Why you should start your pension today

by Jane Baker on 07 May 2009  |  8 comments
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New research from Halifax reveals half of Brits don't pay into a pension. Here's why that could be a huge mistake.

According to a recent survey from Halifax, a whopping 52% of Brits don't pay into a pension. I think that's a pretty scary statistic. To stand any real chance of building up a decent pension pot at retirement, you need to start early and save hard.

Of course, you may have decided to plan for your retirement in a different way. Many people like to invest in property instead, or prefer the flexibility offered by ISAs. But in my opinion, the traditional pension route remains the best strategy for the majority of people. Read Why you should boost your pension with your savings to find out why.

That said, not only are we failing to get to grips with pensions, more than two-thirds of us overestimate how much income we will get from the basic state pension. On average, most people think it's double the actual amount of £4,953 a year.

Halifax says that of those who do save, most are only able get started at the age of 32. Worryingly, these savers put away just £59 a month, but they still want to retire at 58!

So, let's just assume for a moment that you're 32 and you save £59 a month. What might you end up with by the time you reach 58?

Pension fund value at 58

Source: Hargreaves Lansdown pension calculator. For the assumptions used to calculate these figures, see the notes at the end of the article.

As the tables clearly show, if you saved £59 a month for 26 years until you reach 58, your pension may only generate an income of £1,716 a year, after accounting for inflation.

A far cry from the retirement income most people want: £24,000 a year, according to Halifax.

So, it's easy to see if you leave your pension planning too late, and save too little, your private pension fund may only produce a tiny income, that's even less than the basic state pension.

How much should I save?

Of course, that depends on how much income you want to generate. Let's assume for now that you want £24,000 a year. How much would you need to put by each year then?

If you deduct the basic state pension (assuming you receive the full entitlement), your private pension provision would need to produce an annual income of roughly £19,000 after inflation. So, if you started saving at 32, and you still wanted to retire at 58, you'd need to put away a staggering £1,068 a month! (based on the same assumptions used in the tables).

Now I don't imagine for one second that's a realistic goal for many of you. So let's re-jig the figures a bit:

Early retirement is a pipe dream for many of us these days. If you don't retire until 65 and you're a 'model' pension saver who gets an early start at 22, you could reduce your contributions to £398 a month and still get a yearly income of £19,000.

Don't forget, all these figures include the effects of inflation at 2.5% a year over the next few decades. Your contributions will need to increase by 2.5% a year to keep up with the assumed rate of inflation too.

How much pension income do I really need?

If these figures still make your hair stand on end, ask yourself how much do you realistically need to live on once you've stopped working? £24,000 might be far more than you actually need.

According to the Office for National Statistics, average earnings were just under £25,000 last year (based on median weekly pay of £479). Now, as a general rule of thumb, most people can live reasonably comfortably in retirement on around half their pre-retirement pay.

So, let's assume you actually only need an income of £12,500. With roughly £5,000 coming from the basic state pension, your private pension provision would need to generate about £7,500 a year. Using a 'model' pension saver who starts saving at 22 and retires 43 years later, a much lower, and hopefully more affordable contribution of £157 a month would be needed.  

You may be able to lower your payments again if you think you might defer your retirement for a time. After all, state pension age is set to rise from 65 to 68 between 2024 and 2044, so you may have an even longer period in which to save.

But if 22 is already a distant memory, don't think you have missed the pension boat. Pensions shouldn't be automatically ruled out just because you're in your thirties or forties. The important thing is you put away as much as you can possibly afford to help make up for lost time. And if you've left it really late, read five top tips for late starters.

Assumptions used in tables: Pension fund grows at 7% a year, an annual management charge of 1% has been deducted, inflation rises at 2.5% a year, contributions increase at 2.5% a year in line with inflation, retirement income is guaranteed to pay out for five years and remains level throughout, no spouse's pension is payable.

More: How women can boost their pensions | How to cope with pension cutbacks