The biggest financial mistake of all

by Jane Baker on 01 July 2009  |  13 comments
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Fail to save during your working life, and you'll condemn yourself to a financial nightmare in retirement.

Do you fancy seeing out the end of your days on an income of less than £5,000 a year?

Thought not. That's just a small fraction of national average earnings. But fail to make any provision for your own retirement, and that's exactly what you'll get.

Actually, you might not even get that much if you haven't built up a full entitlement to the basic state pension. On current rates, you'll get an income of just £95.25 a week or £4,953 a year at best. (Couples will get £152.30 a week or £7,919.60 a year.)

But, if you haven't paid enough National Insurance Contributions (NICs) during your working life, then you'll end up with an even lower income.

Worse still, the Government's balance sheet is looking less than healthy. And it could easily deteriorate even more, putting the state pension in serious  jeopardy. In fact, it could be slashed to less than 15% of average earnings in years to come.

The worst state pension of all

As if that wasn't bad enough, recent research from the Organisation for Economic Co-operation and Development (OECD) has revealed that the UK state pension is already less generous than all other OECD member countries.

So, you can easily see why relying solely on the British government for support in your twilight years is a big, big mistake.

How should you prepare for your retirement?

Since you won't get a decent income from the state, you'll need to start saving for retirement yourself. Personal pensions are still the traditional route, despite a lingering bad reputation for poor performance, high charges, mis-selling scandals and government tax raids. 

In fact, after several years of runaway house price growth, many of you argued that using your property as a pension made far more sense. But since prices have been on a dramatic slide, suddenly that argument doesn't sound quite so convincing.

The point is, like it or not, a personal pension plan - or a scheme run by your employer - is probably still the best way for most of us to go.

Pensions don't have to be painful

The best thing you can do is start your pension today. Save whatever you can afford, even if it's only a small amount each month. You don't necessarily need to put away great chunks of your salary, especially if you start early.

Let's imagine - in an ideal world - that you open your pension at the tender age of 20, and you don't retire until you're 68. (State pension age will rise to 68 in 2044.)

If you save just £50 a month throughout that 48-year period, you could end up with a pension pot worth almost £68,000*. This could give you a yearly pension income of more than £5,000*. So, with a smallish commitment each month, you could build up an income that beats the current basic state pension.

Even if your twenties are a distant memory, the same principle still applies. Whatever your age, save as hard as you can for as long as you can. If your employer is happy to pay into a pension scheme on your behalf, make sure you grab the offer with both hands.

I know affordability can be difficult at times, especially if you're trying to get by with a recessionary pay freeze or cut. But think of your pension as an essential bill which has to be paid in exactly the same way as your household bills or mortgage.  

When the recession is over and the economy improves, you can really boost the value of your pension again by putting in say, half your next pay rise or part of your bonus. That way you can step up your contributions without even really noticing.

Pensions and the recession

There's absolutely no question the current economic downturn has taken its toll on pensions. Take final salary schemes, for instance. These work-based pensions promise generous benefits which can provide an income of up to two-thirds of an employee's final salary.

But the massive costs involved have forced many schemes to close. In fact, of the 100 largest UK companies, only four still offer a guaranteed pension. Find out more in No hope for final salary schemes.

These days, with the loss of final salary plans, most of us will have to take our chances by investing our pension on the stock market, and hoping for the best. It's true that the return from shares has been dismal in recent years. Even so, you shouldn't let that put you off pensions, as I explained in Why pension savers should still trust the stock market.

Despite the tough economic climate, and the disappearance of generous pension schemes, the fact remains that we are all individually responsible for our own retirement provision. And, unless you're happy to live off a tiny income each year when you retire, I suggest you do something about it today.

Put if off until tomorrow, and you're the only one who will suffer for it in the end. 

*Assumptions: Pension fund grows at 7% a year. Charges of 1% a year are deducted. No spouse's pension or guarantee is provided. Inflation is set at a compound rate of 2.5% a year. Your contributions rise in line with inflation at 2.5% a year.

More: Help! I can't afford a pension | Why delaying your retirement makes sense