How much pension do you need?

How much pension do you need?

Planning for retirement can be daunting as there’s so much to think about. Everyone’s situation is different, including the lifestyle they want in retirement. Whether you're just starting your career or are closer to retirement, understanding the amount of pension you might need can be really helpful. Today we’ll break down some of the common considerations. 

1. Assess Your Desired Retirement Lifestyle

The first step in determining how much pension you need is to envision your retirement lifestyle. Will you downsize to a smaller home, travel frequently, or perhaps take up new hobbies? Your desired lifestyle will significantly influence your required pension income.

Basic Retirement

For a modest lifestyle, where your needs are mostly covered but without many luxuries, the Pensions and Lifetime Savings Association (PLSA) suggested in February that a single person might need about £12,800 per year, while a couple might require between £19,900 and £22,400. 

Comfortable Retirement

If you’re aiming for a more comfortable retirement with occasional dining out, a car, and European holidays, you'll need more. The PLSA estimates that this would require around £23,300 per year for a single person and £34,000 for a couple.

Luxury Retirement

For those dreaming of a luxury retirement filled with long-haul travel, regular theatre trips, and more indulgences, you might aim for around £30,600 per year for a single person and £49,700 for a couple.

2. Calculate Your State Pension Entitlement

In the UK, the State Pension is a significant part of retirement income. As of 2024, the full new State Pension is £221.20 per week. To qualify for the full amount, you’ll need 35 years of National Insurance contributions or credits.

It’s important to check your State Pension forecast to understand how much you’re likely to receive. This can help you determine the gap that your personal or workplace pension needs to fill.

3. Workplace and Personal Pensions

In addition to the State Pension, most people will have either a workplace pension or a personal pension, or both. Workplace pensions typically come in two types: defined benefit (final salary) schemes, which provide a guaranteed income, and defined contribution schemes, where the income depends on the amount contributed and investment performance.

Defined Contribution Pension

With a defined contribution pension, the amount you'll need to save depends on several factors, including:

• Your age: The younger you start, the less you’ll need to contribute monthly due to the power of compound interest.

• Expected investment returns: This can vary depending on your investment choices.

• Annuity rates: If you plan to purchase an annuity, current rates will affect how much income your pension pot will generate.

4. Using the 4% Rule

A commonly used rule of thumb in retirement planning is the 4% rule, which suggests that you can withdraw 4% of your pension pot annually. This rule aims to ensure that your savings last for at least 25 years. For example, if you desire an income of £25,000 per year (excluding State Pension), you would need a pension pot of £625,000.

5. Factor in Inflation

Inflation can erode the purchasing power of your pension over time. Therefore, it’s vital to factor in inflation when calculating your retirement income needs. Consider investments or pension plans that offer inflation protection or plan for a higher pension pot to account for future cost increases.

6. Consider Other Income Sources

Don’t forget to include other potential income sources in your retirement planning, such as rental income, investments, or part-time work. These can help reduce the pressure on your pension pot.

7. Review and Adjust Your Plan Regularly

Your retirement plan should not be static. Life changes, such as marriage, children, health issues, or changes in income, may require adjustments to your pension plan. Regularly reviewing your plan ensures that you stay on track to meet your retirement goals.

8. Maximising Your Pension Contributions

One of the most effective ways to ensure a sufficient pension pot is to maximise your contributions. The earlier and more consistently you contribute, the more your savings will benefit from compound growth over time.

Take Advantage of Employer Contributions

Many workplace pensions in the UK operate on an auto-enrolment basis, where your employer must contribute a minimum amount to your pension if you do. Typically, employers match your contributions up to a certain percentage. To make the most of this, try to contribute at least enough to get the maximum employer match - it's essentially free money towards your retirement.

Increase Contributions Over Time

As your salary increases, it’s a good idea to gradually increase your pension contributions. Even small percentage increases can make a significant difference over the years. Some schemes allow you to automatically escalate your contributions annually, which can be an easy way to grow your pension pot without feeling the pinch too much.

