Life is all about balance, whether it’s treating yourself to a pizza, a couple of drinks down the pub, or saving for your future. When you’ve got competing priorities, putting money aside for your retirement can be difficult, which is why you should know of an easy way to boost your savings by 25%.
Maximise your savings with tax relief
The government wants to encourage you to save for retirement, that’s why they offer tax relief on your pension contributions relative to your income tax bracket.
For example, if you’re charged the basic tax rate, you’ll only need to pay £8,000 into your pension for a £10,000 contribution. This tax incentive is a real draw to saving for your future, as it essentially gives your savings a 25% boost.
Imagine you’re paid £1,250 as a basic rate taxpayer. You pay £250 to the taxman (20%), and decide to put the remaining £1,000 straight in your pension.
The government tops up your contribution with the £250 they assume you paid in tax when you got paid, which is equivalent to 25% of your net savings.
If you’re a higher rate or additional rate taxpayer, you can claim back even more through your annual tax return.
This is equivalent to a higher rate taxpayer paying £6,000 for a £10,000 contribution and an additional rate taxpayer paying just £5,500 – although the additional relief is reflected in your tax band and isn’t process like your basic rate tax relief.
Income tax in retirement
There are other tax incentives to saving in a personal pension. Once you get to the age of 55, you can withdraw 25% as a lump sum tax free. You’re then charged income tax on the rest.
In retirement you won’t be earning as much as you did in employment, and you might slip from the higher rate tax band to basic. This means that whilst you got 40% tax relief on your pension contributions, you’ll only pay 20% in income tax when you draw from your savings in retirement.
If you don’t want to take a lump sum, you can get a quarter of each withdrawal tax free, and pay income tax on the remainder.
What are your retirement goals?
The generous tax incentives make saving in a personal pension attractive, but it can be difficult knowing how to make your money work harder for you to secure your financial wellness in the future.
Life is personal, which means the way you save should be too. We all have different retirement dreams, whether its fishing in the Highlands, knitting clothes for your grandchildren, or travelling the world.
Understanding your investor profile is one of the first steps to achieving your financial goals. Your investor profile acts as your investor DNA by taking what your saving for, when you’ll want your money and your financial background, and using this to influence what you invest in.
Your portfolio should reflect your investor profile to get you a step closer to your financial goals.
How much will I need for retirement?
It’s generally thought that you can maintain your standard of living when you retire with two-thirds of your final salary – you won’t have to pay for commuting, work clothes, you’ll probably have paid off the mortgage and your children will hopefully be independent by then.
That’s around £26,000 a year if you want to comfortably afford the essentials and a few luxuries along the way – you’ll be able to eat out and afford a European getaway every six months the research from consumer research group Which? shows.
If you want to have an income of £26,000 a year gross, and assuming you will have no state pension income, you’re going to need a pension pot worth a minimum of £520,000.
The logic behind this is that from a balanced and diversified portfolio, it’s reasonable to expect an average annualised return of around 5% over the long term. Assuming this is your return, if you withdraw up to the same 5% each year, you’ll never deplete the nominal value of your pension over time.
If you’ve been planning to travel more during your retirement and want to treat yourself to a new car every five years, you’re going to need around £39,000 a year. Remember, as you get older your priorities will change, and you’ll probably have to swap jet-setting for better life insurance.
For an annual income of £39,000, you’ll need at least £780,000 when you retire if you want to withdraw 5%. If you’re a bit more conservative over your expected returns and want to withdraw 4% a year, you’ll need a pension pot worth at least £973,500.
When should I start saving for retirement?
The earlier you start the better. It’s as simple as that.
Not only will you have longer to build up your savings and have to sacrifice less of your monthly earnings, but you’ll also be able to benefit from compounding – one of the most powerful forces when investing.
This is when the returns you generate on your investments are reinvested and then earn their own returns and can make a real difference over the long term.
Ideally you’ll start saving as soon as you’re working, but it’s difficult to put money away for the future when you’ve got a low income. But the benefits of starting early are easy to see.
How much do I need to save for retirement?
A couple in their 20s who want to have an annual income of £26,000 during retirement will need to put away £131 a month, although this creeps up to £198 a month if you leave it to your 30s.
Leave it any later and the costs begin to get a bit more daunting. A couple in their 40s will have to ring-fence £338 a month, whilst those in their 50s will have to save £633 a month.
You’re going to need to be a bit more organised if you want to have £39,000 a year – otherwise you’re going to find a serious hole in your pocket trying to save for this goal later in life.
Couples will need to put away £342 every month in their 20s if they are after the retirement highlife, £424 a month in their 30s, £731 each in their 40s and a whopping £1,657 a month in their 50s.
You can use Moneyfarm’s Pension Calculator to help you work out how much you need to be saving a month to get the income you want in retirement, or start one of Moneyfarm’s regular investment plans.
Are there any limits to how much I can save in my pension?
There are limits to how much you can save towards your pension to ensure the scheme is as sustainable as possible. You can only put £40,000 or your annual salary, whichever is lower, into your pension each year.
If you find yourself maximising your pension contributions, it might be wise to look at other tax-efficient alternatives that are more flexible and can provide you with an income throughout retirement, like an ISA.
You can put up to £20,000 in your stocks and shares ISA each tax year, and any increase in the value of your investments or income can grow tax free for as long as it’s protected in the wrapper.
You can deposit and withdraw from your ISA throughout the year without this affecting your annual allowance, although it’s a case of use it or lose it, as you can’t roll the allowance over into the new tax year.