Author: Amy Duckworth, 16 November 2007.
Leading
independent financial adviser Alan Boswell & Company(ABCO) highlights the surprising fact that, for many people, the State will provide more towards their overall
pension than their
company pension scheme.
According to
ABCO, the problem is due to a massive shift from
final salary pensions to
money purchase schemes and the fact that average
pension contributions are simply too small. With employer contributions averaging 6.8% and employee contributions at about 3.6%, the total amount put into
pensions represents just over 10% of salaries. This is seen as highly unlikely to provide enough for a
pension to retire on.
Pension example:
Take a man of 40 who earns £50,000 a year and intends to retire at 65 with a
defined contribution (money purchase pension). In our example, inflation is set at 2.5%, while earnings grow at 3.5% a year. Investment growth (net of charges) is assumed to be 6% a year. The basic
state pension will grow in line with inflation until 2012 and then in line with average earnings (at least this is the plan).
Our "guinea pig" can expect to be earning £118,162 a year just before he retires and the
state pension could provide £16,502 a year (less than 14% of earnings) for a married couple; less for a single man.
If employee and employer together contribute 5% of his annual earnings to his
pension, each year, the
private pension will be just under £10,250 a year, assuming he wishes it to rise with inflation and to give his widow a 50% pension. This is
less than two thirds of the state pension.
If the contributions are 10%, his
pension will be doubled, but his total income will still be less than a third of what he was earning in the run-up to retirement. In fact, a contribution rate of more than 20% of earnings would be required every year, just to achieve a
pension of 50% of pre-retirement earnings.
Pension Planning Vital
The purpose of all these figures is simply to demonstrate how vitally important it is to take control of your
pension planning as early as possible. For someone of 30, the figures would be far less daunting. But the fact remains that, even for them, a relatively high proportion of income needs to be committed to
pension planning.
Of course, not all this needs to be within formal
pension arrangements, although there are tax benefits in doing so, since contributions attract tax relief at the highest marginal rate paid and a quarter of the fund can be taken as tax free cash after age 50 (rising to 55 in April 2011). While there are other ways to save for retirement, only
pensions carry the tax incentive.
Thanks to changes made in April 2006, everyone can now contribute to a
personal pension in addition to - and quite separately from - their company pension scheme. This is even the case if it is one of the highly-prized defined benefit (final salary) types. This gives considerable flexibility to everyone and allows a completely different
investment strategy to be followed (including using "self invested" pensions) if required.
Alan Boswell Insurance Brokers Limited, Alan Boswell Insurance Services Limited and Alan Boswell & Company Limited are authorised and regulated by the
Financial Services Authority.
