If you want a comfortable retirement, you will need a £260,000 pension pot.
That’s the target a worker needs to secure two-thirds of the current average salary once their state pension is taken into account, a report by Royal London says.
Sounds a lot doesn’t it? Well, there’s some good news and bad news.
Someone retiring in 30 years would need a pension pot of more than £560,000 to match the the £260,000 pot required to retire comfortably now – but it might not be that bad
The good news is that it’s less than last year’s figure of £290,000, thanks to improving rates on annuities, products which provide an income for life.
The bad news is that unless you are retiring soon, inflation means the figure you need will be bigger than £260,000.
Royal London’s sums were based on the amount needed to bridge the gap between an £8,500 state pension and two-thirds of the £26,700 average salary.
But what if instead of retiring now, you won’t reach pension age for another 30 years.
Allow for annual wage inflation of 2.5 per cent and the average salary will be £56,500 in three decades’ time, while if the state pension rises at the same pace it will be £18,000.
There is a £20,000 gap between the state pension and £38,000-a-year, which is two-thirds of that 2048 average salary.
To secure that £20,000 a year income, using the same annuity rate of 3.56 per cent that Royal London did for its calculations, someone retiring then would need a pension pot of £562,000.
If you retire in 30 years you might need £400,000
At which point, we should probably switch back to the good news.
Because if annuity rates improve by then – even just to a still historically modest 5 per cent – then the pot needed to deliver £20,000 of income would shrink to £400,000.
If you could achieve an average 5 per cent a year return, you would need to invest £480 per month for 30 years to get there.
That sounds like an awful lot to pay in each month, but for some workers it would only require they saved about £220 themselves per month.
For some workers a £400,000 target would require saving £220 themselves per month
How does that work?
Well, the first benefit is that you can save into a pension tax-free, so money paid in automatically gets a 25 per cent boost to take you back to where you would have been before basic rate tax.
If you pay in £220, this extra 25 per cent takes your contribution up to £275.
If your employer matches your pension contributions, which many do, they will pay in £220 as well. Add that to the £275 that’s already gone in and you have £495 a month.
A £220 a month contribution is still a sizeable chunk of most people’s earnings – it’s a shade under 10 per cent of that £27,000 average wage – but it certainly seems a much more attainable target than £500.
We make good work pensions a badge of honour for companies again
The issue is that most companies cap the maximum percentage they will match, often at about 5 per cent.
And unfortunately, not every employer is a generous as that – some pay in the bare minimum that pension auto-enrolment requires them to, which is currently 2 per cent of an employee’s salary.
And this is where the problem currently lies with pensions.
Companies are far more focussed on containing the costs of their old final salary schemes, than on making the work pensions that their employees now pay into as good as they can be.
It’s hard to imagine, but there was once a time when companies made their pension a real selling point for working there.
If we want people to build the pension pots they need, that’s the mindset we must get businesses to return to.
We do more to save for our retirement, they do more to help us – and in the decades to come we get rid of a potential pension saving crisis.
Forget tinkering with the system and tax relief, a concerted effort to achieve that would do far more to deliver the comfortable retirement people hope for.
What is an annuity – and why do many people no longer buy them?
An annuity is a financial product that provides a guaranteed income for life.
They can come with extra benefits, such as payouts rising with inflation, or a payout that goes to a surviving partner when you die.
Annuities were the main option for those retiring with defined contribution pension pots for many years, however, they became increasingly unpopular due to low returns and the fact that those who died early could end up getting less back than they put in.
Annuity returns were pushed down by the emergency low interest rates introduced after the financial crisis and quantitative easing, which lowered the rates paid by the government bonds that drive annuities.
Pension Freedom rules introduced by George Osborne as Chancellor meant people no longer had to buy an annuity – as most were previously forced to do – and could keep their pension pot invested in retirement and draw on it as they wished.
Annuity sales have since plummeted, as most people choose the pension freedom options. Royal London used an annuity in its example, however, as it provides a guaranteed income.