What do you need to save for retirement?

If you’ve joined your workplace pension or you’re self-employed and you’ve set up a private pension, how much should you save for your pension each month? What do you need to retire on a decent pension?

How much do you want to retire on?

You can only answer the question of how much to save each month if you know how much you want to retire on. Some women will be happy with £10,000 a year, others won’t be happy on £40,000.

A general rule of thumb is to aim for two thirds of your salary. But, if you still have to pay rent, that may not be enough. While if you’ve paid off your mortgage, you may not need that much.

What the state pension will pay

There may be further changes to the state pension before you or I retire. There have been some big changes in the last decade and there’s certainly no guarantee that politicians won’t change it all again.

At the moment, most women reaching state pension age over the next 20 or so years will have built up their state pension under two systems. They will have paid National Insurance towards their state pension under the system that existed until April 5^th 2016, and the rest under the system that came in on April 6^th 2016.

As a very rough rule of thumb, if you’re entitled to the maximum amount of state pension under the new system, you’d receive £164.35 a week at today’s rates (2020 – 2021), which works out at £8,546.20 a year.

SAVVY TIP: If you’ve been contracted out of National Insurance, you’ll receive some of that amount from your workplace pension instead of your state pension.

How much pension you may need

Figures from the Office for National Statistics show that the average retired person spends around £21,000 a year. If you assume you’ll need the same, then you’ll need to generate an income of around £12,500 a year from your workplace or private pensions. If you add this to £8,500 a year, which is the maximum you may get from your state pension, you’ll have £21,000 a year in total.

Another way of looking at it is to take the current average earnings figure, which is £28,600 a year, and aim for two thirds of that. This would be approximately £19,100 a year.

What do you need to save for retirement?

The amount you need to set aside each month will depend on three key factors:

How old you are when you start saving for your retirement
Whether you are in an employer’s pension scheme, where your employer has to pay into it for you, or your own pension scheme, where you alone make the contributions
The type of pension scheme you are in. If it’s a final salary workplace pension, your employer promises to pay you a certain amount when you retire. If it’s a ‘defined contribution’ pension, how much you get at retirement will depend on how well the funds you’ve invested in perform.

SAVVY TIP: If you’re in this type of pension, the income you get at retirement will also depend on what you do with your pension money – whether you invest it, leave it where it is, take it out and stick it in a bank account etc etc.

How much you need to save each month?

I’ve used the Money Advice Service calculator to work out how much someone might need to save at different ages. I’ve assumed in each case that you’re earning £28,600 a year, which is the UK average income. I’ve also assumed that you will not retire until state pension age. Your employer may pay more into your pension than I’ve assumed – and some employers are quite generous.

If you start saving at age 25: If you’re employed, you and your employer would need to pay in 16% of your salary between you. If we assume that your employer pays in 4% of your salary, you’d need to pay the other 12% of your salary. That means you’d be paying £286 a month into your pension. If you work for yourself, you’d have to pay in that 16% yourself, which works out at £4,576 a year or £381 a month. This would generate an income of around £19,100 a year from the age of 68, if you’re entitled to the full state pension of around £8,500.
If you start saving at age 35: If you’re employed, you and your employer would need to pay in 22% of your salary between you. If we assume that your employer pays in 4% of your salary, you’d need to pay the other 18% of your salary. That means you’d be paying £430 a month into your pension. If you work for yourself, you’d have to pay in that 22% yourself, which works out at £6,292 a year or £524 a month. This would generate an income of around £19,100 a year from the age of 68, if you’re entitled to the full state pension of around £8,500.
If you start saving at age 45: If you’re employed, you and your employer would need to pay in 36% of your salary between you. If we assume that your employer pays in 4% of your salary, you’d need to pay the other 32% of your salary (eek!). That means you’d be paying £760 a month into your pension. If you work for yourself, you’d have to pay in that 36% yourself, which works out at £10,296 a year or £858 a month. This would generate an income of around £19,100 a year from the age of 67, if you’re entitled to the full state pension of around £8,500.

What I’ve assumed: I’ve used the Money Advice Service pension calculator, which assumes that you will increase your pension contributions by 2.5% a year, as your salary increases. It also assumes that your pension charges 0.75% a year, and that the money you’ve invested grows by 5% a year. However, your pot may grow by more or less than this. For example, over the last ten years, stock market returns have been around 10%, before charges. The calculator also assumes that inflation is 2.5% a year. Finally, the calculator assumes that you buy an annuity with your pension pot to provide a guaranteed income for life. Most people don’t do this anymore, but it’s useful to look at how much you’d get from an annuity.