There has never been a better time to review your retirement planning and take advantage of generous tax reliefs.
Most advisers will tell you that creating a healthy nest egg for your retirement is the most important investment you can make.
If you are going to make only one financial new year’s resolution it should be to put a rocket under your pension planning. Not only is Britain’s long-term savings crisis getting worse, but the writing is on the wall for generous tax reliefs that can make all the difference to those confronting the challenge of retirement strategy. Use them before it is too late.
The latest research by Chase de Vere, the independent financial adviser, shows that we are woefully unprepared for retirement compared with people in Germany, France, Switzerland and Austria — so much so that almost one in two Britons considers a rising average life expectancy as a problem rather than something to celebrate.
Only a minority of people have final-salary pension schemes, which offer guaranteed and attractive retirement incomes. Most have money-purchase schemes, in which the outcome is unpredictable and employers’ contributions are lower (or nonexistent if you are self-employed).
At least the tax system still provides incentives in the form of relief at a marginal rate of income tax on contributions. It costs a basic-rate taxpayer £800 to contribute £1,000 to a pension, while higher-rate taxpayers spend just £600.
This generosity may not last, given the £48 billion annual cost to the Treasury. Tax breaks have already been cut back for the highest earners and those with the most savings, and the chancellor’s autumn statement contained clear hints about possible reforms.
Against this backdrop, the call to action could not be clearer. Now is the time to put your retirement finances in a healthier state and grab every pound of tax relief while it is on offer.
What does that mean in practice? How much is enough? Well, one formula on which financial advisers depend is simple; if you are starting a pension, halve your age to work out what percentage of your salary should be going into it each month. If you are 50, say, you need to put 25 per cent of your pay into a pension — although that may include a contribution from your employer, and if you have the option of joining a workplace pension scheme you should almost always do so.
Philippa Gee, the managing director of Philippa Gee Wealth Management, says: “You need to aim for a savings pot worth £1 million when you retire. You can do that through investments in a variety of assets.”
Why £1 million? This is the maximum value that a private pension fund may reach, including contributions, tax relief and investment growth, before tax charges kick in.
If you think that the sum sounds fantastical, bear in mind that £1 million today would buy you a retirement income of between £25,000 and £45,000 a year, depending on whether you want to protect it from inflation and have benefits to leave to dependants. That is a good income, particularly with state benefits on top, but it is hardly going to fund a jet-set lifestyle.
A £1 million pension pot today would buy you a retirement income of between £25,000 and £45,000 a year
For those starting young, hitting the £1 million target by 65 is not out of the question. Assuming an average annual investment return of 5 per cent on your savings after charges, a 30-year-old would need to put £1,145 a month into their pension, including tax relief and employer’s contribution, and then increase their savings in line with average earnings each year.
As you get older, however, with fewer years to benefit from the value of compound interest, the figures become more demanding. For a 40-year-old starting a pension, the required level of savings increases to £1,925 a month.
If you cannot afford to aim for a £1 million pension pot — and the reality is that contributions of this size are not possible for most people — set yourself as ambitious a target as you think might be practical.
“It’s better to start saving something than to go on putting it off, and it’s never too late to start,” says Martin Bamford, managing director of Informed Choice Independent Financial Planning.
Even relatively small pension savings add up over time. Save £50 a month and earn the 5 per cent after-charges return, and you will have more than £7,700 after ten years — and almost £30,000 after 25 years. In the end, long-term investment can deliver sizeable sums, especially because investment returns on pensions are tax-free.
However, warns Patrick Connolly, a certified financial planner at Chase de Vere, keeping a close eye on your pension progress is as important as maximising your contributions. “Make sure you review your pensions to ensure they are performing, that you’re investing in the right areas and that you’re not paying too many charges,” he says.
Mr Bamford says that dedicated pension plans are not the only way to save tax-efficiently. If you are close to reaching your pension investment allowances, or you are just keen to spread your bets beyond private pension schemes, individual savings accounts (Isas) are also attractive.
From April the options will include a new lifetime Isa, or Lisa, which pays an upfront government bonus of £1 for each £4 invested, up to a maximum of £4,000 a year. And while Lisas are available only to the under-40s, everyone is entitled to the full annual Isa allowance — £15,240 in the 2016-17 tax year, rising to £20,000 thereafter.
“Pensions and Isas have a role to play in retirement planning,” Mr Bamford says. “For higher-rate taxpayers pensions are probably more attractive than Lisas [from a tax perspective], but the opposite is true for basic-rate taxpayers.”
If in doubt, says Mr Connolly, taking good-quality independent financial advice could be the key to getting your pension performing strongly in 2017.