Turning 40 without any pension savings can be daunting. But all is not lost, even if you're among the lucky one in six people age 40 who are expected to live to 100.
If you start today and invest 17 per cent of your gross annual salary, you could still afford to retire in your sixties and be able to provide retirement income until you are 100.
That is the conclusion of calculations undertaken by wealth manager Cazenove Capital and investment firm Schroders. The numbers are based on a range of assumptions for someone aged 40 earning £45,000 a year today.
What are the chances of you living to 100?
But why should you need to fund a retirement to the age of 100? The statistics tell a story, and most of us will be quite familiar with the outlook for those born recently. Mortality.org says of all Britons born in 2007, 50 per cent will live until age 103. It's a result of healthcare improvements and lifestyle changes but remains only a projection.
But the figures are also surprising for 40-year-olds. Consider, for example, that there is a 13.6 per cent chance of a man and 19.1 per cent chance of a woman born in 1978 living to 100, according to data published by the Office for National Statistics (ONS).
Even if the chance of reaching 100 might be relatively low, you can still anticipate living a long life. The average life expectancy for men and women born in the late Seventies and alive today is 87 and 89 years of age, respectively.
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Of course, it really helps if you start saving early. The extreme effects of compounding, where you earn returns on returns, can help an investment grow at a faster rate.
However, you may be among the many who have not saved anything for their pension. You are not alone.
Around three in ten (28 per cent) 35-44 year olds have no private pension in place and 15 million workers in the UK are not putting away anything for retirement, according to the Financial Conduct Authority.
Although it may not seem like it, you still have time on your side. At 40, you are closer to your student years than you are to the state retirement age of 68. In fact, you are not even halfway through your life, according to the ONS longevity figures.
What's needed at age 40 if I want to start saving for retirement?
Discipline is needed, because saving is hard. In practical terms, if you are on a salary of £45,000 a year you’ll need to start saving around £7,500 a year, or £625 a month, according to our calculations.
These are not firm projections but meant to give an idea of different scenarios.
That could afford you the equivalent of £27,500 net per year in retirement, providing you also receive a full state pension and based on a range of assumptions. That should be enough to pay your household bills and extras such as leisure activities and holidays until your 100th birthday, even retiring at what will by then, based on current legislation, be the state pension age of 68.
The assumptions made for the calculations
Due to the complexities and uncertainties of saving for retirement we have based our calculations on current UK legislation. Each person will have different needs and requirements, so we have also made the following assumptions to keep the calculations simple:
- Your salary starts at £45,000 and rises in line with inflation (2.5 per cent per year)
- There are no bonuses or big pay rises
- You have no dependants
- 5 per cent of your salary is paid into a company pension, and your company puts in 7 per cent
- 12 per cent of your gross salary is paid into a tax-efficient investment Isa
- The Isa annual allowance, currently £20,000, increases by the rate of inflation
- Pensions and Isa investments return 5 per cent a year after fees (remember that past performance offers no guide to future returns and your capital is at risk when investing)
- The state pension is still available and rises based on current legislation of a minimum of 2.5 per cent a year.
- You will retire at 68 and live until 100
We have based all the saving and withdrawing calculations below on current legislation and the assumptions above.
Please remember these calculations are for illustrative purposes only. There might be more tax efficient ways to save and spend your money. You should consult an independent financial adviser. Investments can go down as well as up and future returns are not guaranteed. Your money is at risk when making any investment.
View from an expert
James Gladstone, head of wealth planning at Cazenove Capital, said: “The example we’ve given here is only theoretical – it’s just one way of doing it and nothing is guaranteed given that reaching the targets depends on future investment returns which are unknown.
“We wanted to show that in theory, you can still afford the 100-year life, even if you start saving later in your career. The best route is to seek professional help from a financial adviser or wealth planner who can offer advice based on your specific circumstances.
“There are a few basic considerations we’ve outlined. A primary one is not putting all your eggs in one basket. To that vein, we have made use of pensions and Isas. Pensions offer greater tax advantages upfront, but you can’t touch your savings until the age of 55 under current rules.
“Isas have less tax advantages upfront but provide the flexibility to be able to withdraw money at any time, tax free. Life doesn’t always go to plan and sometimes you need that flexibility.
“There are a number of different ways of approaching saving for retirement. There is no one size fits all solution. Hopefully we have provided some food for thought if you haven’t already started saving.”
How your savings add up
Now you know the assumptions, here is how it works.
Example: Isa savings
Your Isa savings will be the equivalent 12 per cent of your gross income per year, the value of which is assumed to grow at 5 per cent, compounded year-on-year after fees. Twelve per cent is just what is left over that isn’t spent on tax, day-to-day living and pension contributions.
At age 40 you should be saving £5,246 of your salary into your Isa, or the equivalent of £437 per month.
At age 41, as your wage increases inline with inflation, you invest a further £5,377, or £459 per month. By the end of that year your investment could be worth £10,885, providing your investment grows at 5 per cent, compounded year-on-year.
Initially, your savings growth will seem slow. However, the miracle of compounding benefits long-term savers and shows your investments accelerating over time, providing all goes to plan.
By the time you are ready to retire at age 68 you could have amassed savings worth £403, 624. Click here to see the full charts and calculations.
Example: Pension savings
Your pension savings will be the equivalent of 5 per cent of your gross annual income with your company adding a further 7 per cent of your salary, the value of which is assumed to grow at 5 per cent per year after fees.
