When you are relatively young, you think that the subject of planning for your retirement is not often a top priority. You often think that Retirement will more often than not take care of itself. As you get older you begin to realise that retirement planning is something that you need to address.
There is little point in hoping that the state will provide you with a decent pension when you retire. It will not. At best, a state pension may provide you with a level of income that offers no more than basic financial support.
You may have an employer who will help you save. But if you are self-employed or work for a company that does not offer a pension scheme you will have to make your own arrangements.
The main rule on pensions is that the sooner you start saving the better off you will be in retirement. Pensions are complex and there are many choices you need to think about.
The basic state pension
Not long ago, many people assumed that when they retired the state would take care of them by paying them a pension adequate for their needs.
Today, nobody really believes that any more. And rightly so. The reality is that the state pension is a very basic safety net, providing only the bare minimum to live on.
To understand that, you need to know some basic facts:
- State pensions are currently paid at 61 for men and 60 for women.
- The applicable rates for the Old Age Pension are as follow: In the case of a married couple when both of them qualify – Lm 44.50 per couple, when only one partner qualifies – Lm 26.82 per week; In the case of other persons (single or widowed etc) – Lm 34.38 per week:
- Weekly means are deducted from the applicable rate. These rates are increased by an additional bonus of Lm 1.34 per week or, Lm 0.67 each in the case of a married couple when both qualify. A bonus of Lm 58.00 is also payable every six months.
Following the launch of the White Paper on Pensions Reform in November 2004, The Pension Working Group carried out an extensive national consultation including 39 sessions with various stakeholders and 17 sessions with the media.
Pension Proposals at a glance
• Retirement age 65, but 61 for manual workers
• Early retirement opt-out for 6 per cent less pension per year
• Two-thirds pension after 40 years of work
• Two-thirds pension to be based on best 10 years of last 20
• Lm 6,750 pension cap to be raised to Lm 9,000 for those aged 45 years or under
• Pension cap to be linked 70 per cent to wage index, 30 per cent to cost of living index
• Minimum pension guarantee to be set at Lm 2,421
The above proposals are still at consultative stage and are subject to change.
Pensions: have you left it too late?
It is a fact that most of us realise we need to save money for our retirement when it is already late in the day. Often, the dawning realisation that we need to do something comes only when we reach out 40s or 50s.
Is it too late?
Of course, not having saved enough in your 20s and 30s will limit the amount you receive when you stop work. But that does not mean it is too late at all.
The compelling reasons this is not the case include:
• For many of us, the period from when we were 30 to the late 40s is the period when we were busy bringing up a family and buying a property. By the time we reach 50, some of those pressures ought to be behind us.
• At the same time, we are probably at the height of our earning power. Many of us will have more money available now than we have had since we were in our 20s and happy to muddle along without responsibility. We can afford to think about ourselves for a bit.
The upshot of these two factors is that if you plan carefully, you can still make a sizeable dent in any gap that might have opened up between what you hope to live on at retirement and what you know is actually there.
The fact is: compounding still works over 10 or 15 years, albeit slightly less effectively. If you are putting more money into a pension in that time than you might have been able to when you were 35, you can overcome much of that deficit.
For example, Lm 300 a month invested in a pension at growth rates of 5% for 10 years will build a pension pot of Lm 47,500. That would add another Lm 50 to Lm 60 a week or so to your retirement income at 65.
What if I’m 45 and I still have kids to get through university?
If you are in mid-life and still have children to worry about and a mortgage to finish paying for, the solution here is to start the kind of pension where you initially pay, say, Lm 20- Lm 50 a month into a scheme. Money you won’t notice, all being well.
As your children work their way through the education system, you gradually increase payments until they become more and more significant. There are pension funds where you can agree a certain annual increase in contributions of, say, 4%.
Within five years you will be paying 20% more than when you started. And at that point, with the kids finally off your back you can finally start saving in earnest.
How much do you need when you retire? Eight steps to working it out
We are always told we should save for our retirement. But how much do we really need?
Many financial advisers tend to give their clients a rough-and-ready figure of between half and two thirds of current take-home income in order to maintain a very similar lifestyle to the one you presently enjoy.
Here are nine steps to help you do that.
1) Assume an ideal income, after tax that would allow you to pay all your bills, including council tax. Your current income (combined with your spouse’s income if you are in a relationship) is a useful start.
2) By the time you retire, you should no longer have to pay monthly mortgage costs or offer financial support to your children. So deduct those costs.
3) Take off the monthly cost of work related expenses, work clothes and dry-cleaning bills, the takeaway lunches and canteen coffees etc.
4) Deduct the amount you currently save into a pension or other saving scheme.
5) Deduct the value of any basic state pension you may be entitled to at age 61. Note that if you intend to retire earlier, you will have to make up this difference.
