You can better your parents' pension
The end of final-salary schemes, falling annuities and inflation can all be beaten with planning. By Chiara Cavaglieri
Sunday 18 March 2012
Theirs is the "golden generation" that got it all, snapping up generous final-salary pensions, watching their homes soar in value and building up a retirement pot that will put the next generation to shame – or at least that's what their children think.
A survey from Schroders has found that only 26 per cent of people think they will be better off than their parents when they retire, with 79 per cent fearing their income will be too low, or that inflation will eat away at any savings they do manage to put aside.
There is no doubt that today's workers will have to retire much later and invest more money than their parents but if you get the planning spot on, a golden retirement is possible.
"The advantage we have over our parents is financial planning. I think most people are more financially savvy today. It is perhaps the case that we have less money to play with in the first place, but we should be smart enough to make it do more," says Dan Clayden from Clayden Associates, an independent financial adviser (IFA).
The average retirement income is currently £1,388 a month according to Aviva, but if you were aiming to retire on £1,500 a month (£18,000 a year), figures from Hargreaves Lansdown highlight just how stark the difference it makes if you start early.
If you were looking to top-up the state pension of around £8,000 a year with another £10,000, a 25-year-old retiring at age 68, would need to save £300 per month. For a 45-year-old retiring at age 66, that figure doubles to £625 per month and those leaving it to age 55, would require mammoth savings of £1,400 a month.
Once you have an idea of the figure you're aiming at, your next job is to maximise your tax-free allowances. You may have already made your mind up in the pensions versus ISAs debate, but most experts agree a combination of the two is the best way forward. Straightforward, tax-free and increasing in line with inflation every year, ISAs are an easy sell. If you had used all your ISA allowance every year since their creation in 1999 you would now have a savings pot worth nearly £54,000, earning over £9,000 in interest, according to Yorkshire Building Society and based on Bank of England average cash ISA rates.
"There is a much broader field of investment types than there were previously. ISA allowances were unheard of pre-PEP [pension equity plan] days," says Amanda Davidson from London-based adviser Baigrie Davies. "So there is encouragement for young people to save tax efficiently for their future which their parents didn't have."
Realistically though, pensions are the more obvious option for serious retirement savings, because contributions qualify for tax relief at your marginal rate of income tax (up to an annual allowance of £50,000). You could also benefit from employer contributions to your pension.
The number of people enrolled in workplace pensions may have fallen below 50 per cent for the first time, according to official statistics, but from October, workers aged 22 and over will be automatically enrolled into a scheme. This will mean paying a phased portion of your salary (rising from 1 per cent to 4 per cent by 2017) into a pension. You can opt out, but with the Government offering a further 1 per cent in tax relief and companies paying a minimum of 1 per cent of your salary into your pension, rising to 3 per cent by 2017, think carefully before doing so.
"A pension as a tax wrapper is probably one of the best vehicles to take advantage of. Sheltering long-term savings within a pension is the only way for most people to significantly reduce their tax bill," says Mr Clayden.
You can also arrange your own personal pension. Stakeholder pensions are popular because there are limits on annual management charges and no penalty fees if you need to stop or change payments. For ultimate control over what you invest in, a Sipp (self-invested personal pension) could be your best bet. These are far more flexible and enable you to invest in individual shares, funds and commodities but charges are higher and there may be more administrative fees.
It may even be worth considering peer-to-peer lending which is an important part of retirement planning for an increasing number of savers, particularly now that the banks are out of favour. Zopa was the first of its kind in the UK and returns are potentially impressive – Zopa lenders earned an average of 6.2 per cent over the past 12 months. These sites credit check borrowers on your behalf but you do pay fees and crucially, deposits are not covered by the Financial Services Compensation Scheme. If you lose your money, you don't get it back, so be cautious and keep it as a small part of an overall portfolio.
Over the long term, riskier asset classes such as commodities and emerging markets are great for diversifying your portfolio. These types of investment are inherently volatile but the potential for strong performance over many years is impressive. Gold is also seen as a useful haven when economic and political uncertainties take their toll. Then, as you near retirement it's time to move out of the riskier classes into more stable investments such as lower-risk bonds and cash. Despite recent experience and serious doubts that the working generation will see the capital growth that their parents enjoyed, many advisers still have faith in property.
"Those that disagree forget the first law of economics: supply and demand. In the UK we have finite supply and increasing demand. As lending frees up and it will eventually, prices will start to rise again," says Simon Webster of IFA Facts & Figures.
Another point worth remembering is that successful retirement planning is often as much to do with learning what to avoid, as it is actively picking the right vehicle. The Financial Services Authority (FSA) has recently published a list of potentially risky products which consumers could face over the next 18 months, including complex investments such as structured products, exchange-traded funds (ETFs), absolute return funds, traded life insurance policies and even packaged current accounts. The rule with any investment is to ensure you fully understand all the dangers and conditions before reaching for your wallet, and if in doubt seek independent financial advice.
Don't undo all your hard work by falling at the last hurdle. When you're ready to retire think carefully about your options; if you're taking out an annuity shop around for the best possible rate and if you have any health problems investigate whether you qualify for an enhanced annuity.
If you have lots of little pension pots you may want to consolidate them to get a better annuity offer and remember that even in retirement there are tax allowances that you need to maximise.
"The personal allowance rises from £7,475 to £9,940 for the 65s and over, meaning a couple can receive £19,880 of income tax-free," says Danny Cox from Hargreaves Lansdown. "To maximise this plan ahead and ensure pension savings are in both spouses names."
Expert view: Dan Clayden, Clayden Associates
"Getting retirement planning right is not that difficult. Failure is either down to people being unaware of these opportunities or inertia; younger people are more financial aware these days, but they need to be taking those lessons on board."
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