Written by Tobie van Heerden, CEO, 10X Investments
Statistics show that those who invest early reap greater financial rewards. Building your wealth doesn’t just mean investing in independent stocks and shares. It starts as early as forming great habits such as saving, and building pension contributions from your first paycheck.
UK pension funds have historically returned an average of 7% annually over the last five years. This means that if you contribute regularly to retirement savings over your working life, in the last few years leading up to retirement the annual growth on your accumulated savings will exceed your annual contributions.
This is all thanks to compounding, where compound interest on your savings builds up so that the return is applied not just to the initial amount you saved, but to any returns you reinvest.
First job finances
With rising inflation and the cost of living crisis, saving can seem a distant thought for many young people. However, saving early will speed up your financial growth and ease the burden of retirement.
In the UK companies must auto enrol employees over 22 years old into the company pension savings scheme. So without having to do anything, a portion of your income is automatically saved and often matched with additional financial contributions from your employer.
Workplace pensions are split into two markets; defined benefit and defined contribution. Defined benefit offers a retirement income based on salary and length of service. Whereas defined contribution is based on contributions made by the employer, employee and government through tax relief.
Beyond this, for those younger and the self-employed, knowing upfront how much you might need in future is a great way to plan for your retirement.
How much to save?
According to Moneyzine, to ensure that you are saving the right amount for retirement, you can use the following three key principles as a guide:
- Multiply your lifetime average yearly wage by 10
If, for example, your annual salary is £30,000 you will need to invest £300,000 over your lifetime to have a comfortable retirement.
However, if you are hoping to travel or do hobbies during retirement that you didn’t have a chance to do during your working years, you will need to multiply your annual salary by a higher figure.
To work out this amount, speak to a financial advisor who can help you determine what your final salary will be based on your age, and compound annual growth at inflation as a good indicator.
- Save half your age
Another option is to determine the age you started saving for retirement and divide that number by half. This will provide you with a percentage of your annual income that you need to save.
- Save 4%
If your annual salary is £30,000 divide this by 4% to give you an amount of £375,000 which is a comfortable retirement.
Balancing financial dependents whilst saving
During your 30s and early 40s you may face significant financial pressure with mortgage payments, children’s nursery costs and other commitments.
In this period women in particular are unfairly impacted financially if they temporarily leave the workforce to raise children or care for elderly parents. Pension contributions stop whilst on maternity leave and statutory maternity pay means a significant drop in income.
There might be temptation to reduce or pause payments to personal retirement annuities to ease the financial pressure. However, it is best to review and possibly reduce expenses elsewhere temporarily, to keep up with your savings plan.
Mid-life moves
While we are ambitiously climbing the corporate ladder many may be tempted to stop paying into corporate pensions either to relieve debt burdens or to have some extra cash flow. What many don’t realise is that stopping paying into your pension can hurt your overall pension outcome. Every time you stop paying into your pension, your savings pot suffers and you break the habit of saving on a regular basis. Instead, you should preserve retirement savings.
Combining pension pots into one place means many avoid losing pension money accumulated from earlier jobs, and you may get more choice of investments. By combining these pots, individuals can also benefit greater compound interest.
Enjoying retirement
By the time you are ready to retire most of your large debts such as a mortgage and car loan should be paid. However, retirees need to ensure that they can comfortably live after retirement and also need to consider that some expenses may increase, such as medical needs or even assisted living.
If you have invested in an annuity product that pays a monthly income you have to ensure that your drawdown rate is sufficient to maintain your lifestyle. This monthly income needs to cover your monthly expenses such as household bills, and allow for any other lifestyle factors you have made allowances for. Most importantly this rate needs to be sustainable to cover your entire retirement.
Sticking to a conservative drawdown rate decreases the risk of your funds running out prematurely. Research suggests a sustainable drawdown range is between 4-5% of your annuity value.
