The amount you can save into a pension basically depends on what you can afford – but the longer you leave it in the bigger you’re pension pot.
Research regularly shows that we put ambitious targets on our desired or retirement income and then underestimate how much cash we will need to set aside in order to achieve the desired pension targets.
First… a quick guide to pensions
There are two main types of pension schemes, defined contribution and defined benefit which can sometimes be known as a final salary scheme.
With a defined benefit or final salary scheme, your employer promises to give you a defined income in retirement and is responsible for doing so.
You will most likely have to contribute each month too, putting in the required amount that your employer specifies.
With a defined contribution scheme you as an employee will need to contribute a specified amount each month.
With a defined contribution scheme, you save into this and get contributions from your employer too. The money is invested to build up a pot, which will then fund your retirement.
With a defined contribution scheme the answer is more complicated because the focus is on you to deliver the money you need in retirement – so the more you save the pension you will get.
When you reach retirement you can keep your pension invested and draw money as income, or buy a regular income until you die in the form of a financial product called an annuity.
If you save into a personal pension this will be a defined contribution type plan. You pay money in, invest it and build up a pot.
How much money do you need in retirement?
You need to consider a number of different essential factors when you consider how much you would need in retirement.
The first is that your outgoings are likely to be lower. One general rule used in the financial industry is that someone aged 40 would need about 50 per cent of their current income to have the same standard of living in retirement.
This rule works on the basis that by the time they retire they will be mortgage-free, not supporting children and no longer spending as much on things such as commuting and other costs involved in going to work each day.
The second major factor to consider is the state pension. Under the new flat-rate state pension scheme this is £155.65 per week, which is £8,094 per year.
Allowing for a full state pension, someone targeting retirement income of £23,000 would need other pension income of about £16,000. You would need a pension pot of £400,0000 taking a 4% income per annum.
How much do you need to save
You receive income tax relief on your contributions to your pension scheme, meaning that you effectively save out of untaxed income.
There are some general rules for working out what percentage of your salary needs to be going into a pension, in terms of your and your employer’s contributions.
The most common is half your age from when you started saving from – so if you start at age 30 it could be 15 per cent, whereas if you start at 40 it is 20 per cent.
The reality is that when you start saving for retirement you may not be able to pay in as much as you would like. It’s important to remember that payments can be upped at any time and the early you start the better chance you have of building a bigger pension pot.