How much should I pay into my pension?
First published 12 September 2018 • Updated 22 January 2020
What is a good pension amount? Some advisers recommend that you save up 10 times your average working-life salary by the time you retire. So if your average salary is £30,000 you should aim for a pension pot of around £300,000.
Another top tip is that you should save 12.5 per cent of your monthly salary. So if your annual salary is £30,000 you would save £312.50 a month – which over 40 years at 4% growth could build a pension pot of over £300,000.
With a workplace pension this is even more achievable, if your employer matches your contributions. You would only need to pay in £125 per month (5 per cent of your salary) which your employer would double up to £250. Tax relief of 20 per cent then takes this up to the required £312.50.
Those are the quick ways to work out how much you should save. But for a clearer idea of how much pension pot you’ll need, use the following simple guide to retirement saving.
What’s my target income in retirement?
The first thing to pin down is your desired retirement income. How much do you need to live comfortably?
For a quick estimate, try the '50-70' rule. This suggests that you should aim for an annual income that is between 50 and 70 per cent of your working income. So if you earn £50,000 now, you will want to achieve somewhere between £25,000 and £35,000 a year.
If you want a more accurate figure, you’ll have to do a few sums.
Calculating your retirement income needs
- Start with your current monthly expenditure
- Deduct any regular costs that may no longer apply after retirement, such as
- mortgage repayments (if you expect to have paid off your mortgage by then)
- work travel costs
- pension contributions
- regular savings
- Make any additional deductions for reduced housekeeping costs (e.g. if you have children who will no longer live at home). A smaller household can mean lower bills for
- Think about any other savings you could make, such as
- running fewer / cheaper cars
- taking holidays at cheaper times
This will give you a new figure for the monthly income on which you could, in theory, live comfortable.
What extra money might I need in retirement?
In working out your target income, we’ve assumed your needs and spending stay roughly the same. In reality, that won’t be the case. You’ll want to indulge yourself now and then, and will continue to face one-off expenses. Additional costs might include:
- Luxury holidays
- Home repairs / improvements
- Dental / medical expenses
- Vet’s bills (if you have pets)
- Helping children financially
- Saving for care costs in later life
It’s therefore sensible to aim for a comfortable safety margin when saving for retirement, rather that just the bare minimum. This might mean a higher income, or just a larger pension pot (this depends on how you choose to take your pension, which we’ll come to in a minute).
Also, remember that the cost of living may have increased significantly by the time you retire. Typically, the cost of living doubles every 25 years, so work out what it might be by the time you retire (and also by the end of your retirement!).
How long will my retirement be?
To work out how much you need to save, you need an idea of how long your retirement could last. This means estimating:
- Your retirement age
- How long you will live
A typical retirement age might be 65. You may wish to retire sooner, but you’ll need to factor this into your calculations (as it means less time saving and also more time living off your pension). If you retire later than 65, you may not need to save as much (but will probably be able to save more!).
Lifespan is less easy to guess, but you can get a rough idea (based on your health and lifestyle) using a life expectancy calculator. Broadly, an average 40-year-old today who retires aged 65 could expect to live to 82 – meaning a 17-year retirement. Those who keep fit and have a healthier lifestyle could add 5 to 10 years to this. That’s good news for you, but it does mean you’ll need more savings.
How much state pension will I receive?
If you qualify for the full new state pension, you’ll receive £168.60 per week from your state pension age. This age is currently 65, but for those born after 5 April 1960 it is 66, rising to 67 for anyone born after 5 March 1961.
This works out as an income of £8,767 per year, guaranteed for life. The amount will also increase over time, so will maintain its buying power - and when inflation and/or wage growth is below 2.5 per cent it will actually outgrow both of them, thanks to the 'triple lock'. On its own it’s clearly not enough to live on, but may be vital in helping you achieve a sustainable retirement income from your private pension(s).
Do I have any final salary pensions?
Some workplace pensions are a special type known as final salary or defined benefit. These provide a guaranteed income for life, and are generally very good things to have. If you have one, or think you might, find out how much it will pay you and when the payments will start (your ‘pensionable age’).
Add this figure to your state pension to keep a running total of your guaranteed income.
Now you can start to work out how much more income you might need from other pension pots.