We have used the 5 per cent/7 per cent split because these are not uncommon contributions to pensions for an employer/employee. More could be contributed to the pension rather than the Isa but having the Isa allows the person the flexibility to be able to withdraw money from the Isa before the age 55, or whenever needed.
At age 40 you will be putting £2,250 of your salary into your company pension, while your company contributes an additional £3,150. It is worth knowing that there are additional tax benefits for paying into a pension.
At age 41 your personal pension contribution will rise to £2,306, while the company’s contribution will be £3,229. By the end of that year your pension could have grown to £11,205, based on the assumptions we described previously.
Again, you can really see the benefit of saving over a long period as the value of your investment starts to accelerate in the later years of your working life. By the time you are ready to retire at age 68 the value of your pension has grown to £415, 505.
The chart below illustrates how your pension and Isa savings start to accelerate after 15 years. The blue bars illustrate the end of year balance for the Isa and the orange bars illustrate the end of year balance for your pension, between the ages of 40 and 100. The fall in value of the pension after age 67 and Isa savings after age 76 is due to withdrawals in retirement, more of which is explained below.
Don't forget your taxes
Nothing is certain in life except, death and taxes. They certainly haven’t been forgotten in our scenarios. For example, in your first year, you will pay tax of £10,400. After tax and all your savings you should have £27,104 left to spend on essentials, which includes rent or mortgage, and leisure in the first year.
For a detailed breakdown of how your yearly expenditure might work read the full report here.
What saving for retirement means for your monthly budget
The table below illustrates how your income is divided between savings, spending and taxes on a monthly basis in the first three years. The contribution from the company into your pension isn’t included as it doesn’t affect your monthly outgoings after tax.
How can I spend the money in retirement?
After nearly three decades of saving you should have accrued a healthy retirement pot, providing everything has gone to plan.
It is now time to retire, start withdrawing your money and hopefully make sure your savings last until you are 100. Accessing your Isa is straightforward. However, there are various ways of accessing your pension fund in order to meet your retirement expenditure.
Before we start, it is worth noting that there will be alternative routes to drawing your money. We have suggested only one route, for simplicity.
For example, you might take money from your Isas exclusively and then, when these are exhausted, draw on your pension. The advantage is inheritance tax protection: the pension remains outside of your estate.
Another route could be to use “phased drawdown” where you take series of tax-free lump sums from your pension (i.e. not using your 25% lump sum in one go) and drawing on the Isas and then drawing on the pension.
A third way could be using Uncrystallised Funds Pension Lump Sums (UFPLS) each year which is where you take a lump sum from your pension of, say, £10,000 which is comprised of £2,500 tax free cash and £7,500 of income, any shortfall is then topped up by drawing on the Isas.
However, we have tried to keep things as basic as possible and used a relatively simple retirement approach for the first three years as an example of what to expect. There is a full breakdown here.
Retirement: Year one
You should receive a state pension of £18,981, providing it has risen by 2.5 per cent per year.
You could withdraw the full tax free cash allowance from your company pension of £103,876. This would allow you to begin drawing an income from the residual pension fund and also fund expenditure and Isa contributions in the early years of retirement.
The tax free lump-sum could be split three-ways: £19,327 is used to help fund expenditure in your first year of retirement; £39,930 is saved into your Isa (which is how far the allowance may have grown to). The remaining £44,619 is saved in a bank account.
You could then withdraw £19,750 from your company pension as ‘drawdown’ income.
There are still taxes to be paid even in retirement. It is low in the first year because of your tax-free pension withdrawal. Tax of £3,154, is due in year one, which will leave you with £54,904 to spend on essentials and leisure.
Remember £54,904 is the inflated equivalent of £27,500 in 28 years’ time, which seems a lot until you consider that the cost of living has risen by the same amount.
The state should pay you a pension of £19,550.
You could withdraw £19,750 from your company pension.
Remember the £44,619 – the remainder of the tax-free lump-sum you took from your company pension in the first year? That is still sitting in your bank account. You take £20,129 of that to fund your retirement expenditure in year two. The remainder of £24,936, which includes £446 gained in interest in the bank account over the previous year, is transferred into your Isa.
Tax is £3,153, leaving you £56,726 to spend on essentials and leisure.
Withdrawals become much simpler. From now on your three sources of income in retirement will be the state, your company pension and your Isa.
- The state should pay you a pension of £20,137
- You could withdraw £19,750 from your company pension.
- You could withdraw £20,950 from your Isa.
- Tax is £3,153
- It leaves you £57,683 to spend on essentials and leisure.
The table below illustrates how the first three years of your income and spending in retirement breaks down. More detailed calculations are available here.
View from an expert
Lesley-Ann Morgan, head of retirement at Schroders, said: “When pensions were introduced in the early 20th century, a 40-year old could expect to live past retirement age, but only just. A century of improving healthcare and working conditions mean the equivalent group today can expect to live well into their eighties or nineties. Government research also expects this trend to continue, with new figures suggesting ten million Britons alive today can expect to reach 100.
“The good news is that it means most people can expect many years of retirement. The question is – how do you build up enough savings to last such a long time?
“The answer is to start as early as you can. But if pension saving wasn’t a priority in your 20s and 30s, it’s certainly not too late. This research shows that even at 40 you should still have time to accumulate enough money. By saving regularly, the dramatic effects of compounding, where you earn returns on returns, can help do the heavy-lifting."
This content is provided for information and discussion purposes only. It is not intended to be professional financial advice and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.
For a complete breakdown of all the calculations read the full article on the Schroders website.