Economists have calculated a way to work out how big a pension you need — and the results will shock you. LONDON (THE TIMES) , June 12, 2005:
AT LAST: a formula for a happy old age, or at least one that shows at a glance how much money you will need to be content in retirement.
Start with the number 55, subtract one third of your current age, subtract one seventh of your expected retirement age and then multiply by your current salary. That is the recipe according to Edmund Cannon, a senior lecturer in economics at the University of Bristol, and JP Morgan Invest, a financial consultancy.
A 30-year-old who earned £30,000 a year and hoped to retire at 70 would need a lump sum of £1.05m — 55 minus 10 (one third of 30) minus 10 (one seventh of 70) multiplied by 30,000. The formula assumes that wages rise by 2% a year.
A lump sum of £1.05m would provide an annual income of £52,500, assuming an annuity rate of 5%.
A 50-year-old who earned £100,000 and hoped to retire at 65 would require a lump sum of £2.91m — 55 minus 16.6 (one third of 50) minus 9.3 (one seventh of 65) multiplied by 100,000. A lump sum of £2.91m would provide an annual income of £145,500.
The figures may seem high: the formula assumes you retire on at least 70% of your pre- retirement earnings, while most final-salary schemes pay only two-thirds of income.
However, JP Morgan Invest believes that in future people will require bigger sums in retirement because they will live longer and demand higher standards of living.
The average 65-year-old male can expect to live to 84 today compared with 77 in 1950, according to the Government Actuary’s Department. It predicts that male life expectancy at 65 will rise to 86 by 2030, so a man aged 40 now who stops working at 65 will have to fund 21 years’ retirement.
Jonathan Watts-Lay of JP Morgan Invest said: “The lump sums required may look shocking, but we have become used to an increasing number of consumer goods, holidays and other luxuries, and are unwilling to sacrifice them once we retire.”
JP Morgan Invest found that more than two-thirds of us would be very unhappy if we were forced to move to a smaller property in retirement. The same proportion could not imagine life without foreign holidays, while nearly three- quarters would be dismayed if they were left with basic TV rather than digital or satellite.
However, financial advisers say that workers who are prepared to scale back their expectations could get by with a smaller lump sum at retirement.
Adair Turner, head of the commission that will report on Britain’s pensions crisis later this year, suggests this benchmark: workers with a final salary of £50,000 or more a year should aim for 50% of their income in retirement; middle earners on £17,500 to £25,000 should target 67%; the lowest earners on less than £9,500 should aim for 80% of their final salary.
A 50-year-old who earned £100,000 and hoped to retire at 65 on half of his final salary would need a lump sum of £1.35m, according to Hargreaves Lansdown, an adviser. This compares with a lump sum of £2.91m required by JP Morgan Invest’s formula. In both cases, wages grow by 2% a year and the annuity rate is 5%.
Turner also suggests a benchmark for the amount we need to save. If you took out a pension at 25, you would need to save 11% of your salary to retire on 50% of your gross earnings at 65. This figure would rise to 14% if you started saving at 30, 18% at 35 and 23% at 40. These figures do not take the state pension into account and assume average earnings.
However, 90% of members of money-purchase company schemes are paying in less than 10% of their gross earnings, including employer contributions, according to the Pensions Commission. The prognosis is little better for personal pensions: three-quarters of contributions are less than 10%.
Financial advisers are therefore urging investors to boost their pension savings. At present you can invest up to 17.5% of your earnings in a personal pension up to the age of 35, rising in stages to 40% at 60. From next April the maximum will be your annual salary, with a ceiling of £215,000.
So which pension funds should you choose? Stakeholder schemes are generally cheapest because charges are capped at 1.5% a year for 10 years and 1% thereafter. But many stakeholders run by life insurers offer a choice of only six or seven funds run by that insurer.
Look for stakeholder firms that offer external funds, such as Scottish Widows and Legal & General.
Self-invested personal pensions give you more control over where you invest, but fees may be higher (see below).
With company money- purchase schemes, employer contributions are usually 4% to 7% of salary, with a further 3% to 4% from workers. But you could pay up to 15%, excluding employer contributions, via additional voluntary contributions.
Experts say you are almost always better off with an AVC plan from your employer rather than a pension firm (called a free-standing AVC), because the charges are generally lower.
HOW BIG A LUMP SUM DO YOU NEED?*
Age Salary Lump Sum Annual Now Required Income
30 £30,000 £1.07m £53,500 35 £40,000 £1.36m £68,000 40 £50,000 £1.62m £81,000 45 £60,000 £1.84m £92,000 50 £100,000 £2.90m £145,500
*Assuming you retire at 65, wages grow by 2% a year and annuity rates are 5%.
Source: JP Morgan Invest By Kathryn Cooper http://business.timesonline.co.uk
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