How big should my pension pot be?
Now you can ask, ‘What size pension pot do I need?’ You should now have the two most important figures to hand:
- Your preferred annual income in retirement
- Your guaranteed income in retirement
Deduct your guaranteed income from your preferred income to find the amount you’ll need to generate from other sources (e.g. your pension pots).
Example: Steve's pension pot
Steve has no final salary pensions, and expects to receive the full new state pension from the age of 68. He is aiming for a retirement income of £25,000. From 68 onwards he’ll need to make up £16,454 a year from his private pensions. If he retires at 65, then for three years he’ll need to find the full £25,000 himself.
Assuming Steve lives to the age of 85, how big would his pension pot have to be to generate that kind of income?
Suppose Steve has saved a pot of £250,000. His financial adviser finds him a drawdown scheme which achieves a steady 4 per cent growth. Steve draws £25,000 a year for three years, followed by £16,454 for each subsequent year (once he starts receiving his state pension). Assuming nothing else changes, the pot will run out towards the end of the 20th year.
This could be almost spot-on as far as Steve is concerned. However, this example depends on his pot growing by a steady 4 per cent. If growth is lower (particularly in the early years) or if Steve takes out more, his pot will run out much sooner. Furthermore, Steve may live to be a lot older than 85.
How much can I pay into my pension?
Up to now we’ve only asked ‘How much should I pay into my pension?’ – but the other big question, especially for higher earners, is how much you’re permitted to pay in.
There is an annual allowance (how much you can pay into your pension each year) and a lifetime allowance (how much you can pay into your pension in your lifetime) that both limit the amount you can save into pensions and still get tax relief. Find out about your pension allowances.
How much can I pay into my pension if unemployed?
Ordinarily, a person can’t pay more into pensions each year than they earn in salary. But what if you have no earnings, or earn very little? Fortunately, you can still pay in a reasonable amount and receive tax relief on it, provided you can find the money to do so (e.g. your spouse might give you the money, or you might have other savings).
If you earn less than £3,600 you can pay up to £2,880 a year into a personal pension (e.g. a stakeholder pension or a SIPP). This money benefits from tax relief to become £3,600 (and since you’re not actually paying tax, this is exceptionally good value). This is enough to build up a decent-sized pension pot – in 20 years you could have over £100,000, and in 30 you could have over £200,000.
How can I stop my pension from running out?
If you’d rather have the safeguard of a guaranteed income for life, you may prefer to buy an annuity with your pension pot rather than use a drawdown scheme. The advantage of an annuity is that it never runs out. The downside is that the annual income may be lower than with a drawdown scheme.
In the example above, what if Steve chose an annuity instead? At today’s best annuity rates, he could use his £250,000 pension pot to buy a guaranteed income of around £13,390 per year (over £3,000 less than his target amount). On the plus side, he would have more security if he were to live a very long time.
However, another option for Steve might be to buy an annuity with £100,000 of his pension pot (bringing an income of roughly £5,357) and drawing down the remaining £150,000 to achieve a total income of £25,000 a year. In this example (assuming 4 per cent growth on his drawdown scheme) his drawdown would again run out towards the end of the 20 years – but after that he would be left with a guaranteed income of £13,903 (his annuity + state pension) instead of just £8,546.
Can I use other sources of income in retirement?
If your pension pot isn’t enough to meet your needs – or if you ‘outlive’ it – then you may have to find other sources of retirement income. These might include:
If you can’t do any of these, or if you don’t own your own home, then you may find yourself completely reliant on the state pension if your private pension runs out.
Am I saving enough into my pension?
The first thing to do is find out how much is in your pension pots now. You may also have old pension pots from previous employments – track these down and ask your adviser about combining them into one pot (‘pension consolidation’).
Your pension provider should be able to give a projection of your expected pension pot at the age of 65 (or whenever you plan to retire). You can also ask a financial adviser to give you an independent forecast.
You can then discuss your retirement income needs with your adviser, who will be able to tell you if your projected pension pot will be large enough to meet them. If not, he or she can recommend an affordable increase in your monthly pension contributions.
Remember: every pension contribution you make benefits from at least 20 per cent tax relief, and if you have a workplace pension your employer also contributes to it – making it the single most efficient way to save money for your future.
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