Session 6: Planning for retirement

Introduction

Pension planning is arguably the most important aspect of personal financial management.

Download this video clip.Video player: Video 1 Introduction to Session 6

Show transcript|Hide transcript

Transcript: Video 1 Introduction to Session 6

MARTIN LEWIS

Planning for retirement. Now, the younger you are, the more likely you are to be thinking, I’m going to blow this one off. It doesn’t matter to me. And you’d be wrong. The earlier you understand it, the better chance you have of having more money and a better life in your retirement. If you don’t plan for your retirement and you just rely on the state pension, well, the way the system’s going there is a probability you will have a cold baked bean future once you retire. So thinking about it now is worthwhile.

Of course, we are all naturally short-termist and like to just think about the here and now and what I need right now. But what it’s important to understand is typical life expectancies are now over 80 years. And yet, most people are only going to work for around 40 years, which means the 40 years you work for has to pay for the 80 years you live for.

You may be thinking, uh, no, the first 20 years, my parents pay for me. True, but you’ll have to pay for your own children. So that’s just a cross-generational subsidy. We move the money over. And when you think about it, 40 years of work to pay for 80 years means you need to save a lot. And the sooner you start to save, the better.

The best way I can explain that is an old rule of thumb. It’s not that accurate. But it puts you in the right mind frame for what you need to save for retirement. It goes like this. Take the age when you start saving towards your pension and halve it, and that is the percentage of your income you need to be putting in to your pension for the rest of your life to have a decent retirement. So start at age 20, it’s 10%. 30, it’s 15%. 40, it’s 20%.

Now, look, don’t worry about the actual numbers here. What it really shows is the earlier you start to save, the less you can put away to still have a good retirement, and that is the golden rule. And it’s that friction between the fact that the earlier you start the better and the younger you are the less likely to think about your pension that’s what makes me a supporter of the change we’ve had in the UK towards auto-enrollment in private pensions.

This was a behavioural economics change, which means the default option for almost every employee, working person, is do nothing and you will automatically be saving towards a private pension. And better still, if you are, then your employer will have to contribute towards your pension pot too, saving for your future.

Now, this is important to understand because there’s a bizarre brain twist you have to get here. The fact that you’re putting money away each month means that you feel like you’ve had a pay cut. But the reality is, because that money is saving for your future and your employer has to put money in too, in fact, auto-enrollment means you’re getting a pay rise. You’re getting more money than you would do otherwise.

And more so, check, if I were to volunteer to save even more, would my employer give me even more? And if it will, try and find out what the maximum it will contribute will be and how much you have to put in to get it to do that. And if you can afford it, I’d go for it.

End transcript: Video 1 Introduction to Session 6

Download

Video _unit7.1.1 Video 1 Introduction to Session 6

Ensuring enough income for a comfortable and hopefully enjoyable retirement has always been important, and with growing longevity, the average time people have in retirement has risen in recent decades. Those aged 65 in the UK currently have an average expected life span of a further 19 years for men and 21 years for women (ONS, 2019a). That is just the average expectation: many people are living into their tenth decade and beyond.

It has always been important to plan for income in later life but growing longevity makes it essential. Other factors have reinforced this need to prepare early for life in retirement:

• The age at which people can start to draw their state pension has been rising – particularly for women – and will rise further in future years. With growing longevity, the cost to the government of the state pension is pushed upwards. So, increasing the age at which people can claim it is one way to contain this cost.
• Low investment returns over the past decade, with interest rates at record low levels, have made it more difficult to amass savings to augment pension income.

This session looks at how to plan for a sufficient income in later life.

You will study state pensions, occupational and personal pension schemes, as well as other means of obtaining cash for use in retirement.

You will also look at the pension reforms introduced in 2015. These have provided more options for people to use their pension funds.

There are complex tax issues surrounding pensions too and you will learn about these.

It’s never too early to think about pension planning, so let’s get going by looking first at how your spending changes when you retire. Before knowing how much income you need in retirement, you require a good estimate of how much you expect to spend.

At the end of this session you should understand:

• how the UK state pension works
• occupational and personal pension schemes
• the differences between defined benefit (‘salary-linked’) and defined contribution (‘money purchase’) pension schemes
• the flexibility now available to use the money held in your pension fund (and the risks this may expose you to)
• the key tax issues that apply to pension planning
• your options if your pension income is insufficient to meet your spending in retirement.