Figures suggest that workers nearing retirement could find they’re facing a significant income shortfall later in life. Understanding how your pension savings will add up before you retire is crucial for creating long-term financial wellbeing.
According to a report from the Social Market Foundation, people approaching retirement are facing a pension shortfall of almost £250,000 if they want to achieve their desired income. Collectively, across the UK there’s a savings gap of £132 billion.
One of the reasons for the gap is that many 50- to 64-year-olds don’t know how much they need in their pension.
Only a third of those nearing retirement have an accurate idea of how much they need to save to reach their goal income.
As a result, two-thirds could face an unexpected gap when they reach retirement or may not notice the gap until they’ve already started depleting their savings.
Not recognising a pension gap until you retire could mean you need to scale back the lifestyle you’ve been looking forward to and working towards.
If you don’t realise there’s a gap and start withdrawing a higher income than is sustainable, you could run out of money.
The challenge of aligning your savings with your income
As fewer people are now paying into a defined benefit (DB) pension, which delivers a reliable income throughout retirement, a key challenge is translating how your contributions will result in an income.
45% of people paying into a pension only have a defined contribution (DC) pension. With this type of pension, you make contributions which are then usually invested. When you retire, you have a pot that you can start accessing to create an income.
As you’ll be responsible for managing withdrawals and ensuring your pension will last throughout your retirement, it can be difficult to understand how much you need to save through a DC pension.
In 2012, auto-enrolment started and now most workers are eligible for a pension that their employer will set up and contribute to, the majority of which are DC pensions.
So, it’s more important than ever that workers understand how their contributions are adding up and what it will mean for their retirement.
42% of people nearing retirement have no idea what income they will need
To be able to understand whether you’re saving enough through a DC pension, you need to understand what income you want in retirement.
Despite this, 42% of people nearing retirement said they have no idea what income they will need to achieve their goals.
Many people find that their essential expenses are lower in retirement than when they were working. This may be because you may have paid off your mortgage or have fewer travel expenses. A rule of thumb is that you need two-thirds of your current income to maintain your lifestyle in retirement.
This is a good starting place but there can be huge differences in what income retirees need. It will depend on your personal circumstances, so it’s important to take a closer look at your expenses.
Start with the essential costs, such as utility bills and grocery shopping, to create a baseline retirement income. Once that’s done, you can add additional costs that will help you create the retirement lifestyle you want, like a budget for eating out, going on holiday, or attending social clubs.
As well as regular discretionary spending, you may have larger one-off costs that you need to factor in, such as updating your home or an extended holiday.
Once you understand what your ideal income is, you can calculate if you’re saving “enough”.
What is “enough” when you’re saving for your retirement?
With a DC pension, you have more flexibility to create an income when you retire. Yet, 16% of people don’t understand what their options are, while 40% aren’t confident about securing the income they need.
This is something financial planning can help you with.
We’ll work with you to understand how much you need to save into your pension to retire when you’re ready and deliver an income for the rest of your life. It means you can look forward to retirement knowing that you’re taking the necessary steps now.
We’ll also help you understand what your options are. From a flexible income to a guaranteed income through an annuity, the decisions you make about how to access your pension should complement your wider plans and priorities.
The sooner you review your pension, the more likely you are to reach your goals and have an opportunity to close gaps if you find them.