While many pensioners benefit from pensions that come from the state and their employer, many have income needs or desires beyond the income these pensions provide. This is why many people who are saving for retirement adopt a three-pronged approach to pensions, using a combination of a state pension, workplace pension (employer or company) and personal pensions. It is also why you should plan ahead and start building retirement savings as early as possible in order to meet your retirement and lifestyle goals.
In order to understand how much pension savings you will need, it's a good idea to first define your investing goals: do you simply want cash flow from your investments, or do you want to grow your money or to create a legacy for heirs or a charity? Or perhaps you are one of the few who truly wishes to simply preserve capital.
Whichever of the above goals most closely aligns with yours, you will need to plan carefully so that you can build your savings. Working out your cash flow needs is part of this process, so you will need to figure out how much money you are spending now as well how much you are likely to spend later in retirement. Be aware that the later phase of your life may well bring increased living expenses—care and medical costs are just two examples of this—and that inflation is likely to reduce your purchasing power.
Calculating your retirement savings goal will also require you to answer a difficult question: how long will you need your money to last? We refer to this as your investment time horizon. Ask yourself how long you expect to live, how long you expect your spouse or any dependents to live and whether you wish your money to continue working for your heirs or chosen charities after you have gone.
Underestimate your investment time horizon at your peril. Many people live longer than their ancestors, so planning early for a longer life is smart—but it means you should start saving early to fund your later years so any contributions you make now to your retirement savings accounts have enough time to become the nest egg you need.
It is hard for any person, regardless of lifestyle, to adjust to constraints caused by lack of money, particularly if you are older and well accustomed to certain comforts and financial freedom.
However, inflation can make your lifestyle much more costly if your expenses are heavily tilted to categories of goods or services with fast-rising prices. Many developed-world central banks target a 2-3% inflation rate, so it is reasonable to expect living costs to rise as you look forward. Make sure you sufficiently account for the impact of inflation on your purchasing power when setting up your savings plan so that it outperforms the rate of inflation.
Also, it's important to calculate the effect of withdrawals on your retirement accounts, as drawdown and removing funds can impact ongoing savings rates, whilst also incurring income tax. Understanding the tax implications of retirement income is also a factor for consideration.
While some people solely want to preserve their wealth, we believe this represents a small percentage of investors, and for many of these people this strategy may actually not be in their best interests.
Perhaps you will never have a need for cash flow from your portfolio and don’t want to see it decline in value. In this case, a policy of pure capital preservation could make sense. But almost every other retirement saver will require some level of growth from their retirement savings plan, and any level of growth requires enduring the risk of loss—which is inherently at odds with capital preservation.
The sooner you plan your retirement savings and start to save or make pension contributions, the more likely you will be to benefit from the power of compound returns—when your investment returns themselves earn further investment returns.
Compound returns calculated on both the initial savings and on any returns accumulated on them. In other words, it's the return you earn on returns you’ve already earned. For example if you save a sum of £50,000 and earn an average of 5% annual return on that amount, with no withdrawals after 30 years you would have about £216,097 of retirement savings.
More good news for prudent retirement planners is that the more you contribute, the greater the benefits of compounding returns. The more you save, the more growth over the long term. Although stock market returns can fluctuate from year to year, over longer periods of time stocks tend to rise. And any percentage increase in your investments will benefit from future percentage increases. In other words, the sooner you invest the higher the likelihood that you will be able to compound your gains.
The mix of investments in your retirement portfolio should be determined by your individual goals and return expectations. Your combination of cash savings, ISAs, fixed interest, stocks and other investments, including pensions, will depend on your goals. If you are starting to save early, you might invest more heavily in stocks, knowing that over the longer term you are more likely to benefit from compound gains. If you are investing later, your approach might differ, depending on your objectives.
By defining your goals, devising a strategy and developing your private retirement assets, you can put yourself in a position of strength so that you are better able to avoid dependence on the state pension scheme which may fluctuate before you retire. What’s more, nothing is certain, not even state healthcare or social care provision later in life.
If you want to enjoy retirement on your own terms, your best bet is to have diversified retirement savings to provide sufficient income and growth. The sooner you start making contributions, the more likely it is that you will be able to reach your retirement goals.
Fisher Investments UK can recommend a long-term asset allocation tailored to your long-term goals. We can help you understand your retirement savings and how changes to your pension contributions could affect your annual income as a retiree.
To learn more about the advantages of choosing Fisher Investments UK to assist you with your retirement planning, get in touch with us today at 0800 144 4731.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.