The earlier you start saving, the more money you’ll have – and the longer your money will have to grow.
This compound growth can have a dramatic effect on the eventual size of your nest egg. For example, imagine you saved £5,000 a year for 20 years with a return of 5% a year. Your eventual fund would be worth almost £180,000 (actual returns may be lower or higher and are not guaranteed)*.
But if you had started saving 10 years earlier, the eventual sum would be more than £350,000, almost twice as much.
Think also about how much money you will need to retire on.
The independent Money Advice Service set up by the UK government says: “Some of the most generous pension schemes in the country aim to generate a retirement income equivalent to two thirds of salary. But most people’s pensions produce significantly less than this, so a good starting point for your calculations might be to aim for half of your current salary.”
Once you have decided on a target annual retirement income, you can use an online pension calculator, such as the one provided by the Money Advice Service to give you an idea of how much you will need to save.
*This does not take account of any costs and charges which will reduce the amount of returns.
Your main decision when starting to save is between cash – typically bank deposit accounts – and investments in shares and other assets.
Generally speaking, returns on cash tend to be lower but the risk that you could lose money is also lower.
Investments on the other hand, offer the possibility of higher returns but also a higher risk which means you could lose money at the hands of poor fund performance.
If you are saving over many decades for your retirement, investing in the stock market gives you a greater opportunity to get higher returns over the long term, although this is not guaranteed.
Most people save for retirement using a personal pension such as a self-invested personal pension (SIPP), a company pension scheme or an ISA (individual savings account).
Pension schemes usually invest in the stock market and assets such as bonds and property– although they can hold some cash as well.
With ISAs, they have significant tax advantages. You can choose a cash ISA – which is similar to a bank or building society savings account, – or a stocks-and-shares ISA, which can include shares, investment funds or certain other assets.
Money in a pension can only be accessed from age 55 under current rules. Withdrawals can be made from an ISA at any time, although fixed-rate cash ISAs may require your money to be left on deposit for a certain period.
At the moment, the most that can be saved into an ISA is £20,000 for the 2018/2019 tax year and this sum can be split between cash and shares.
There are also tax incentives attached to both pensions and ISAs.
Currently, any money you put into a pension gets basic-rate (20%) income tax relief. This means either that the contributions you make to a pension are deducted from your salary before you pay tax, or they are topped up: so for every £8 you put into your pension, you get £2 tax relief on top.
Higher- or top-rate taxpayers can claim extra relief through the self-assessment system when necessary.
Returns from ISAs are free of tax: so there is no income tax to pay on the interest from a cash ISA, and no capital-gains tax on the growth in a stocks-and-shares ISA. Tax of 10% is automatically deducted from any dividends paid on a stocks-and-shares ISA, but there is no further income tax to pay.
There may be a further incentive to pay into a pension scheme: company pensions often offer contributions from the employer to match those made by the employee.
When the government’s new auto-enrolment pension scheme is fully up and running in 2018, the vast majority of companies will have to offer a pension where the worker pays in 4% or more of their salary and the company pays at least 3%.
- Please bear in mind that tax treatment depends on your individual circumstances and tax incentives may change in the future.
Saving for the future is important, but think about using spare cash to clear expensive debts as well.
If you have borrowed on a credit card or overdraft you could be facing annual interest charges of 20% or more and it may make more sense to pay these debts off before you start saving into a pension.
Even if you have little or no personal pension provision, you should still be entitled to the State Pension – although there are no guarantees it will be around in anything like its current form in two or more decades’ time.
From 2016, a flat-rate state pension worth around £8,000 a year is being introduced. Would this be enough to provide a comfortable retirement for you?
Many people hope that rises in the value of their own properties will help fund retirement. However, this strategy can be risky: there is no guarantee house prices will always rise, and it is not simple to convert housing equity into cash. This could involve downsizing to a cheaper home or signing up for an equity release scheme, but both options can be expensive and may not be as profitable as expected if there is a housing-market downturn.
It is also equally important to think about how you will fund any future long-term care that you or a loved one may need. Options can be varied and often complicated, so it’s worth considering how you would pay for care at home or in a care home in retirement.
Once you have set up a long-term savings vehicle, you should check how it is performing on a regular basis – say, every year – to see whether it is on course to provide the income you need in retirement.
And if your earnings increase or you receive a windfall, consider paying more in.