Saving for your pension - it doesn't pay to delay

Pension saving is hardly the sexiest of subjects. Small wonder, then, that so many of us put off thinking about it until it is too late. With most people living longer than ever before and with a 20-30 year retirement a distinct possibility, the need to save has never been greater.

But survey after survey shows that many people fail to start saving until their late 30s or early 40s, by which time, the amount you need to put away each month in order to build up a decent pension in retirement has become eye wateringly high. Recent research by Prudential shows that 60% of 16-34 year olds are saving nothing towards retirement, even though by saving £200 a month gross (that's £156 with tax relief at 22% or £120 at 40%), a 25 year old man could expect a pension pot in the region of £400,000 at age 65, assuming an annual growth rate of 7% a year, according to Legal & General.

This could buy you a pension of around £28,000 a year, assuming an annuity rate of 7% for a 65 year old man. But if you delay saving until age 45, a £200 / month gross contribution could produce a fund of only £91,800, (assuming the same 7% growth rate), which, converted into an annuity, would give you a pension of just £6,426 a year at age 65 - less than a quarter of the pension of someone who started saving at 25.

For women, the potential pension would be even worse, because women currently have a longer life expectancy than men, so insurance companies offer women lower annuity rates to account for the extra years they have to make payments to female annuitants.

However, there is no point in saving for a pension if you are in debt, particularly if the interest rates being charged exceed the likely returns on any pension savings you might make. In addition, all debt should be prioritised so that you pay off mortgage, rent and council tax first in order to keep a roof over your head and stay out of jail! Then you should set about paying off other debts in descending order of the interest rate being charged - for instance, store cards, credit cards, personal loans and lastly student loans.

How much should you be saving?

Assuming that you can put some money away each month, how much should you save? To give you some idea of the sums needed to buy a reasonable pension, a £50,000 annual income would require a fund of roughly £750,000 assuming an annuity rate of around 7% for a 65 year old. As we've already seen, even a more modest £28,000 annual income would require a fund of around £400,000 for a 65 year old man or approximately £430,000 for a woman (assuming a 6.5% annuity rate). If you buy an annuity before age 65, you will get even less because annuity rates rise with age.

Another rule of thumb is that you should invest half your age, so that at age 30, you should save 15% of salary, 20% at age 40 and so on. In practice, you should save as much as you can afford and early as possible because savings made in your 20s will normally have 40 years or more to grow in a near tax-free environment

Starting the saving habit early will also give your retirement planning some leeway, in the event that you start a family, take a sabbatical or are made redundant and cannot afford to make contributions for a few years. As for where you should save, anyone who is eligible for a company pension scheme to which their employer pays a contribution is normally best advised to join it.

"To fail to join a company sponsored scheme is like turning down a pay rise," says Adrian Boulding, director of pensions at Legal & General. If you don't have access to a company scheme, you are on your own and will have to choose from the range of personal pensions on offer.

Most people on average earnings should consider a stakeholder personal pension first, because the charges are low (capped at 1.5% a year, although some charge as little as 0.6%) and most stakeholder plans offer a reasonable choice of funds, including some externally managed ones.

An independent financial adviser should be able to advise you on stakeholder pensions, although you may have to pay a fee as these low cost pensions pay very little commission compared to personal pensions. You may be offered the latter on the grounds that they offer greater choice of fund. But this comes at a cost of higher charges which will eat into the value of your fund, so for those on average or lower earnings, this could be an unnecessary and expensive luxury.

If you really want choice, and want actively to manage your pension, a Self Invested Personal Pension (Sipp) may be appropriate. There are over 80 Sipp providers (www.sippprovidergroup.org) but before choosing a provider, you need to decide the type and frequency of investment you are likely to engage in. Each provider has its own particular charging structure and terms and conditions, so it is worth reading the small print so that you know what you will be paying for and when.

10 July 2006 © Moneyextra.com

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