Pensions - How much is enough?
Over the last two decades the pension barometer has swung away from the civil servant “final salary” style of scheme to the now more common “money purchase” scheme.
In simple terms (with the aid of various tax relief concessions) a money purchase pension scheme builds up a fund of money to be used at retirement to buy a pension.
I am asked by clients time and time again “how big does my pot need to be to purchase a meaningful pension”? This is almost an impossible question to answer as one person’s “meaningful” pension is another person’s “meagre” pension.
However, in an effort to provide at least basic guidance I need to look no further than the current “old age pension”. If I stick with the basic version and ignore extra payments into the State Second Pension (“S2P”, used to be known as the State Earnings Related Pension Scheme (SERPS) we can at least create some sort of “benchmark.
Currently the normal state retirement date for pensions is 65 and if I focus on a male life with a spouse two years younger we can at least calculate some meaningful figures.
The current basic old age pension is in the region of £90 per week (£4,680 per annum) but it does, in pension terms, contain some very special features.
The first of these is that it normally increases each year and, of course, there is always debate about by how much! For this discussion I will assume Retail Prices Index. The Pension also includes a 50% widow’s benefit.
If we assume that both the male and female are in standard normal health I can search the current open market and find the best commercial terms available in order to arrive back at the lump sum needed to purchase similar benefits in the commercial world.
In order to purchase a pension equivalent to the current state old age pension (in the region of £90 a week), you would need a lump sum of £100,500. The national average for independent pension savings is only £50,000 per person. Add to that the fact that the majority of people that have small pension funds tend to want to take the 25% tax free allowance, reducing the average pot from £50,000 to £37,500!
Currently, the average earnings for males in the Colchester area is in the region of £24,750 p.a. Therefore, if Mr “Average” wants to retire on a meaningful pension –a minimum of two thirds of a pre-retirement salary – it needs to provide £356 per week.
In other words, to provide the balance of £266 per week you will need your own lump sum of approximately £315,000 from your own independent savings. Even if you take a mixture of pensions, ISA investments and possibly an investment property, it is a huge extra sum.
In order to arrive at some meaningful conclusions you need to check with your independent financial adviser as to where you are on the “pension ladder” and take into account your current arrangements, anticipated future contributions and any changes that you may need to make.
Income in retirement is not just about pensions and obviously other savings/investments can be taken into the calculation, but at the end of the day the size of pot available should be sufficiently large enough to keep both husband and wife in sufficient funds to really enjoy – what I am told - are the best years of your life!
Remember this £315,000 is based on a current salary of £24,750 p.a. – in other words the equivalent to 12 years salary. However, with the chances of a man having already reached age 65 and a spouse of 63, where at least one of them being alive 15 years later being quoted at 94% you begin to see the size of the problem.
With a 57% chance of a husband or wife reaching age 90, and even a 25% chance of reaching 95, you can see why the question – “how much is enough?” – is asked.