At 40 retirement may seem like a long way off, but to be sure of a level of income when you retire that will allow you to enjoy life to the full and do what you want to do, you need to start saving early!
Once you’ve decided to start saving for retirement, you need to choose how to do so. Pensions have a number of important advantages that will make your savings grow more rapidly than might otherwise be the case.
A pension is basically a long-term savings plan with tax relief – your regular contributions are invested so that they grow throughout your career and then provide you with an income in retirement. Generally, you can access the money in your pension pot from the age of 55.
How Tax Relief Tops Up Your Pension Pot
Once your income is over a certain level, the government takes tax from your earnings. You can see this on your payslip. If you put money into a personal pension scheme, it qualifies for tax relief. This means that as well as the money you’re putting in, some of your money that would have gone to the government as tax now goes into your pension pot instead. The government will still put tax relief into your pension pot, even if your income is too low to pay tax.
Top-Ups From Employers
To help people save more for their retirement, employers are gradually being required to enrol their workers into a workplace pension scheme if they are not already in one. This is called ‘automatic enrolment’ and is gradually being made compulsory for all employers.
If your work gives you access to a pension that your employer will pay into, then unless you really can’t afford to contribute or your priority is dealing with unmanageable debt, staying out is like turning down the offer of a pay rise.
Of course, if your employer will contribute to your pension regardless of whether you pay into it, then you should join the scheme whatever your financial circumstances!
For more on automatic enrolment or workplace pensions visit GOV.UK here.
A Tax-Free Lump Sum When You Retire
You can usually take up to a quarter of your pension savings as a tax-free lump sum. If you have built up your own pension pot in a defined contribution scheme (as opposed to a salary-related pension scheme) you can then use the rest of your pot as you choose from age 55 onwards.
How To Start A Pension
Your employer’s pension scheme is always a good starting point. If your firm is already subject to the auto-enrolment rules your employer is required to pay in, unless you have opted out of the scheme. Saving into a pension is tax-free as contributions are deducted straight from your wages so coupled with any employer contributions, this means that you can accumulate a much bigger pot than you could get when investing in normal savings or investment products – even ISAs!
You can contribute up to 100% of your earnings into a pension tax-free (subject to the annual allowance of £40,000) but any savings above this are taxed.
Save as much as you possibly can into your pension. Taking a detailed look at your current finances and budget can really help here. Review your outgoings even your mortgage (even if it doesn’t cost a great deal) to make sure you’re repaying debts as cheaply as you can. Reviewing your insurance and utilities can save money as well.
For example, even if you can only free up £50 per month, an extra £50 into your pension would be an extra £16,200 you could contribute to your pension over the next 27 years. That’s before any investment gains or tax relief you may qualify for over that period!
Could Your Home Fund Your Retirement?
More and more of us who are approaching retirement are considering using property to help fund life after work. Partly, this is due to spectacular gains in property prices over the past few decades, meaning many homeowners are sitting on pots of cash in the bricks and mortar of their own homes (if we use the Halifax House Price Index as a guide, the average house price 27 years ago, in February 1988, was £50,757. In February 2015, this average has skyrocketed by nearly 400%, to £190,157!).
However, although property has performed well over the past 27 years, this is no guarantee that it will perform well over the next 27.
When it comes to using your home to fund your retirement, you have two options open to you: downsize to a smaller house, bungalow or flat, or take out a lifetime mortgage (otherwise known as an equity release scheme) on your existing house.
Both of these options could seriously impact any inheritance you leave behind, so think carefully about this decision and involve your children as well as your financial adviser.
Selling up and moving to a smaller property can free up tens, even hundreds of thousands of pounds for your retirement. If you own a house worth £300,000 for instance, and you downsize to a bungalow worth £150,000 you’ve freed £150,000 to put towards your retirement fund. Not only does this option release money, but it can also mean that you’re in a property that’s easier to move around in, and more economical to run – not to mention clean – than the family home where you currently reside.
However, downsizing will depend on you owning a property big enough to downsize from, as well as your own feelings – you may not want to move from the home you raised your children in. If these are concerns you have, maybe a lifetime mortgage, or equity release scheme, might be a way for you to stay in your home, whilst unlocking some money for retirement.
A Lifetime Mortgage (or equity release plan)
A lifetime mortgage is basically a type of financial product where you “borrow back” some of the equity, or cash, you have tied up in your home. Whilst you are borrowing, interest is charged, although you won’t have to make repayments as the lifetime mortgage provider typically gets their money when your house is sold, usually on your death, or if you have leave to go into permanent residential care.
The advantage of a lifetime mortgage is that you can release money whilst staying in your home (without paying any rent), although it is a complex option and must be considered very carefully as there are considerable risks.
Choose and Strengthen Your Investments
Since you’re only about 25 or 30 years away from retirement, you won’t want to invest as aggressively as a 20-year-old might, but you should still find a good mix of options. Index funds are often a good choice, though you’ll want to make sure to balance your portfolio with “safer” investments like bonds or cash deposits. They may not earn as much, but they’ll protect you in case of a rollercoaster market.
Since you’re contributing to your accounts each month, help them grow more quickly by adding as much extra cash as possible. Add any windfall money — like a birthday gift or a tax return — to your retirement accounts to boost your bottom line. If any of your investments pay dividends, reinvest them so your money grows faster.
All set? You’re not quite finished; it’s time to check your work.
Test Your New Retirement Plan
Now that you’ve put a retirement plan into action, put it to the test to make sure you’re on the right track.
Use the Money Advice Service’s Pensions Calculator to see whether you will have the funds to retire. If you’ve closed the gap between your estimated retirement expenses and income, congratulations! If not, read this post on accessing and trimming your living expenses or this one on plugging the shortfall in your projected income.
Planning for retirement isn’t simple, especially if you’ve waited until your forties. But the sooner you start, the better off you’ll be.