Can you envisage living a comfortable retirement on the £168.60 a week currently offered by the State Pension? If not, you’re going to need to do something about it. This is particularly the case if you’re already in your fourth decade and have little in the way of savings.
Here’s what I’d recommend.
1. Stop spending (so much)
Generally speaking, a person’s earnings tend to peak during their 40s. This could make it very tempting to splash the cash without considering the long-term costs of doing so.
The situation is even worse if, despite taking home a decent salary, you’re actually spending more than you earn. This is a problem frequently seen in relatively high earners. Perhaps as a result of wanting to impress their peers, the lifestyle they adopt and maintain ensures they actually have very little in terms of wealth.
There’s nothing wrong with a few treats, of course, but this shouldn’t be at the expense of planning for the future.
So, if you have a habit of spending all that you earn (or worse), it’s probably time to cut up some credit cards, pay off your debts and be more conservative with your cash.
2. Start saving. Now
If you’ve put off saving until reaching 40, it now needs to become a priority. I’ll use an example to illustrate why.
Since we’re living longer these days, let’s assume the retirement age in the future will be 70.
A 20-year-old investing £100 every month for 50 years will end up with a little under £488,000 (assuming an average annual return of 7%). Someone saving the same amount from their 30th year — and achieving the same average annual return from their investments — would have almost £240,000 by the time they hit 70.
With fewer years to take advantage of the magic of earning interest on interest (a.k.a compounding), however, a 40-year-old would leave the market with only £113,000 — less than a quarter of the wealth our 20-year-old managed to accumulate.
To have any chance of retiring with roughly the same amount, I calculate our 40-year-old would need to stick away £430 a month for three decades.
If that seems like a lot, spare a thought for anyone beginning to invest in their 50s. He/she would need to set aside almost £1000 a month to achieve the same result.
3. SIPP it
Having committed to saving more, another thing you can do to increase your chances of securing a comfortable retirement is to ensure that your investments are held within a Self-Invested Personal Pension (SIPP).
Thanks to the tax relief you receive from the government, this kind of account allows you to put more money to work than a Stocks and Shares ISA.
Returning to the example, if you pay the basic rate of tax (20%), that £430 per month becomes £537.50. Three decades of compounding this higher amount will leave you with just over £600,000.
For me, one of the best justifications for having a SIPP, however, is the fact that you can’t get access to your cash before the age of 55. This should be regarded as a great thing for those playing catch-up with their savings since it means they won’t be tempted to withdraw the money on a whim.
Hopefully, the gains made between 40-55 will also encourage them to stay invested and continue adding to their investments for many years to come.