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Saving for Retirement

Paul Hazard APFS Chartered Financial Planner - 01/08/2011

Saving for Retirement

I often get asked, “When should I start a pension and how much should I contribute?”   

Most individuals need some type of investment which will provide an income for when they stop working. This can be completed in different ways but a Pension and an ISA give tax advantages over other investments.

An ISA will currently pay an income free of any income tax. This can be a useful planning tool at retirement, although you pay into this scheme with taxed income. This is the major advantage of a pension which will give full tax relief on payments made up to the annual allowance.

Your main objective would be to get your investment pot to a level to provide the cash and income required at retirement.

The three main questions to ask for your retirement planning are:

  • When do I want to retire?
  • How much cash do I require?
  • How much income will I need?

From these three simple facts a plan can then be made on how much you require to invest as monthly amount or/and a lump sum in the future. You might not currently be able to afford what you need, so you will have your targeted figure and affordable amount to invest per month. This should then be reviewed annually.

The longer your time frame, the annual cost will be lower to achieve your target. Most individuals do not retire early because their pension pot is not large enough. In realty this means most retire at state pension age, which is now been increased to age 68 from 2042. For current post graduates this could be higher.

For Example...

To get a fund of £500,000 would need just under £261 per month at 6% net growth per month over 40 years.

If this is reduced to 30 years, the payments would increase to approximately £511 per month to get the same fund value of £500,400.        

The premium increases to a massive £1,098 per month over a 20 year period.

At today’s rate a fund of £500,000 gives a 65 year old a level annuity payment of £32,500 per annum with no indexation. In 40 years time (using 3% inflation), this would reduce to £9,963 per annum! 

The two main aspects on all investments will be the cost of the investment and the overall performance. The cost will include the product, investment and adviser charge.

The Government are about to introduce changes in employment law which require Employers to provide a qualifying pension scheme. If they do not have a scheme then individuals will be automatically invested into the National Employment Savings Trust (NEST).  

NEST

In the next few years (depending on the size of a Company), new employer duties will start and they will need to provide some or all of your workers with access to a qualifying pension scheme. If the qualifying pension scheme you choose is a defined contribution scheme they will need to make minimum contributions on behalf of some or all of your workers.

How much will the legal minimum be?

In 2012 the legal minimum will start at 2 per cent of a worker’s qualifying earnings. Of this, you need to pay at least 1 per cent. By 2017 the minimum contribution level will rise gradually to 8 per cent. Of which an employer pays 3% and employee 4% of qualifying earnings plus 1% from tax relief.

What are qualifying earnings?

This is the band of gross annual earnings on which contributions are calculated.

This is currently between £5,035 and £33,540* a year in November 2008 terms. Qualifying earnings include a worker’s salary, wages, overtime, bonuses and commission, as well as statutory sick, maternity, paternity or adoption pay.

The gradual process through which minimum contributions are phased in is set out in the table below.

Date

Minimum contributions
as a percentage of a worker's qualifying earnings

October 2012 to September 2016

Minimum contribution: 2 per cent.

Of this, you must pay at least: 1 per cent.

For every £100 of qualifying earnings a worker earns, the minimum contribution is £2. Of this you must pay at least £1.
From October 2016 to September 2017

Minimum contribution: 5 per cent.

Of this, you must pay at least: 2 per cent.

For every £100 of qualifying earnings a worker earns, the minimum contribution is £5. Of this you must pay at least £2.

From October 2017 onwards

Minimum contribution: 8 per cent.

Of this, you must pay at least: 3 per cent.

For every £100 of qualifying earnings a worker earns, the minimum contribution is £8. Of this you must pay at least £3.

The time scale can be found at http://www.thepensionsregulator.gov.uk/pensions-reform/duty-dates-timeline.aspx .

If you are self-employed this new scheme will not be applicable to you. If you are self employed and have employees, they will be allowed to join a scheme.

If you are employed in a practice and they have no scheme, they will have to auto-enroll you into nest.

The range of funds at the moment will be limited to just five funds.

No advice will be given unless paid by the individual or employer.

Stakeholders were introduced in 2001 with a 1% cap on charges. This is a low charge when starting a pension because at £200 per month, there is only £24 charge for the first year, then increases by another by another £24 with any additional growth in the period.  The main problem with this approach has been the reduction in the choice of investments made available with this type of product. Over time this has resulted with most providers using their own internal funds or tracker funds.

Some pension products are lower than this stakeholder cap by using passive funds.

Although costs are important, so will be the performance of the investment.

My next subject will be based on passive vs. active funds.

 

This article was kindly provided by Mr Paul Hazard, who is also the father of a vet.  Mr Hazard works for Omni-Financial Ltd:

Omni Financial

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