6) Deduct the value of any investments you have already set aside, such as company share saving schemes or other lump sums (maturing endowment policies) you might have – as long as they are not earmarked for any immediate spending needs. Assume 3.5% as a rough income from these sums: this is a relatively safe amount that should not put your capital at risk.
7) Calculate the pensions or investments you have so far saved into. Then deduct this amount from your monthly needs.
8) If you are planning to “downsize” - moving to a smaller/cheaper property and using the spare capital for income - calculate roughly the amount of equity you hope to release by such a step
The above calculations should give you a rough idea of your monthly or annual “savings gap”.
Obviously, if you were planning to stop work before you reach 61, you will also need to take into account that larger gap before your various state and any other occupational pensions actually kick in.
What you then do is work out how much you need to save each month to achieve that annual target income.
Picking the right pension
The changes in working pattern include more people working part-time or on short-term contracts, rather than leaving school and working with one employer for the whole of their working lives.
A new generation of pension plans has sprung up to meet the demands of new working styles. Which will be the right pension for you? The following is a guide to the different elements of a pension plan; understanding some pension details will help you enormously in picking the right plan for your circumstances.
Working patterns
Many employers are now encouraging people to make their own pension arrangements. The self-employed have always needed to make their own pension contributions, and have had to take account of fluctuating earnings. More women are looking to build a pension in their own right. They want pensions that allow for periods of non-payment should they take a break from work to have children.
These changes have been hastened by increasing life expectancies and a transfer of responsibility to individuals to make more provision for retirement as the strain on the state of providing pension benefits grows.
Fortunately, most insurance companies and investment houses now offer pension products that can cope with changing circumstances during a normal working life. However, different companies will, of course, have different charges, and it is important that the charges should be established before deciding which company to invest in. Although a small initial difference may not look important, over the lifetime of a pension plan it can have a substantial effect on the amount that is finally paid out at retirement.
Contribution holidays - allowing you to take a break on your payments
It is important to ensure before starting the plan that you are acquiring a flexible pension. This will allow you to take contribution holidays and restart the plan at a later stage without paying any penalties. A truly flexible pension product will allow contributions to be stopped at any time for any reason without imposing an additional charge. Charges within the pension will, of course, continue, because the pension provider will carry on managing your assets. You should not be put off if a provider refers to making a pension 'paid up' as this may cover a temporary cessation of contributions. It is, however, worth checking with the provider to ensure that is what is actually meant.
Upfront charges
Unfortunately, there are still regular contribution plan that have large charges during the first few years. The problem with this type of arrangement is that if you stop contributions soon after starting, the amount of money that has actually been invested, and will eventually be used to buy pension benefits, can be small.
The reverse argument is that such companies usually apply larger 'allocation rates' the longer the contract is in force. Allocation rates are the amount of your premium that is actually invested, usually expressed as a percentage (for example, a 98% allocation rate means that 98% of your premium is used to buy units in a fund; the other 2% goes to the pension company).
If you are uncertain about your short-term future within an organisation and your ability to maintain the pension contributions, you should check how much of your money is actually being invested during the initial period.
Key questions to ask before taking out a personal pension
• can contributions be stopped without penalty?
• for how long can contributions be stopped before they either have to be restarted or the policy is paid up?
• if the policy is paid up, will there be any additional charges apart from the ongoing management and administration fees?
• if the plan is restarted are there any reinstatement charges?
Making single annual contributions
An alternative to paying regular contributions is to pay single contributions on an annual basis. The advantage of this is that the level of charges is reduced because each payment is treated as a single contribution. In addition you are not committing yourself to a regular payment, and you can pay one-off lump sums from funds built up elsewhere.
The drawback of the single contributions approach is that you cannot take advantage of the waiver of premium benefit that is offered with some regular contribution contracts. Waiver of premium benefit is effectively an insurance policy which guarantees payment if you are unable to continue contributions through ill health or disability.
You cannot insure ongoing contributions if you pay only single contributions. In these circumstances it is worth considering paying low annual or monthly contributions with which you feel comfortable, so that you can have a waiver of premium benefit. Towards the end of each tax year you contribute what you can afford as an extra single contribution to the existing plan. This approach applies to personal pensions and to stakeholder pensions.
Choosing the best policy
If you are consulting an independent financial adviser, that person should already be taking into account the need for flexibility. However, it is still important to find out the situation with regard to changes in the level of contributions in the first few years. If you think that the only change you may want to make is to increase the amount you pay early in the life of the plan, perhaps you should consider a plan that charges more initially, and gives a higher allocation rate later on. In these circumstances you may end up with a better pension benefit than you would from those plans which offer greater flexibility initially.
On the other hand, if you feel uncertain about your continued occupation, or feel you may move on to a new job in the near future, then you should have the more flexible plan and just accept that perhaps the final benefits may not be as high.
Performance of a pension plan
It is worth bearing in mind the overall performance to date of the company with which you are dealing. However, remember that past performance is not a guarantee of future returns