Planning for retirement

Income in retirement

Even if retirement is many years ahead, having an idea of how much income you will need in later life will help you to set aside enough savings today.

How much income you will need depends on your lifestyle choices and varies from person to person. Our budget calculator can help you estimate how much may be right for you.

Saving for retirement

Retirement can easily last 20 or 30 years or more. Saving enough to fund a long period after work is costly. There are many different ways to save for retirement. For example, you could use individual savings accounts (ISAs) or invest in a second home or buy-to-let property. But saving through a pension scheme has some advantages.

Joining a pension scheme through work makes sense if your employer will help to meet the cost by making contributions to the scheme on your behalf. When the new system of auto-enrolment is introduced between 2012 and 2017, all employers will have to contribute something. If you are self-employed or topping up a work-based scheme, you will normally save through a personal pension plan and bear the whole cost yourself.

Under auto-enrolment, your employer might choose to enrol you in the National Employment Savings Trust (NEST), a national scheme with low charges. From late 2011, self-employed people can opt to join NEST too.

Whatever the type of pension plan or scheme, you usually get tax relief on your contributions at least equal to the basic rate of income tax (20% in 2012-13). This means, for every £80 you pay in, the taxman provides another £20. Depending on the scheme, tax relief may be added to your pension plan or given as a reduction in your tax bill.

The table below gives an idea of the amount you would need to save each month in mid-2011 to provide yourself with each £1,000 a year of before-tax pension when you retire.

How much you might need to save to provide each £1,000 a year of pension*

* Assumptions: investment growth 7% a year; charges of 1.5% for the first 10 years and 1% thereafter; pension contributions increase by 4% each year in line with assumed increase in earnings; amounts shown in today's money, assuming inflation averages 2.5% a year; pension fund buys an annuity for a single person with income increasing each year with price inflation (rates at 6 July 2011 from Money Advice Service); tax relief at 20% added to the monthly amounts shown. Any employer contribution would reduce the amount you might need to save to less than the amounts shown.

** From 1 December 2012, annuity rates are due to be equalised for men and women, who will then need to save the same amount to receive the same pension.

For further help working out the amount of pension your retirement savings might provide or to check how much you might need to save to produce a given amount of pension, use our pension calculator.

Choosing your pension age

The table above assumes that you will retire at state pension age under the rules as they stood in mid-2011.

If you want to retire earlier, you will have to manage for a while without your state pension. On top of that, starting your pension early makes it more expensive because the pension has less time to build up and longer to be paid out. So you will normally have to save more each month to provide each £1,000 a year of pension that you want.

If you plan to retire later, your pension will have longer to build up and less time to be paid out. This makes it cheaper so that you may be able to save less each month to provide each £1,000 a year of pension. For example, if the 40-year old in the table above puts off retiring for five years to age 72, the amount he or she might need to save each month falls to £28 or £31, respectively.

Phased retirement

Retirement does not have to be a cliff-edge where you are working one day and finished with work the next. In 2011, around one in eight people over state pension age are still working, often part-time.

If you plan to carry on working into later life, you will not necessarily need all your pensions or other savings in one go. With phased retirement, you divide your pension savings into chunks and can start drawing a pension from each chunk at a different time. Some other types of savings and investments, such as ISAs also give you this flexibility.

As you cut back on work, you could increase the amount you draw from your pension scheme or other savings and investments so that your overall income is maintained.

A phased approach to retirement also gives you a way of planning to deal with the effect of inflation. You can start retirement on a lower amount of income and gradually increase it later to compensate for rising prices.

Drawing a pension

You might have to take the pension from an occupational pension scheme all in one go. But with a personal pension plan, you usually can phase in your retirement income. This is because each plan is usually set up as a group of segments. You can start the pension from each segment independently of the others.

When you want to start a pension from a segment, you would typically take part of the pension fund as a tax-free lump sum and use the rest to buy a lifetime annuity. An annuity is an investment where you exchange a lump sum (in this case, some of your pension fund) and in exchange get an income either for a set period or for life.

Alternatively, you could draw your pension from some or all of the segments using income drawdown. Again, you would typically take a tax-free lump sum but then leave the rest of the pension fund invested and just cash in bits of it as you need to draw off some income.

Income drawdown is especially suitable for phased retirement because you are not committed to receiving a set level of pension at regular intervals. You can choose when and how much to cash in (normally up to a maximum amount each year). But income drawdown is more risky and costly than buying an annuity, because the maximum income you can draw may fall. This means it is usually suitable only if you have a large pension fund or other reliable sources of income.