A pension is the most tax-efficient way to save for your retirement. The government provides pension tax relief at your highest marginal rate, which means every pound you put into your pension actually costs you a maximum of 80 pence once tax relief is taken into account.
It’s important to start saving early for your pension; ideally, you should contribute to a pension for as long as possible.
Thanks to the power of compound interest, if you start saving early you’ll need to put away a far lower proportion of your income compared to someone who starts saving a decade down the line.
55 is the age where those with defined contribution pensions can first access their retirement savings and start to make decisions about how they want to draw the benefits.
Just how much you should have in your pension at this age depends on when you want to retire and the lifestyle you’re looking to lead in retirement.
Obviously, you’ll need a lot more in your pension if you want to retire straight away as soon as you reach 55 than if you want to retire closer to your state pension age, which is likely more than 10 years down the line from the age of 55.
Again this is incredibly subjective and really depends on the kind of retirement you want.
If you want to spend to enjoy your retirement, perhaps on foreign holidays, a new car or to help your children out financially then you’ll have to save more. If you’re happy to live a more frugal retirement, then you can afford to save a little less.
For the purposes of this page, we’ve taken the average UK yearly salary — £27,976 as of June 2019 according to the Office for National Statistics — and aim to replicate this in retirement.
We’ve included in this figure the £8,767.20 per year an individual will receive in 2019/20 if they’re entitled to the full New State Pension, which you get providing you’ve made 35 years of qualifying National Insurance contributions.
This means to make up an income equal to the average UK yearly wage, you’ll have to fund £19,208.80 per year from your own pension savings. We’ve rounded this up to £20,000 to provide a little extra fiscal headroom and to make the calculations easier.
Obviously those who’ve enjoyed a higher income during their working lives will likely want a larger pension and so will have to save more, whereas those who feel they could live on less during retirement won’t have to save quite so much.
If you have a defined contribution pension — which you’ve been saving into during your working life and is essentially a big ‘pot’ of all those savings that belongs to you — then you have two main options at retirement: You can either buy an annuity or enter income drawdown (also known as flexi-access drawdown).
Buying an annuity sees you swap all or some of your pension pot for a regular income for the rest of your life. This income is guaranteed and will pay out no matter how long you live for.
How much you’ll receive from an annuity is dependent on a number of factors, such as:
Today’s 55-year-olds have a state pension age of 67, so we’ll assume they want to retire then. We’ll also assume they’re in good health, a non-smoker, are looking for a single annuity and live in the same postcode as our Brighton-based financial advisers.
For a 67-year-old to get an annuity worth £20,000 a year to make up the income not covered by the New State Pension, they’d need a pension pot of around £370,500. This would buy them a secure annuity of approximately £20,000 for the rest of their life according to our Annuities Calculator.
If you wanted to retire early, say at 60, you’d need a larger pot because you’d be drawing on the pension for longer. To retire at age 60 with an annuity worth £20,000, you’d need to trade in a bigger pot — around £465,000.
This doesn’t even account for the fact that you’d probably require a higher income initially to bridge the gap between you retiring at 60 and the New State Pension kicking in at 67.
Income drawdown, also known as flexi-access drawdown or simply drawdown, works differently.
Here, your pension pot stays invested in the markets and you draw down an income from it. You can adjust this income up and down as needed, unlike an annuity, where the amount you’ll receive is fixed (unless you opt to index the annuity so it rises with inflation each year).
However, whereas an annuity offers guaranteed income for life, the risk with a drawdown pot is that it may run out.
As such, one of the most important calculations when figure out how much you’ll need in your pension is working out how long you’ll live and therefore how long you’ll need the pension for.
According to life expectancy statistics from the Office for National Statistics, a man age 67 has a further 17 years on average to live (surviving to 84), while a woman can expect to live for a further 19.3 years (surviving to almost 87).
A man would need a pension pot of £582,805 if he wanted to draw down £20,000 a year for 17 years (assuming inflation over this period of 2% and pot growth of 4%). A woman would require a pension pot worth £597,120 to draw down £20,000 a year for almost 20 years working on the same assumptions.
You can use our Pension Pot Calculator below to work out how much your pension will be worth at retirement based on the current size of your pension pot and your current pension contributions. Then use that figure to work out how long your pension would last if you choose to use income drawdown to fund retirement.
The absolute maximum you can save into a pension each tax year is 100% of your earnings or £40,000. This is known as your annual allowance.
