There probably isn’t a week that goes by where there isn’t something about pensions in the press, which is great news if you are an independent financial advisory firm like us, but with the new freedom and choices in pensions merely months away, there is now even more to think about and consider when it comes to retirement choices.
Despite the extensive media coverage, according to a survey by Prudential, 27% of the over 55s they approached were still not aware of the changes to pensions announced in the March budget and further research by Fidelity Worldwide Investment found that retirees are expecting to live on an average of around £11,232 per annum and they expect this figure to increase over the next five years. Women were more conservative than men in estimating their income needs in retirement, suggesting that they could live on £9,708 per annum, whereas men thought that £12,420 is required.
If we consider that the maximum state pension is currently £5,881.20 per annum, we can already see that there is a gap between expectations and the income that the state will provide, so in many cases this will need to be filled by savings of some sort. Add to this that people are generally living longer, it’s clear that many retirees will need to rely on a fairly substantial pot of money to satisfactorily maintain their standard of living.
Even if we look forward and take into account the new State Pension (due to be introduced in April 2016 and which the Government states will be no less than £148.40 per week), this still only takes the annual amount from this source to £7,716.80, which would still be some way short of many people’s requirements.
Prudential has come up with a retirement calculator that helps show the level of income you could get for a given level of input, based upon a number of assumptions. It is merely a guide though and the results can’t be relied upon as a personal illustration or a definitive statement, but let’s take a look at some examples.
Our first subject is a male aged 40 with earnings of £50,000 and retiring at age 68. He requires an annual retirement income of £12,420 (in line with Fidelity’s research) and has no existing pension provision, but is commencing his own contributions at 5% of his salary per annum and his employer will also make a 3% contribution to meet with auto enrolment requirements.
According to Prudential’s calculator and based on these contributions, he is projected to receive an annual income of £11,720 at age 68. This won’t quite be enough, but let’s look at the assumptions being made.
A full state pension for a single person of £113.10 per week will be taken at state pension age (based upon current levels) and the pension contributions made will achieve an annual investment growth rate of 5% before inflation. An ongoing annual fund management charge of 1% will apply. The pension in payment is assumed to be a single life, conventional level annuity, adjusted for inflation at an annual rate of 2.5%. A 25% tax free lump sum of £33,200 will be taken prior to purchase of the annuity. Of course, an increase to the state pension may bridge the shortfall, but not by much.
So, what if our subject is a 40 year old female and requires the more conservative income of £9,708 per annum? As annuity rates are the same for both men and women the outputs would be the same, but as the expectation of income is lower, there is now an excess, making it more financially comfortable to live in retirement.
In this instance our subject is a female aged 20, also retiring at age 68. The same percentages of income will be taken as pension contributions and all other assumptions on rates and charges remain unchanged, but to keep things realistic let’s reduce her earnings to £20,000 (there aren’t many 20 year olds earning £50,000 per annum). The level of contributions going in will be correspondingly lower, but because of the increased time to retirement, the projected annual income equates to £10,340, plus tax free cash of £26,700.
The examples above serve to demonstrate the importance of not only having a realistic expectation of income in retirement, but additionally, to fund a reasonable standard of living most people cannot afford to rely upon the basic state pension alone, so extra savings are often required.
If you need advice in relation to your own financial arrangements please contact us to discuss your needs.
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