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Most people I speak to are between age 40 and 60 and want to start working out when they can retire. This often involves me gathering their pension details from a few previous employers and then telling them the harsh truth, that it isn’t much and they are going to have to go without for a few years, so that they can afford to retire.
How does this Happen?
There are normally two reasons I often find, as to why someone hasn’t built up the pension they would expect:
- They only ever paid in the minimum contributions.
- They never looked at how their pension was invested, and it performed poorly.
This is not at all those people’s faults. It is a fair assumption to think that your pension is going to support you and every day people do not have the knowledge to make the decision early. I often rattle on about number two, which is the goal of trying to beat the growth rates that I am about to use for some examples, so today I will focus purely on point one and contribution levels.
The Facts & Figures – What is a good pension contribution level?
The point of all workplace and employer pensions is to be a baseline of contributions and people often believe that, if they pay in the base 8% a year, they will have a decent sum in retirement. This is sadly not often true and though it can cover some bills, the resulting pension would not afford them the standard of living that they would like.
This is best shown by an example. A 20-year-old who earns £30,000 a year, that goes up with inflationuntil they are 67. Their inflation adjusted pension (meaning in today’s money terms) would be £287,063, under mid growth rate assumptions, which could provide an estimated pension of £11,483 per annum.
A lot of words there but essentially it means that he would be projected to get a pension equivalent to £11,483 per annum, in today’s terms. So, forget your mortgage payment (assuming you fully own your house by that point) and that is what you will have to live off, for the rest of your life and you could live a very long time.
By simply increasing their contributions to 12%, that gives them £17,224 per year, under the same assumptions. This is not the ‘recommended’ contribution level but shows the impact that increased contributions can have on your lifestyle in later life. The point of what we do is to have an early conversation, come up with projections and take early action to ensure you are not left clambering in later life to pump your pension up.
Why Start Early? – Compounding
Compounding in investing, is the exponential impact on investments, as growth is then repeatedly earned on the gains already made in previous years. In basic terms, the longer you leave something invested and achieving gains, the greater the gains will be over the long term.
Below shows the projected value of a person’s pension at age 67, if they started contributing £10,000 per annum from various ages, under the same growth and inflation assumptions as before:
From age 60 – £80,023
From age 50 – £237,102 – 296% more than from age 60
From age 40 – £459,795 – 195% more than from age 50
From age 30 – £769,951 – 167% more than from age 40
From age 20 – £1,196,094 – 142% more than from age 30
This shows the power of compounding and why the earlier you make contributions, the greater your eventual pension is projected to be.
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A pension is a long term investment. The fund value may fluctuate and can go down. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
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