How to calculate what to contribute in to a pension?

JustAnotherSaver
JustAnotherSaver Posts: 6,709
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I'm working my way through Tim Hale's book & finding it really good so far.
I just got to the section where he says (as a very rough guide i guess) to put about 15%-20% of your wage in to your retirement plan.

I'm just wondering how you calculate that, especially for someone like me who has a variable wage.

My last P60 stated i earned gross £21000. I haven't had a pay rise but at the moment i'm in line to earn more at the rate i'm going.


*Edited out for sad people who trawl through old posts trying to prove some point. Sorry.*

Have i done the numbers correctly or have i once again made an error somewhere?
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  • How old are you and is the pension an occupational pension where your employer pays in too? If so how much do they contribute?

    There is no blanket rate for pension contributions.

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  • as a very rough guide i guess.

    As with the "half your age when you start, as a percentage of your gross pay, as a gross contribution to maybe get 2/3rds of wage when you retire" guideline - that's all they are; they're a rough guide to give you an idea of the scale of contributions you should be looking at. ("Should I be contributing £100 a year? £1000? £5000? £12,000?" Because the answer to that question usually surprises most people when they first find it out.)
    Is that before tax relief? So i'd actually only pay in an amount less than that & tax relief would bump it to £4,240?

    Once again, they're a guide, but the numbers given generally refer to what eventually ends up in your pension pot. So 'deduct' any tax relief from contributions made out of net pay and employer contributions from that number to work out "what you 'should' be putting in."
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  • Malthusian
    Malthusian Posts: 10,857
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    Virtually all such rules that appear in financial self-help books are too high, because they are not so much an accurate calculation of the fund required in retirement, more a wake-up call that no, the £100 per month you pay into your Stakeholder Pension isn't enough. Nor is the 4% of salary (plus employer contributions) demanded by auto-enrolment. (The auto-enrolment percentage is designed to save the Government from having to pay means-tested benefits, not to provide for a sufficiently comfortable retirement.)

    And if someone does pay "too much" into their pension in their 30s it hardly matters, as they won't have to pay as much in later. And it will probably just be money that would otherwise have been wasted on car finance or something equally useless.

    The answer to your question is however you like. It is an arbitrary rule so how you calculate it is equally arbitrary. If you can afford to pay in 20% of your gross salary calculated on the highest possible basis, do it. If you can't but you can afford to pay in 15% of the average of those six figures then do that. The question is how much you think you can afford, how much you can actually afford, and how much income do you want in retirement.
  • I knew that these figures weren't gospel & mainly just try to drum it in that most people will need to pay in more. I just wondered how you calculate properly.

    It's about getting the right balance. If i'm fortunate enough to live until retirement i may be unfortunate enough to only live 1 year into retirement, in which case i could've enjoyed all that money now & only saved a small amount for retirement rather than wasting it.

    Since i've read online calculators for projected income are not the most reliable, i don't really know how much i should be putting away.
  • kidmugsy
    kidmugsy Posts: 12,709
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    I just got to the section where he says (as a very rough guide i guess) to put about 15%-20% of your wage in to your retirement plan.

    Notice that it's a "retirement plan" not a pension. I'm rather sceptical about youngsters (if young you be, OP) on modest wages heaping money into pensions unless they are using salary sacrifice, or harvesting an employer's contribution. The money will be inaccessible for ages, and there's no way of knowing what income tax laws will apply to you at the point of retirement. Moreover there's a chance that the rate of tax relief will go up for 20% tax payers: why not wait a few years to see whether that happens? An S&S ISA might be a better home for some of the money. You can always reverse that decision later, withdraw the capital, and contribute it to a pension. Maybe you'll get 40% tax relief. Yippee! As you get older the balance of advantage changes in favour of pensions, not least because you can begin to guess how much Personal Allowance you will have unused in retirement.

    Meantime youngsters often have serious other financial needs e.g. saving towards eventual house purchase. Then a LISA might be attractive.

    Of course these musings assume that you have enough self-discipline to avoid splurging your savings and investments on follies.
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  • It's about getting the right balance. If i'm fortunate enough to live until retirement i may be unfortunate enough to only live 1 year into retirement, in which case i could've enjoyed all that money now & only saved a small amount for retirement rather than wasting it.

    If you're dead you won't be sitting around worrying about all the things you missed out on. If you live to be ninety then there'll be plenty of time to consider your pension (or lack of it). The risk of not having enough money in retirement is real whereas how you're going to feel after you've died is somewhat irrelevant.

    You are right about finding a balance. You just have to decide whether having a larger pension pot will make you happier than the other stuff you could spend it on now.
  • Linton
    Linton Posts: 17,045
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    I knew that these figures weren't gospel & mainly just try to drum it in that most people will need to pay in more. I just wondered how you calculate properly.

    It's about getting the right balance. If i'm fortunate enough to live until retirement i may be unfortunate enough to only live 1 year into retirement, in which case i could've enjoyed all that money now & only saved a small amount for retirement rather than wasting it.

    Since i've read online calculators for projected income are not the most reliable, i don't really know how much i should be putting away.

    A reasonable basis for the right balance would be to put enough into a pension to ensure that your ongoing expenditure in retirement is the same as when you were working. The more you put into the pension now the less money available for your current expenditure and the greater that available for retirement and vice versa.

    One way of calculating this is to develop a spread sheet based on assumed investment returns, assumed inflation salary,current expenditure etcetc and work out how much you need to invest each year to achieve the constant expenditure objective. Then each year you can update your current situation and assumptions and recalculate.

    Or you could achieve similar results by using your calculator of choice. Provided they are at least roughly reasonable It doesn't matter too much how accurate the calculators are as the process is self correcting as you update your current situation each year as you approach retirement.
  • kidmugsy wrote: »
    I'm rather sceptical about youngsters (if young you be, OP) on modest wages heaping money into pensions unless they are using salary sacrifice, or harvesting an employer's contribution. The money will be inaccessible for ages, and there's no way of knowing what income tax laws will apply to you at the point of retirement. <snip>

    But, but, but.. pension funds for babies! (Never quite figured that one out, basically for the same reasons in your post.)
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  • Alexland
    Alexland Posts: 9,652
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    edited 21 September 2017 at 7:50AM
    I guess people figure that there is a reasonable limit on the amount of income tax that could be applied to a baby's pension draw down in future. It is unlikely to be worse than the tax benefit from when it was originally invested but yes there is a risk. There's also the risk that if they become a low earner whatever you give just replaces their entitlement to benefits.

    However similar to a JISA a child pension still has the benefit of tax efficient growth - not that it's worth much with the various annual allowances for growth outside a wrapper.

    Mostly it's a good control to delay access to the money and enable a parent to contribute across the whole child's lifecycle.

    Personally I am divided on child pensions. Part of me thinks the child shouldn't be denied the achievement of building their own pension pot from scratch. Another part of me thinks it would be a good way to disinherit myself early and they will need all the help they can get to build a decent pension.

    Alex
  • Alexland wrote: »
    Mostly it's a good control to delay access to the money

    For upwards of 57 years? Especially if it's the only source of investment, which is how it's normally talked about.
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