Published on August 5th, 2015 | by Pete0
How to Save For Your Pension – Setting Saving Targets
For any frugal person, pensions are an important issues, although perhaps not the most exciting. But since the guys kindly agreed to let me write a guest post for them so long as it was useful, I thought I would try to tackle the topic with a few handy tips:
This is pretty basic, but it’s a point that is always worth repeating. If you don’t already have a pension, no matter how old you are now is the time to start investing, simply because money invested now will grow so much more than the money you invest in 20 years’ time.
The government’s new budget this year actually puts a limit on how much you can invest each year before you pay tax on it. It’s a high limit, but who knows what might happen in the future. So the point is that the mentality “I will invest loads when I’m earning more” is flawed.
Here’s a recent blog post about the latest budget and how it affects pensions.
Plan For What You Need
Pensions don’t have to be a scary proposition. In fact, they become a lot less of a mystery when you actually start to plan what you might need. If you are in your 20s it might be hard to envision your life at 60, but try to figure out what your life might be like:
• You have paid off your mortgage
• You don’t have a job to travel to
• You want to travel lots and eat nice food
• Your kids are financially independent
Some things are hard to predict, but if you can get at least an idea of what your costs might be, you can start to think about how much you need to save to produce that amount of income.
How Much To Save?
Once you know what you need you can run some figures through an annuity calculator (here’s a useful one) to get a ballpark figure for what you need to save.
You might not actually use an annuity when you retire, there are certainly other options (investing in property for instance) and you can withdraw a lump sum tax free when you do retire. But an annuity calculator is a handy way to convert your monthly requirements into a nest egg goal.
As an example:
If you want a monthly retirement income of £1,750 (inflation linked) and you plan to retire at 65 and are reasonably healthy, you might need a pension pot of around £500,000.
Adjust For Inflation
Ok, so you know that figure you just worked out? Well the bad news is that that is what you would need if you were buying your annuity right now!
If you are 45, you won’t be buying your annuity for another 20 years. And in 20 years’ time £500,00 won’t be worth what it’s worth now. In fact, if inflation averages 3.5%, £500,000 now is the same as £1M in 20 years!
So the next step is to figure out what your true savings target is. Again, there are loads of inflation calculators online, so just put in your target from the previous step and however many years it will be before you retire.
Create Your Savings Plan
Hopefully now you know have an idea of what you need to save. If you’re still young, the good news is that you have plenty of time. So let’s figure out what you need to save each month in order to reach your goals.
There are plenty of handy investment calculators online. Here’s a very simple calculator that can give you an indication of your monthly target assuming a given rate return on what you save.
So using our numbers, if you plan to retire in 40 years, you don’t currently have any savings and assuming a 5% annual return, you would need to save around £700 per month.
So there you have it, if you follow each step above, you can work out what you need to start saving right now in order to reach your goals. That goal might seem high now, but if you start working towards it, it will become habit, and as your income increases you can save even more.
The next step is to create a budget of your own and start finding ways to save money day to day. And for that I will refer you to the rest of this site. Enjoy!