Why I'm Investing Into A Pension In My Twenties
"Have you started saving for a pension?” my Dad asked, looking at me pointedly. I looked up from my plate of rice with a blank stare. A recent graduate, I had just moved back home from university and the "p" word was the least of my concerns and my Dad had started inserting it into his life lectures. There was a limited amount of time left before he would ask to see my pension fund, so I knew it was time to get with the programme.
In this day and age, it feels like we are badgered to save more earlier on in our lives. It's a no-brainer once I break it down for you. The harsh reality, however, is that 20-something year olds are still struggling to save for first properties, pay rent and are still fighting to earn the salaries they deserve. We cannot ignore what our futures look like. With the current state pension age at 65 forecasted to increase to 67 in 2028, who knows what it will look like by 2060? Will we be working until we die?
Without further ado, here is a brief overview of what your options are.
Option 1: Rely on the State Pension alone
The State Pension is a regular income that is paid by the UK government to anyone who reaches State Pension Age [SPA]. You'll need to have paid at least 10 years of National Insurance contributions to qualify by the time you reach the SPA. To get the full State Pension, you will have to have paid NI for 35 years. The full state pension is £159.95 a week, amounting to £8,296 per year until you die. Any contributions between 10-35 years are worked out proportionally, e.g. if you pay NI for 20 years, your State Pension will be £91.17 a week, (£4,740.84 a year).
The National Employment Savings Trust says we need at least £15,000 in retirement to live comfortably and have a significantly better quality of life. Simply put, doing next to nothing and just relying on the state pension is not enough.
Option 2: Automatic enrolment
Like option 1, option 2 also doesn't require you to lift a finger.
At the moment, automatic enrolment is in place at many workplaces and by 2018, all employers are legally obliged to provide it. So if you don't opt out, you will be automatically enrolled if you work in the UK, are at least 22 years old but under the SPA, earn more than £10,000 a year and do not already pay into another workplace pension. The total minimum contribution is currently 2% of your earnings over £5,876 (you pay 1% and your employer pays 1%). From April 2018, the total contribution will increase to 5% (you pay 3% and your employer pays 2%).
In terms of breaking it down for the new tax year (from April 2018) with an example, (let's call her Sarah):
Sarah is 25 years old.
Sarah earns £25,000 per annum.
Through automatic enrolment, she will contribute (3%) £48 a month and her employer will contribute (2%) £32 a month, all on £19124 (£25,000 - £5874).
If the SPA remains at 68, when Sarah chooses to retire in 43 years, her pension fund will stand around the £58,000 mark.
So let's look at her income per year once retired:
State pension = £8,297
Automatic enrolment = £2,201. If Sarah decides to take the entitled 25% tax free lump sum (£14,500), the remainder of her pension will leave her with £183 a month, £2,201 a year (if spreading over 19 years).
£6000 short of what statisticians deemed as the minimum target income for Sarah’s retirement with her current income.
Option 3: Start now, maximise your workplace pension and employer contribution
The rule of thumb when starting to save for a pension is to halve the age at which you start and put that % of your pre-tax salary away until you retire. For Sarah, that would be 12.5%, starting at £260 a month. That is a lot of money to put aside for a fund you can't access for at least 30 years. Here's where employer contributions come into play. Some employers have a matched contribution scheme where your pension contribution will be matched up to a certain % (basically free money). Additionally, the contribution will be based on your full income, unlike automatic enrolment. If your employer does, now is the time to jump in. If you have been automatically enrolled, contact your payroll team.
Sarah has seen the light.
Sarah now contributes (5%) £104 a month and her employer will contribute (5%) £104 a month (again free money),
Therefore a 10% contribution, close enough to 12.5%.
With the same assumptions as above, her pension fund now stands at £151,000 almost triple what it was with automatic enrolment.
However, let's factor in current research that shows that people don't start think about retirement until in their 40's. Imagine Sarah decides to delay until she is 40. To get the same amount in her pension fund as if she started at 25, she would have to invest over 30% more, at least a total contribution of 20% of her pre-tax salary to make up for lost time. If Sarah had started at 25, she could keep her contributions at 5% until retirement, factoring in the average 6% annual growth of a pension fund with a beautiful thing called compound interest (i.e. interest on interest). This would allow for costly life events to go by without having to worry about forking out extra money or investing in unreliable or low return funds in order to retire comfortably.
We can no longer look to the government to be a safety net and with life expectancy in the UK steadily rising, working into our 80s may well be a possibility. My ideal retirement age is one where I am still physically able to enjoy the pleasures of life and I am taking steps to ensure it's a viable option. I hope you can too.
**The calculations are based on assumptions: an increase in monthly payments to account for pay rises, inflation of 2.5% a year, pension fund growth of 5% a year and tax relief on your pension contributions.