The Cost to Retire
The cost of retirement – preparation is the key
How much do I need?
This is a rough idea of how much you need
£100,000 in your pension could give you £3,500 per year from income drawdown.
£600,000 gives you £21,000 per year, plus a single maximum state pension the total is £30,000. For a couple with two state pensions the same income can be achieved with £350,000. The planner will give you a more a realistic picture of course.
There are many articles discussing this calculation, sometimes with a higher expectation of return, but these calculators will allow you to see the differences.
How much should I save?
If you are 43 and have 25 years to age 68, when your state pension is due.
If you saved £450 a month and already had £50,000, then at 68 you could have £400,000.
Assuming 2.5% inflation and 3.5% growth.
If you were a couple it could last to age 90 paying an increasing £30,000 and this would include two full state pensions.
Annuities are secure and guaranteed, as a result they will give less income than drawdown.
Income drawdown is questionable if you are using it to pay basic income needs, except when you have some fixed incomes or access to other investments to fall back on and if your financial adviser recommends it.
Very few savers put enough into their pensions to give them anything like the income available from defined benefit final salary schemes.
The value and costs of a final salary pension
Final salary schemes or Definded Benefit (DB) schemes can give a guaranteed benefit. If you have a final salary pension from a previous employer or at some time worked as a teacher, the NHS, or been a member of any other public sector scheme, you have a valuable benefit and this is how they work.
Alternatively, Defined Contribution (DC) schemes depend on your contributions, the result is rarely guaranteed. Defined Benefit schemes are still offered to most public sector workers, such as local government, teachers, NHS workers, police officers and firefighters. Some private sector larger employers still have them, but are now limited in numbers.
Funded and Un-funded schemes
Private sector schemes are Funded, i.e. they put the money aside to fund future expectations of income. It’s an open cheque book for DB pension schemes in the private sector, they are required to have substantial pension funds. If the size of this fund is below the necessary amount to provide projected benefits, the scheme is said to be Underfunded. There are increased numbers of private sector underfunded schemes now and it means your pension benefit could be reduced.
Public sector schemes are Un-funded, so pensions are paid directly from government income derived from taxes, there is no future pot of money. It’s still an open cheque book, but the difference is UK government does not put a cap on the benefit cost. These schemes do not become underfunded, but some of the benefits have been cut back slightly for new members, although they are still considered to be gold plated schemes.
Providing this level of guarantee has proved too expensive for most private sector employers, who now usually offer non-guaranteed workplace or personal pensions, Defined Contribution (DC) schemes instead.
Why are they so expensive?
DB scheme guarantees are connected to the government lending rate, i.e. the rate the government pays to borrow money.
Interest rates fell to very low levels after 2009/10, these low rates have forced private sector DB pension schemes to pay more to provide guaranteed pension incomes, the cost of which can put an employer out of business. So they move to non-guaranteed schemes to reduce their liability.
Since 2020 the vast majority of IFAs no longer ‘transfer out’ a DB scheme, which normally leads to the loss of generous guarantees. One reason is that so many members have transferred money out and lost their guarantees, the regulator has decided to clamp down on these transfers. It is now virtually impossible for advisers to be covered by their Professional Indemnity Insurance making it hard to find anyone who will do this for you. You can’t transfer out yourself, because pension providers will only accept a transfer if financial advice has been given.
Bank of England base rates
DB pension schemes from private sector employers need to buy guarantees for the future to secure benefits, when interest rates are low the future cost of these guarantees rises. This graph shows how rates have fallen since 2010.
This is also the reason why an annuity provides less income now, leading to more people choosing pension drawdown.
As interest rates start to increase, the process reverses.
The impact of investment charges
Annual fund charge
Investment managers charge for managing your investment.
Index Funds and Exchange Traded Funds (ETFs) track indexes, for example the UK or US stock market and there are thousands to choose from. These funds are low cost at less than 0.2% of your investment, because tracking an index is inherently less expensive than active management.
Active managed investment aim to outperform the markets. They generally charge from 0.4% to 0.75% although there are specialist funds that charge more.
Fund charges are deducted before you see the value of your investment, i.e. before the unit price is updated each day.
This usefully allows you to compare the performance of a fund or portfolio including charges.
There are frequent articles written about charges, these will often prescribe low charging index funds to save money. Generalisations don’t tell the full story, nothing is that simple.
Annual Charges – are shown as AMC (annual management charge) as well as OCF (Ongoing Charges Figure), which includes the small incidental charges and you find these in the fund documentation.
How inportant are these charges?
It’s more important to get the best return from your investment and that’s not necessarily the cheapest option, however you can get a good return from index funds, but like anything else you have to choose the right ones.
Good results can often be achieved by mixing Active and Passive funds within a single portfolio. Choose the one most suitable for each sector, but cheap is not always best and there are some world-beating managed funds that consistently beat index trackers. You can find outstanding active managed funds charging 0.4% to 0.75% that represent global multi-assets and stay within a declared level of risk.
Active and Passive Funds
There has always been an ongoing debate over the merits and shortcomings of active and passive investing and the difference in charges. Both types of funds measure themselves against one or more market indexes for example Japan, US, or a broader area like the FTSE All World index. The difference is that Actively managed funds aim to beat an index or other measure and Passive funds simply aim to track a particular index. There are large numbers of Active funds that rarely beat the index and there are some that consistently out-perform, the key is to have regular reviews of your portfolio and constant monitoring.
You can pay 0.1% to 0.4% for an index fund or ETF and upwards from 0.4% for Actively managed funds.
So to sum up, unless you want a specialist fund, you should not need to pay much over 0.75%. If a higher charging fund is performing better than the index then keep it. It all about research because that extra 1 or 2% per year can make a difference. Don’t leave your investments without reviewing them every year because markets and funds can change.
An independent financial adviser with investment experience will create a portfolio for you and keep it up to date.