Investing for retirement
The state pension is unlikely to provide the standard of living in retirement that most of us would like or expect. Today, enjoying a decent retirement generally means providing a savings pot for ourselves.
While a home is the biggest single asset that most of us will ever have, a pension pot is most likely to be the second.
The aim should be to have as large a pension pot as possible to provide ourselves with as high a standard of living in retirement as possible.
But how should you invest for your retirement?
How much should I invest?
The first issue that you must consider is when you hope to retire.
This will influence how long you will be able to save for and the level of risk you feel comfortable taking with your investments.
The second issue is how much to invest to deliver the level of retirement income you want. You can consult a financial adviser to help evaluate how much money you will need in retirement based on a number of factors including life expectancy, current spending and your ambitions during retirement such as travel. As a general guideline, experts suggest saving a percentage of your income that is half your age. For example, a 30-year-old should invest 15% of your income, whereas a 50-year-old should target 25%.
Securing tax-free returns
In terms of the vehicles that investors can use, the optimal tax treatment for most is available through recognised pension plans. These include personal pensions, self-invested personal pensions (SIPPs), small, self-administered schemes (SSASes) and employers’ defined contribution and final salary schemes.
These pension plans offer various tax breaks, including rebates on contributions. Furthermore, investments are largely tax exempt and 25% of the pot can be taken as a tax-free lump sum after the age of 55, although any income taken after that from the pot is treated as taxable.
There are limits on the tax rebates that can be claimed on contributions into a pension pot each year – linked to your income - as well as the final pot size that can be accumulated, called the pension lifetime allowance. At present (2021), this lifetime limit is £1,073,100, which is beyond the reach of most people anyway.
It is clearly preferable to have as large a retirement pot as possible. But the final pot will depend on how much you invest, for how long and your investment returns.
The longer you have to your planned retirement date, the more exposure your pension portfolio can be exposed to higher risk assets that tend to deliver better returns over the long term if you want to target a larger pot.
As you get closer to your retirement date though and become less willing to tolerate losses, many people will reduce exposure to higher risk assets in favour of lower risk assets such as bonds or cash. But this does depend on whether you will need to continue to generate growth from your savings pot – see later in this article.
We suggest you consult a professional adviser about the tax implications of your investments.
Setting up a pension plan
Employers are legally bound to set up pension schemes for their eligible staff.
You should take advantage of these if you can, not least because employers must top up eligible employees’ contributions.
You can also set up a pension plan privately, either through a professional financial adviser or one of the online platforms that are available, or directly with a pensions company.
Pension plans give varying degrees of choice with regards to investments, depending on the policy and provider.
Some will enable you to select individual investments such as equities listed on the stock market, but most offer a choice of mutual funds, including a default fund in which a professional manager will monitor markets and the portfolio to optimise returns and manage the risks.
Liontrust’s funds, for example, are available to pension savers on various investment platforms.
Low interest rates weigh on pension income
The amounts that are needed to generate a decent retirement income are often misunderstood.
Analysis in 2021 by the Pensions and Lifetime Savings Association, for example, estimates that a single person needs a post-tax income of £10,900 and a couple £16,700 for a minimum standard of living in retirement.
But this does not cover housing costs nor running a car, although it does cover some social activities, including an annual week’s holiday and eating out once a month.
Many people underestimate how much they will need to retire. Interest rates have been at historic lows for some years and this means the rates on annuities – the financial products used to provide pension income – are also very low. For example, at annuity rates in March 2022, a pension pot of £100,000 would only provide around £4,000 and £5,000 income per year, and possibly significantly less than this depending on circumstances, such as your age and life expectancy, as well as whether you want your annual income to rise in line with inflation.
We suggest you consult a professional adviser about the tax implications of your investments.
An alternative to annuities
There is an alternative to annuities, however, which is to continue investing your portfolio and taking an income from it, which is known as ‘drawdown’.
By continuing to invest, you can aim to continue growing your pension pot and preferably insulate it from inflation.
ISAs also offer tax benefits
Another tax-efficient way to accumulate wealth for retirement is to use Individual Savings Accounts (ISAs). The capital gains and income accumulated within an ISA are tax-free, as are any withdrawals, although tax rebates do not apply to contributions.
We suggest you consult a professional adviser about the tax implications of your investments.
Next steps
For more information on how to invest, see our article on constructing a portfolio. Given the complexities involved with pension planning, you may wish to speak to a financial adviser to receive professional advice.
