Will your pension see you right?

The problem is, it says, that average contributions are simply too small. With employer contributions averaging 6.8% and employee contributions at about 3.6%, the total amount put in represents just over 10% of salaries. This is seen as highly unlikely to provide enough to retire on.

We looked at some specimen figures, as follows.

Take a man of 40 who earns £50,000 a year and intents to retire at 65 with a defined contribution (money purchase pension). In our example, inflation is set at 2.5%, while earnings grow at 3.5% a year. Investment growth (net of charges) is assumed to be 6% a year. The basic state pension will grow in line with inflation until 2012 and then in line with average earnings (at least this is the plan).

Our “guinea pig” can expect to be earning £118,162 a year just before he retires and the state pension could provide £16,502 a year (less than 14% of earnings) for a married couple; less for a single man.

If employee and employer together contribute 5% of his annual earnings into his pension, each year, the private pension will be just under £10,250 a year, assuming he wishes the pension to rise with inflation and to give his widow a 50% pension; less than two thirds of the state pension. If the contributions are 10%, his pension will be double, but his total income will still be less than a third of what he was earning in the run-up to retirement. In fact, a contribution rate of more than 20% of earnings would be required every year, just to achieve a pension of 50% of pre-retirement earnings.

The purpose of all these figures is simply to demonstrate how vitally important it is to take control of your pension planning as early as possible. For someone of 30, the figures would be far less daunting. But the fact remains that, even for them, a relatively high proportion of income needs to be committed to pension planning.

Of course, not all this needs to be within formal pension arrangements, although there are tax benefits in doing so, since contributions attract tax relief at the highest marginal rate paid and a quarter of the fund can be taken as tax free cash after age 50 (rising to 55 in April 2011). Other investment options can offer tax benefits too, such as Individual Savings Accounts (ISAs) and some of the more “high-risk” investments utilising what is called “sideways relief”, which involves offsetting “losses” in selected investments against current and past tax liabilities. (These are highly complex and require specific and specialised advice.)

Returning to the mainstream of investments, it is important to be aware that, thanks to changes made in April 2006, everyone can now contribute to a personal pension in addition to – and quite separately from – their company pension scheme, even if it is one of the highly-prized defined benefit (final salary) types. This gives considerable flexibility to everyone and allows a completely different investment strategy to be followed (including using “self invested” pensions) if required.

If you require any further information about the services that we provide or would like to review your financial planning position, please contact us

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