“Will I have enough money?” That’s the big question for many people approaching retirement without the benefit of a generous State or employer-guaranteed “final salary” pension.
The Big Picture
Lifetime financial planning doesn’t get ditched just because you have stopped working. It is quite the reverse; as you travel through retirement you will still need to monitor and manage three distinct requirements:
- A cash-based rainy day fund that will cover you against any emergencies and stop you liquidating other longer-term assets at the wrong time
- A portfolio of investments that will generate your main retirement income or supplement what you receive from the State, an existing annuity or property
- Funds earmarked and managed to meet specific retirement goals, such as travel, clearing debt and funding long-term care.
Naturally the bigger the pot you have accumulated at the point you want to stop work, the better your chances of achieving all three. So how can you boost it?
Personal pensions carry some risk, in so far as the size of the underlying funds is dependent on the performance of various parts of the markets. They are also inflexible in terms of when you can withdraw your capital, with the minimum age currently set at 55. However the flip-side is some generous tax reliefs, especially for higher rate taxpayers:
- Every 80p paid in by a basic rate taxpayer becomes £1 invested thanks to tax relief given by the government
- Every 60p paid in by a higher rate taxpayer can become £1 invested thanks to basic rate tax relief and the ability to claim further relief at 20%
- Money invested in a personal pension fund can grow free of income tax and capital gains tax whilst it is inside a wrapper such as a Self Invested Personal Pension (SIPP)
- Once you reach the minimum pension age of 55 you can withdraw up to 25% of the total fund tax-free.
Another tax-effective way to boost your pension contribution is through salary sacrifice. This is a way that an employee can get a pre-tax benefit at its post-tax cost. For example, if you agree with your employer that you will sacrifice £5,000 of your gross income so that it can be paid into a pension on our behalf, and your tax and national insurance contributions (NICs) would normally be £2,000, then in effect you give up £3,000 to get a £5,000 contribution paid by your employer. What’s more, since your employer will save NICs at the same time they may even be prepared to pay in a little bit more.
Increasing longevity means that many of us will need to work on well past 55 or 60. However, that brings a triple benefit from a pension perspective:
- Your assets have longer to grow
- You are not drawing on your retirement fund as quickly
- You can carry on contributing beyond the earliest retirement date.
Every year that you defer a pension you potentially boost its value. For example under the new rules, applicable to anyone retiring on or after 6th April 2016, you accrue 1% for every 9 weeks that you defer taking the full State pension. That equates to an uplift of 5.4% per year. Looking at private annuities, based on data from the FT, deferring retirement from age 55 to age 60 could result in around a 10% annual uplift in the value of a single life, level pension.
Consolidate small pension pots
Many of us build up multiple small pension pots as a result of changing jobs. One way you may be able to boost your buying power when it comes to buying an annuity is via pension consolidation whereby you sweep these little pots into a bigger one. This process will also ensure that you track down old pension pots that might otherwise get forgotten and will cut down your future administration. However, do take advice first as some older schemes will hit you with transfer charges and/or take away loyalty benefits which could reduce or even negate the overall benefits of a consolidation.
A word of warning
Whatever you decide to do to boost your retirement fund, avoid taking chances with your asset allocation in the run up to stopping work. The reason is that if you take short-term investment risk, by switching your money out of relatively safe assets, you open yourself up to the possibility of a big hit should the market dip; years of careful saving could then be cast off in the quest to find a quick boost via excessive risk-taking, which would be a bad idea.