How do you rescue your retirement if you’ve hit middle age and saved nothing into a pension yet?
Ed Monk, associate director for personal investing at Fidelity International, says people in the ‘squeezed middle’ can still retire with peace of mind about their finances.
He explains how an average earner in their forties can build a pot of £100,000-plus – or even double that if they try a bit harder – over the next couple of decades.
Life milestones: Get a job, buy a house, get married, have kids, buy a coffee every day AND save for a pension
Get a job, buy a house, get married, have kids – the order might change a bit but it’s these priorities that tend to occupy the minds of people as they move from being young to, well, not quite so young.
And as each milestone is passed, responsibility and pressure mounts up, free time shortens (to nothing, based on the new parents I know) and every penny that was once expendable becomes suddenly accounted for. These are the squeezed middle years.
It’s difficult, then, to add another headache on top – what happens when you retire?
Before a certain age this is only a distant worry but that can change quickly, normally around the time a person realises they’re closer to a free bus pass than freshers’ week.
Saving for a pension has been the one blind spot in their otherwise well-planned life. They know they should have paid more attention to it but it was easy to forget when money was tight at the start of their career. Then came saving a deposit, paying for a wedding and, finally, the money vortex that is children.
The traditional messaging around pension saving does little to help them feel better either, mostly telling them that, yes, you really should have started saving hard many years ago and probably now face a retirement eating dog food. It is not an inspiring message.
Ed Monk: ‘I’m NOT going to tell you to give up all frothy caffeine drinks for life to save money’
It does not have to be this way. Fidelity recently ran the numbers on what can be possible for those who have neglected retirement saving until their forties.
The results showed that even by doing nothing, making only small financial sacrifices and starting from nothing, there was still time for these people to build a pension pot that would make a real difference to their income and wealth in retirement.
Try a bit harder and they could do surprisingly well.
How a 45-year-old average earner can build a £107k pot from scratch
The modelling imagined a person 45 years old and earning the current average salary for the 40-49 age group according to the official Annual Survey of Hours and Earnings, which is £31,122 a year.
This person would have 22 years in which to save, before retiring at 67, and we’ve assumed their salary will rise by 3 per cent a year during that time.
When they hit 67 they’ll be able to receive the state pension, which by then will be £15,897 a year if it were to rise at the same rate as earnings.
In terms of contributions, we’ve used the rates and rules that will, from April 2019 onwards, apply to anyone auto-enrolled into a pension. As long as they don’t opt out, these people will benefit from these contributions without having to do anything.
They’ll pay 5 per cent of their salary above a threshold of £5,876, while their employer and the Government will pay 3 per cent. The money then grows inside a pension at a rate of 5 per cent a year.
At the moment, the minimum auto enrolment contribution from an individual, an employer and the Government only adds up to 2 per cent of salary, but this is scheduled to rise to 5 per cent in April 2018 and 8 per cent in April 2019 (see the table below).
Who pays what? How pension contributions stack up under auto-enrolment schemes (Source: The Pensions Advisory Service)
Many employers already pay in more than they are obliged to, while others only put in the legal minimum.
People whose employers plan to wait until 2019 to pay in the full whack can voluntarily put in extra themselves – and get the Government’s tax relief top-up – to get their contributions up to at least 8 per cent now.
That way, from a starting point of nothing at 45 years old, they will have built a pot worth £106,812 by the time they retire at 67.
Drawing a conservative 3.5 per cent income from that pot means extra annual income of £3,738 in retirement – a 24 per cent boost from the level provided by the state pension alone.
Crucially, with withdrawals at that level, your pot has a fighting chance of maintaining its £106,812 capital value indefinitely.
That’s £106,812 that can be drawn on if needed, underpinning your peace of mind throughout retirement – and you can bequeath anything left over to loved ones.
How to budget successfully to save money into a pension
The monthly contribution to someone’s pension would start at £168.31, but the real cost to them is far lower because this contribution includes tax relief and their employer’s contribution. In fact it is just half that amount – £84.16 a month from their take home pay.
That £84.16 still has to be found from somewhere, of course, and at this point it’s traditional financial guidance practice to helpfully suggest how many latte coffees this amounts to, and how easy it would be to amass if only you’d give up all frothy caffeine drinks for life.
I’m determined to avoid this (although, annoyingly, £84.16 a month does work out at nearly bang on £2.70 for every day of the year – the exact current price of a regular latte from Starbucks).
Traditional messaging around pensions does little to help people feel better – yes, you really should have started saving hard many years ago and probably now face a retirement eating dog food
More usefully, saving this amount is plausible from sources that don’t involve giving up caffeine, something many stressed-out parents would rather sell an organ than do. We all have many essential costs that we could lower if only we bothered to do so.
Look for monthly subscriptions you’ve long-since stopped making use of. Idle gym memberships and free trials that are no longer free should be the first to go.
After that, target the hundreds of pounds that can be saved on broadband, mobile bills, energy bills and insurance for the car and home. Unlike your treasured morning beverage, these are all things you really won’t notice spending less on.
Only if those savings don’t get you there would you need to cut back on other spending. At this point it’s useful to have a proper trawl of your bank statements to remind yourself of the many small and unnecessary purchases we make – is there really nothing that can be trimmed?
How to double a pension pot to more than £214k – painlessly
The exercise demonstrated the pension saving that’s possible for those feeling the squeeze and starting from nothing.
The modelling here is on the conservative side and only really requires you remain opted into any pension you’ve been enrolled into. Anyone earning more than average or setting aside more than these levels will do significantly better.
And a small tweak to our model showed how much better. We’ve assumed a person’s salary will grow by 3 per cent.
If each time that rise came around they use one percentage point of it for extra pension saving – 1 per cent for the pot, 2 per cent for them – they would dramatically increase the size of their fund by age 67.
Increasing contributions this way is a good idea because you still get to benefit from most of the pay rise and won’t feel any great sacrifice has been made.
If contributions were ratcheted up this way for 12 years – by which point they’d be 57 and contributing 17 per cent of their salary to their pension – and then maintained, their eventual pot would more than double to £214,684.
It shows that, next to the hard work of getting a job, buying a house, getting married and having kids, saving this kind of sum for retirement is easy, even if you’re starting from nothing.
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