is to keep track of what you are contributing over time and take the opportunity to boost contributions at key points such as when you get a pay increase or new job,” adds Morrissey.

“There are pension calculators online that can help you model how much you are on track to receive and the impact of boosting your contributions when you can. It’s also worth taking the time to think about what you want your retirement to look like. 

“The PLSA retirement income standards can prove a useful guide to how much you need to fund various lifestyles at retirement.”