High-earners are able to pay in less thanks to the tapered annual allowance that potentially whittles their available pension annual allowance down to as little as £10,000.
If you haven’t made any contributions, or haven’t made full use of your contributions, for the past 3 years then you have the potential to carry forward those contributions into the current tax year.
Without carry forward, the maximum £40,000 contribution each year means in the 12 years between age 55 and a 55-year-old’s State Pension Age of 67, you have the potential to save up to £480,000 into a pension.
However, this is impractical for a number of reasons, not least because it’s unlikely to be affordable for most people. Alternatively, £40,000 may be above the annual allowance available given the annual allowance is capped at the lower of £40,000 or 100% of earnings.
The average person aged 50-59 working full-time is earning £31,391 according to the Office for National Statistics. Assuming they save 10% of their income (including both employer and employee contributions), this amounts to £3,139.10 per year, or £37,669.20 over the 12 years left to State Pension Age for a 55-year-old.
Given we know we need a pension pot of £370,500 to generate that £20,000 annuity, this means at 55 you should ideally have over £300,000 in your pension if you want to retire on the average UK salary by age 67 using an annuity. This will be added to the £37,669.20 you might generate in the 12 years leading up to age 67.
Assuming you start saving at age 25, you’d need to put away around £440 per month to generate a pot of more than £300,000 by the time you’re 55 according to our Pension Pot Calculator. This includes both employer and employee contributions and assumes a growth rate of your pension of 4%.
To have a pot worth £370,500 by age 67, again assuming you start saving at age 25, you’d need to save £284 a month for the 42 years between age 25 and retirement. This includes both employer and employee contributions and again assumes a growth rate of 4%.
Whether or not you can retire at 55 depends on a number of factors.
Firstly, you’ll likely need a defined contribution pension, as few defined benefit or final salary schemes allow a retirement date of 55.
Secondly, you’ll need to consider how much income you want in retirement, how you’ll generate it and whether it’s affordable to stop working so early.
Today’s 55-year-olds have a State Pension age of 67, so you have 12 years of pension income to fill in if you retire early that you won’t be getting from the state.
To generate an annuity worth the average UK salary of £27,976 at age 55 — to cover the fact that you won’t be in receipt of the State Pension for more than a decade — you’d have to have a very large pension pot worth around £720,000. This is because the annuity company assumes they’ll be paying for an annuity for much longer given how young you were when you started claiming it.
If you wanted to enter drawdown at 55 and pull an income worth £27,976 each year from your pension, you’d need a pot of £640,000 to last you until age 86 (the average life expectancy for a man and a woman at age 55) assuming growth at 4% and inflation at 2%.
However, while this would be sufficient until you were 86, your pot would then be exhausted. Men aged 55 today have an 9.2% chance of living to 100, while women at age 55 have a 13.7% chance according to Office for National Statistics life expectancy data — clearly you might need a lot more in reserve based on these figures.
With an annuity, your pension will last as long as you do. This is because an annuity is a promise to pay you a guaranteed pension income for the rest of your life, no matter how long that might be.
With an annuity, if you’re planning to retire at 55, you’ll need a significantly larger pot that if you are looking to retire closer to State Pension age because of the additional years you’ll be drawing on a pension income.
As such, to retire on the average UK salary with an annuity at age 55, you’ll need to save up more each month and perhaps even start saving earlier to meet your retirement goals.
With drawdown it’s more complicated — your pension only lasts as long as you can make it last. It’s a finite pot of money and can therefore be exhausted if you take too much too soon. It’s also invested in the markets, which means that its value can fall as well as rise, meaning you may get back less than you invested.
Drawdown also requires a lot of guesswork surrounding life expectancy that’s taken out of the equation when you purchase an annuity. You need to take a sustainable level of income from your pension pot to ensure it lasts as long as you live, but how long might that be?
Use our Pension Income Drawdown Calculator below to model how long your pension might last in drawdown.
If you’re approaching 55 and want to look at your pension options, don’t hesitate to get in touch.
You have a number of important decisions to make as you reach the age where you can access to your defined contribution pension savings, including how and when you want to take your pension.
It’s essential you get these right to get the retirement you deserve, which is where an expert can step in to help.
A good financial plan can help you make the right decisions when it comes to your finances. Make the right decisions today to build a more prosperous future.
Good financial planning with clear goals can increase your retirement income by as much as 53%. Old Mutual Redefining Retirement Survey
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