9. Consider Pension Tax Relief

In the UK, pension contributions benefit from tax relief, which means some of the money that would have gone to the government as tax goes into your pension instead. The level of relief depends on your income tax band:

• Basic rate taxpayers receive 20% tax relief.

• Higher rate taxpayers can claim 40% tax relief.

• Additional rate taxpayers receive 45% tax relief.

This tax relief effectively means that saving into your pension is highly tax-efficient. Higher and additional rate taxpayers can claim extra tax relief through their self-assessment tax return. Maximising this tax relief can significantly boost your pension savings.

10. Utilise Lifetime and Annual Allowances

The UK government sets limits on how much you can contribute to your pension without facing tax penalties. The two main limits are the Annual Allowance and the Lifetime Allowance:

• Annual Allowance: As of 2024, the annual allowance is £60,000. Contributions above this limit may be subject to a tax charge. However, you can carry forward unused allowance from the previous three years if you're eligible.

• Lifetime Allowance: This cap was abolished in 2024, meaning there is no longer a maximum amount you can accumulate in your pension without facing additional tax charges.

Understanding and managing these allowances can help you maximize your pension savings without incurring unnecessary tax costs.

11. Diversifying Your Pension Investments

While many people rely on a default investment fund provided by their pension scheme, diversifying your investments can help balance risk and improve potential returns. Consider a mix of asset classes, such as:

• Equities: Stocks and shares offer growth potential, especially over the long term, but they come with higher risk.

• Bonds: Generally lower risk than equities, bonds provide more stable, if lower, returns.

• Property: Direct property investments or property funds can provide a steady income, though they come with liquidity risks.

• Cash: Keeping a portion of your pension in cash can offer safety, though it won’t provide significant growth and may lose value in real terms due to inflation.

A well-diversified portfolio can help protect your pension pot from market volatility, particularly as you near retirement.

12. Timing Your Retirement Wisely

The age at which you choose to retire can significantly impact how much pension you need and how long it will last. Retiring earlier means your pension pot will need to stretch over more years, potentially requiring a larger amount.

If possible, consider delaying your retirement to increase your pension savings and reduce the time it needs to last. Delaying your State Pension claim beyond your State Pension age can also boost the amount you receive. For each year you delay, your State Pension increases by approximately 5.8%.

13. Consider Your Health and Longevity

Life expectancy in the UK has been steadily increasing, meaning that your pension may need to support you for 20-30 years or more. While it’s impossible to predict exactly how long you’ll live, it’s wise to plan for a longer retirement, especially if you’re in good health.

If you have any health conditions that might reduce your life expectancy, you might consider an enhanced annuity, which offers a higher income based on your health status. On the other hand, planning for longevity might involve considering income drawdown options that offer flexibility as you age.

14. Plan for Healthcare and Long-Term Care Costs

Healthcare in the UK is mostly covered by the NHS, but some expenses, such as dental care, prescriptions, and eye tests, may need to be paid out-of-pocket. Additionally, long-term care - whether in your home or a care home - can be a significant expense in later life.

While no one likes to think about the possibility of needing long-term care, it’s prudent to include potential care costs in your retirement planning. Consider whether your pension savings will be sufficient to cover these costs or if you need to explore other options, such as insurance or selling assets.

15. The Role of Professional Advice

Retirement planning is complex, and getting it wrong can have serious consequences for your financial well-being in later life. Seeking professional financial advice can help you tailor your pension plan to your specific circumstances and goals. An adviser can assist with:

• Investment choices: Ensuring your pension is invested appropriately for your risk tolerance and retirement timeline.

• Tax planning: Making the most of tax reliefs and allowances.

• Retirement income strategy: Deciding between options like annuities, drawdown, or a combination of both.

While financial advice comes with a cost, it can be a worthwhile investment to secure a comfortable retirement.

Final Thoughts

Planning how much pension you need is a highly personal process that depends on your lifestyle goals, current savings, and potential future expenses. 

However, we’ve covered some common things to be aware of, and there are generally some good rules to live by, such as starting early with your contributions and ensuring you hit your NI qualification years. 

If you’d like to go into any of the topics mentioned in more detail and would like professional pension advice, then please don’t hesitate to get in touch with us.