The maximum New State Pension in Britain currently stands at just £164.35 per week. Could you live on that little income? That’s £712.18 per month or £8546.20 per year.
I’m not yet retired but have no mortgage and pay no rent because I own my own home. However, I’d struggle to pay all the bills and put decent food on the table on that small income, even without the cost of paying for accommodation. Running a car would be a big squeeze on that tiny amount of money and as for nice holidays, forget it.
Retirement savings mistake number 1
Retiring on that meagre income would plunge most people into a subsistence lifestyle. To make ends meet many would probably depend on other government benefits, but there’s no guarantee that other benefits will be available by the time we retire. Another option might be to plunder our own assets such as selling the home we own and moving into rented accommodation so that we can live on the capital raised from the sale. Or we could enter into one of those equity release agreements and remain in our homes. However, the terms will likely be poor and a lot of the value of our capital will be lost as it finds its way into the hands of the company that offers the deal.
If you don’t own your home and have nothing to sell, your financial survival could even come down to relying on charity. That’s a bleak picture and it leads to the number one retirement saving mistake that millions of people are making right now: relying on just the state pension to finance your retirement.
It’s clear that most of us need to build up a savings pot of money that will be available to us in retirement on top of the pitifully small state pension we’ll get. Luckily for me, my employer made me start paying into a company pension scheme when I was 20, I had no choice. At the time I was a bit miffed. I didn’t want a chunk of my income to be deducted from my pay before I got it. Back then I wanted to spend the money on other ‘more-pressing’ things to help me enjoy life to the full, as many people do at that age. Retirement was decades away and it seemed to be so far into the future that there was no rush to worry about it.
Retirement savings mistake number 2
Such thinking was a big mistake on my part. The most important thing about saving for retirement is to get your money to compound – where your money earns interest, the interest earns interest and the interest on the interest earns interest and so on. Compounding really starts to accelerate the growth of your savings pot when you add the ‘magic’ ingredient of time. So, the number two retirement saving mistake is to only start saving later in life. Ideally, you should start putting regular money away as soon as you start earning and certainly when you are in your 20s.
If you if you don’t get around to thinking about saving for retirement until mid-life or later, all is not lost, but you will have to save more each month, or earn greater returns on your savings each year, or both, if you want to end up with a pot as large as the one generated by early saving.
Retirement saving mistake number 3
Once you’ve mastered the savings habit it’s important to choose the most efficient investment vehicle to make your money compound and grow. One of the best routes to saving is through a workplace pension scheme provided by your employer. You will get tax relief on the money you pay into the pension each month and your employer will pay some money in for you on top.
That’s right: most employers pay between 3% and 10% of your annual salary each year into your pension scheme and it’s a completely free gift! Such a big benefit will really turbocharge your pension pot and to turn your nose up at a chance to participate in a company pension scheme is the number three retirement saving mistake.
But if you don’t have the opportunity to participate in a workplace pension organised by your employer, you can pay into a personal pension, self-invested personal pension (SIPP) or stakeholder pension anyway, without an employer contributing. The chief advantage of using a pension wrapper for your retirement funds is the tax relief you receive on the money you pay in. Although it’s worth remembering that when you draw money out of your pension upon retirement, it’s taxed as if you are earning it after the first 25% of each withdrawal, which can significantly reduce your investment gains.
Retirement saving mistake number 4
That’s why many people shun pension wrappers altogether and use Individual Savings Accounts (ISAs) to save for retirement and I think that is a good idea. The main advantage of an ISA account is that you are not taxed when you draw money out. However, there is no tax relief when you pay money in. But I think that’s the best way to have it. Assuming you get compounding to work well for you, your gains will be large after several decades so the tax relief is applied to a much larger amount of money than what you were taxed on when you paid in.
But the number four retirement saving mistake you can make is to choose a cash ISA instead of a stocks-and-Shares ISA. Compounding will not work very well with the derisory interest rates paid on many cash ISAs and even when interest rates rise, your money will rarely keep up with inflation. Meanwhile, shares have beaten most other asset classes over long periods of time and there’s a good chance investing in shares will help your investment pot grow ahead of inflation.
