How to avoid sleepwalking into a retirement shortfall
What’s a reasonable amount of money to save each month towards your retirement?
Some new research suggests a combined 12% employer and employee contribution as an adequate level of saving.
Saving for the future at that sort of level could be a hard pill to swallow, especially for cash-strapped millennials who experience several demands on their disposable income.
We’re not saving enough
As a nation, we don’t seem to be saving enough for the future.
The savings ratio – a measurement of the outgoings and incomings that affect households – has been falling sharply for more than a year.
According to the latest figures published by the Office for National Statistics (ONS), the savings ratio stood at 1.7% between January and March. It was down from 3.3% in the previous quarter.
New research from Scottish Widows, as part of their 13th annual Retirement Report, has found that 70% of 22-29 year olds are failing to save enough for retirement.
This is despite the relative success of pension auto-enrolment, which has resulted in 80% of people in this age group saving something into a pension.
According to Scottish Widows, the lack of retirement savings is putting at risk their ability to achieve their desired income of just over £23,000 a year in order to enjoy a comfortable retirement.
The report found that average contributions are £184 a month (including employer contributions), meaning those in their twenties can expect an annual pension of just £15,200 including the current State Pension.
A 30-year-old contributing the current minimum of 1% to their workplace pension (matched by their employer) will achieve an income in retirement of £9,734 each year.
And even when the minimum contributions rise to 8% (employee and employer combined) in 2019, they will only achieve an annual retirement income of £14,047. This is a shortfall of almost £9,000 on average expectations.
Since pension auto-enrolment was introduced, the opt-out rate has been reasonably low; it seems that this behavioural ‘nudge’, switching from an opt-in system to one where people need to opt-out, has achieved its desired result.
However, there is evidence that more people will begin to opt out of pension schemes as contributions increase through auto-escalation from April 2018.
When 22-29 year olds were asked if the planned increases would affect how they save, less than half committed to staying enrolled in the pension scheme.
The later you start the harder it gets
If someone starts saving into a pension at 25 years of age, they would need to put aside £293 each month to reach a £23,000 annual income.
Not starting to save until 35, monthly savings would need to jump to £443. At 45 this would be £724 a month.
For someone who left retirement saving to their 50s, they would need to put away £1,445 a month to enjoy a £23,000 annual pension.
We call this the ‘cost of delay’ and it occurs because the earlier you save for retirement, the greater opportunity that money has to enjoy compound growth.
Catherine Stewart, Retirement Expert at Scottish Widows, said:
“There is no doubt auto-enrolment has been a success in kick-starting the savings habit for millions – but it is not a silver bullet.
“Auto-enrolment may well be lulling people into a false sense of security that they are putting away enough for a comfortable retirement. For many, that is simply not the case, particularly given retirement is looking more expensive than ever.
“With one in every 12 private rental sector tenants now a pensioner, ‘Generation Rent’ is headed for a more expensive retirement than previous generations.
“While retirement may feel like a long time away for those in their 20s, it’s really important they start to think about it as soon as possible.”
Young people are maxed out
Despite the dangers of pensioner poverty, a little more than half of those in their 20s say they can’t afford to save for the long term because of competing financial priorities.
Those in their 20s are saddled with twice as much debt as other age groups, on average owing more than £20,000.
Almost four in ten have student loans eating into their monthly pay cheques, one in five have unpaid credit card bills and 15% have other loans to pay off.
Within the report, Scottish Widows suggests a combined 12% employer and employee contribution as an adequate level of saving.
How to avoid sleepwalking into a retirement shortfall
Here are a few suggestions from the Informed Choice team, which should help anyone saving for their retirement from sleepwalking into a shortfall.
1 – Start saving as early as you can
As the old Chinese proverb says;“The best time to plant a tree was 20 years ago. The second best time is now.”
It’s never too late to start saving for the future. Starting as early as you can is a great way to take advantage of time and compound returns, but starting later is still better than never starting at all.
2 – Regularly review your progress
Retirement planning isn’t something you can do once and then forget all about until that magic day you stop work.
Schedule a formal review of your progress at least once a year and adjust your savings rate to stay on track to meet your goals. Think of it a bit like flying a plane; you need to make regular, gradual adjustments to your course in order to arrive at the chosen destination.
3 – Align your investment strategy with your goals
When it comes to choosing the investments for your retirement plans, you might be tempted to stick with the default option.
Make sure the investments you pick are suitable for your retirement goals. How much risk do you need to take to meet your goals? Can you afford to take that level of risk?
4 – Retirement planning is about much more than pensions
A pension is only a tax-wrapper designed with retirement planning in mind. Successful retirement income strategies usually combine a mix of assets; pensions, ISAs, savings, investments, business ownership and property.
When you’re getting started, it makes real sense to keep things simple and stick to a pension as your preferred retirement savings vehicle, especially if your employer is contributing too. Over time, you might want to branch out a little and diversify.
5 – Make sure you clear debts too
Because retirement planning is holistic, it’s important to consider your overall financial position. Getting rid of any unsecured debts is an important step for two reasons; it will give you more to allocate each month towards the future and, when you get to retirement, less of your income will need to be spent on repaying debts.
This all starts with good budgeting and making sensible choices about how you allocate your monthly income. A good rule of thumb is the 50/30/20 approach. This sees 50% of your after-tax income allocated to ‘needs’, 30% to ‘wants’ and then 20% to saving for the future.