projecting long-term savings, retirement, and economic calamity

geekboy

So with various impending change in my life, including a new job and a possible 5-figure lump sum inbound, I've been pondering what I should do about savings and pensions and retirement and all that jazz. I'm 28, and have about £14k in a company pension with the firm that's about to make me redundant. I expect a seamless transition to a new job with a hefty payrise - lucky me.

It seemed pretty simple: work out how much income I'd need to live comfortably in retirement, use an online annuity calculator to roughly estimate what that translates to as my savings/pension pot at retirement, then work out how much I need to save every year (as a proportion of income) to accumulate that much at age 68. It's all a rough guess, so I assumed my savings/pension would accumulate 5% interest a year, because that seems like a sensible conservative number averaged over forty years. Excel's goal-seek function gave me a sensible and affordable number. I'm not seeking detailed plans - I'm seeking a rough and conservative outline of how much I need to put into a diverse range of investments to build my assets adequately.

But here's the killer. I'm trying to predict forty years ahead (assuming retirement at 68). What is inflation going to do? What are interest rates going to do? What is the economy going to do? What about the economic effect of demographic problems, with an increasingly elderly and shrinking population? I don't see how the comfortable assumptions of the previous (i.e. baby boomer) generation can hold. In the extreme, are we going to have a global economic meltdown that throws all this out the window? And surely the government is going to have to raid my carefully-accumulated pension pot to pay for all those people who aren't able to afford (or can't be bothered) to save for their own pensions? Surely the government can change the rules on a whim to effect such a grab, throwing all my plans out the window?

Clearly, these things can't be predicted, so a guess has to be taken. Has anyone been through this process? How do you go about making those guesses and assumptions?

Maybe you just assume that average returns on investments will consistently be x% higher than inflation? How much higher? 2% sounds sensible, but is that excessively conservative?

Thanks very much for any informed opinions.

cheers,
geekboy.

clairehi

This is why you cant just make a decision now and leave it unchanged until retirement. As you get closer to retirement you will need to move your investments into progressively lower risk areas to avoid being caught out by a downturn in the stockmarket.

Do your calcs now, but be prepared to review the situation annually. You can then adjust your financial planning to reflect changes in your situation and the outside world.

For example, the state pension may not be around when we retire. In which case I will have to change my plans as soon as any announcement is made, rather than leaving everything unchanged and having a £5K income gap on retirement.

You may find the FSA pension calculator is a useful DIY tool to estimate the savings you need to make into your pension pot.

https://www.pensioncalculator.org.uk/pages/home.php

geekboy

Thank you, clairehi

I'm well aware of the points you make, but the calculator website gave me useful information.

The actual calculator is not much use, because it assumes constant pension contributions between now and retirement. But in my line of work, my salary will probably at least double over the next forty years, so my pensions contributions will also change significantly. This is why I need to do build my own model.

BUT - it lists some assumptions on there that answer my questions:

# Investment growth: Your pension fund will grow by 7% a year until you retire.

# Inflation: The Retail Prices Index (RPI) will rise by 2.5% a year until you retire.

# Pension fund charges: The company providing your pension will charge 1.5% of your fund for the first 10 years, and 1% thereafter.

# Income tax rebates: The Government will add a tax rebate to your contributions at the basic rate (22%), so that every £1 that goes into your fund consists of 78p from you and 22p from the Government.

Since those are officially-sanctioned estimates, I guess they're as good as I can get for now. I can feed them into my model.

Does anyone disagree with those numbers, or with the wisdom of relying upon them?

Thanks again.

geekboy.

EdInvestor

IMHO you might as well ignore the tax relief as the vast majority of it is just deferred tax - you have to pay tax on the pension income after you retire, so they take it back. If you are a higher rate taxpayer you get an extra 18%, which would help, assuming you don't spend it.

The 7% investment growth is based on the stockmarket dividend yield (3%) + estimated GDP growth (2.75%) + inflation (2.75%) net of charges and is backed up by long term studies of the structure of returns.

Obviously an investor can alter this outcome by choosing investments that pay higher or lower dividends.

geekboy

Thanks, EdInvestor.

I note your point about the tax relief. I'm about to become a higher-rate taxpayer. It occurs to me that although the tax is ultimately payable one way or another, tax that's deferred for forty years might contribute significantly to investment growth in the meantime. So I think I should include it in my predictions, and base my retirement lifestyle budget on taxable income. If tax levels change (almost certain), I'm in a better position to calculate the impact then.

Thanks for the insight into the origin of the 7% investment growth - though being a pedant, your numbers don't quite add up ;-)

gb

EdInvestor

It occurs to me that although the tax is ultimately payable one way or another, tax that's deferred for forty years might contribute significantly to investment growth in the meantime.

Don't kid yourself. There is no "growth on the tax relief". They take it all back (apart from the 25% tax free cash and I wouldn't bet on that being around in 40 years) and you lose control of the capital as well.

your numbers don't quite add up

They do if you're using 1.5% for the charges - and believe me, unless you buy shares direct, there's nothing worth having that charges less than 1.5%.

geekboy

EdInvestor wrote:

Don't kid yourself. There is no "growth on the tax relief".

Yup, maths error. Oops.

EdInvestor wrote:

They do if you're using 1.5% for the charges

Right, that adds up now. Thanks.

clairehi

geekboy wrote:

in my line of work, my salary will probably at least double over the next forty years, so my pensions contributions will also change significantly.

Probably - but not definitely. If I were you Id base my projections on todays salary rather than making assumptions about future salary growth.

clairehi

geekboy wrote:

Thank you, clairehi

The actual calculator is not much use, because it assumes constant pension contributions between now and retirement..

No it doesnt. From the website

The Pension Calculator estimates also assume that:

You keep up regular monthly payments from now until you retire.
Each year you increase your monthly payments by a minimum of the estimated rate of inflation (2.5%).