Savers need to get started early if they have any hope of achieving a comfortable retirement, says Ian Cook, financial advisor at Quilter Cheviot.
With recent “wake-up call” figures from the Pensions and Lifetime Savings Association (PLSA) revealing a single person could need up to £800,000 for a comfortable retirement, a number that will swell with inflation, it is more important than ever for savers to understand how to take advantage of their pensions.
However, pension planning can be challenging, particularly for those who have not previously considered their savings. In the first part of a new series, Trustnet looks at the steps savers across different age brackets need to take to achieve a comfortable retirement, starting with 20-year-olds.
Cook explained pension planning is usually the last concern of the average 20-year-old who, despite having a lot to save for, is enjoying their “first brush with financial freedom and independence” and so has more immediate priorities such as nights out or holidays.
While this is understandable, Cook said it is a crucial mistake. “Your 20s are really when you need to do the most work on your savings,” he said.
Young savers’ “number one priority” should be to build themselves a cash ballast to draw on if an emergency, such as job loss, happens. This is a common recommendation among financial advisers. Last year Brown Shipley recommended investors should keep at least six months of their salaries in cash.
Once savers have this store of cash, the most important thing to do is to start saving often and early for retirement. “You need to think about automating an amount of money for your future self.”
One way young savers can do this is by taking full advantage of their workplace pension. “Very simply, if an employer pays a maximum match contribution of 8% in your portfolio, you should match it.”
While opting out may seem initially tempting, as it gives more money in a person’s pocket each month, Cook argued it was the wrong move. Although the PLSA report found the state pension was enough for a couple to have a minimal retirement on its own, he said it was unreliable and offers no protection to savers who may need to consider early retirement because of health reasons, for example.
An investor who contributed as little as £100 a month into a workplace pension at a 7% growth rate could end up with a pot of close to £380,000 over 45 years, close to half of the PLSA’s prediction of the pot needed for a single person to comfortably retire.
This is money that is taken directly from a paycheck and so is cash most savers “would not have noticed they had to begin with”, making it a relatively easy and stress-free way to prepare for retirement.
Savers who start thinking about their pensions for the first time at age 40, for example, “are already a bit too late”, he argued. The problem with not investing early is that as people get older, they need to save more money to make up for the years of contributions not made and supplement the growth they missed out on.
In a worst-case scenario, a 40-year-old may have to contribute at least four or five times as much as someone who started saving early. “For many people, I just do not think that kind of comfortable retirement is achievable if you start late.”
Additionally, while rising inflation means retirement will become more difficult, by starting early, young savers can approach their later years more flexibly.
“From a psychological standpoint, your future is uncertain at age 20”, he explained. A job you start your career in could become something you hate in later life but, if it pays well, people may have to keep working at it to achieve a comfortable retirement.
However, those who have started contributing early and have done most of the heavy lifting in their 20s could have the freedom to do something different later in life. This could cover anything from a career change to raising a family to travel or engaging in something vocational, a benefit later savers will not enjoy.
“It is easy for young people to think of pensions as something that’s for when you are old, but they aren't. A pension is just a name for a pot of money you will use later.”
Finally, once savers have started automating a regular contribution that they will not need for a long time, they can then start thinking about their medium-term goals, through individual savings accounts (ISAs).
For investors' three-to-five-year needs, Cook recommends some combination of stock and shares ISA and lifetime ISA, the former of which could significantly contribute to buying a house, a car or starting a family, which may not be as immediately important for younger savers.