Our youngest daughter is currently saving for her wedding to Harry. They have 18 months to save a quite ridiculous amount.
I have every confidence they will do it. Their goal is clear and obvious – a fabulous wedding and wedding party. The amount they need has been fixed by the wedding planner (and the smaller amount that Sue and I are willing to contribute!)
Why is it so much more difficult to save for retirement?
Firstly, when you are young and struggling to build a career or business, setting a retirement goal is probably the last thing on your mind.
Secondly, as you look forward, the years and decades seem to disappear over the horizon. I have not met anyone who can put a 40 year plan in place.
But what about a 20 year plan? With a successful career at Citibank and at age 45 I started to plan for retirement.
At the time my pension savings were modest. This was mainly due to a draconian “10 year vesting” requirement at my first employer KPMG which I failed to understand. The meaning became clear when I left KPMG after nine and a half years and the firm withheld the contributions they had made to my pension savings because I had not been there 10 years.
At age 45, I started to work out what I would need in my pension pot to allow (hopefully) a comfortable retirement by my early 60s.
Interest rates were 5% (do you remember those days) so I naively applied this rate to the pot of money I would need at age 65 to provide Sue and me with a reasonable income. The pot needed was large (but in retrospect, I am not sure the challenge was any greater than that faced by my daughter).
A combination of salary sacrifice, pension tax relief, generous employer pension contributions and decent (if volatile) investment returns got me to my goal several years early.
Would the same approach work now?
Not everyone will benefit from generous employer contributions. The 4.8 million self-employed don’t have an employer to help grow their pension pot and the newly “auto-enrolled” into new workplace schemes are unlikely to see the generosity I saw at Citibank and State Street.
But the other factors are, by and large, still in place.
Assuming an investment return after fees of just 4%, the following is achievable over 20 years:
1. If you are a 40% tax payer and put aside just £200 from your pay packet every month, you will accumulate a pension pot of £122,655 of which the tax relief gift from the government is £31,992 and investment return £42,663.
2. If you are either 1) a 20% tax payer, or 2) pay no tax at all, and save £200 per month, you will accumulate a pension pot of £92,000 of which £12,000 is tax relief from the government and investment return £32,000.
By the way, if you save £200 a month in the bank (£48,000 over 20 years), you would earn just £5,157 of interest (assuming a 1% interest rate) and accumulate just £53,157.
Just like saving for your wedding, successfully saving for your retirement requires you to have a clear and obvious goal. What is the size of the pension pot you will need? Thereafter, a combination of sacrificing income now, understanding the boost that tax relief gives to pension savings and taking advantage of employer contributions if available should get you most of the way.
The final piece needed in the jigsaw is a 4% investment return after fees. More on this next week.