Pension - Rule of Thumb

atush

I thought it included employers

Malthusian

Surely it includes employers' contributions as different jobs offer different levels of employer contributions, and you wouldn't tell a self-employed person to save the same net amount as someone who had 2-for-1 employer matching.

The rule of thumb isn't supposed to be accurate, it's supposed to make you think "oh I must start / increase my pension contributions". As long as it gets you thinking it's done the job.

ex-pat_scot

It has multiple purposes:
- it's large enough to be scary and a bit of a wake-up call
- it clearly articulates the fact that you need to start early or it costs a lot lot more
- it is very simple to understand
- it is scalable, ie relevant to pretty much every income level.


It is "gross" ie er & ee combined contribution as % of gross salary.
It ought to be "contribute (50% of age) as % of gross, based on the age you first started.
It does not usually talk about escalating as you age (although there's nothing to stop you doing that - indeed each year you get older, that would mean adding an extra 0.5% which should be below the long-run inflationary pay rises you get).


Frankly there's no right answer, just as there is no right amount of retirement funds you should aim for.

eastcorkram

Also, only really works if you start young!
Doesn't really work if you start at 50 for example, and pay in 25%.

bigadaj

eastcorkram wrote: »

Also, only really works if you start young!
Doesn't really work if you start at 50 for example, and pay in 25%.

Well it does thats the whole point.

The problem with starting late is multiple, including less opportunity to retire early, more susceptible and affected by stock market crashes, or accepting lower returns from lower risk assets.

bowlhead99

eastcorkram wrote: »

Also, only really works if you start young!
Doesn't really work if you start at 50 for example, and pay in 25%.

It certainly works better at young ages when you have a long long time for investment gains to work their magic. As other people pointed out, the purpose of these "rules of thumb" are as an indicator to get you thinking about what you might need and encourage people to do something about their lack of provision. It is designed to be a motivator and give people a kick, but doesn't mean they will get the exact same retirement income whenever they start.

For example if you tell a 20 year old they can just put away 10% of their salary now between themselves and their employer, and continue with that rate comfortably as their salary goes up and up over their working life... but if they don't, they might end up in a situation where they need to put away 20-25% of a large salary for the rest of their working life, at a time when they're perhaps a high rate tax payer, they might think "wow I don't fancy giving away half my income to tax and pension, I'd better get cracking".

But if you make the numbers too comparable and say to a 50-yr old that he should start contributing 40%+ right now, it won't be a motivator at all because he can't afford 40% so will consider it a "lost cause" and not bother. It's perhaps better to just tell him to make an effort to do 25% and he'll definitely get something out of it, but he needs to appreciate that *of course* he's not going to have as good a pension as if he'd started when leaving school or graduating uni. Because he initially chose to avoid pensions, and p1ss his money up the wall for three straight decades before getting round to starting.

Running some basic numbers on the back of a beer mat:

Imagine you are age 40 working in middle management and expect to earn on average £30k over the rest of your life in real terms, assuming no pay rise above inflation. Put 20% of that a year (£6k) into pension for 28 years until you're 68: it's £168k. Then make the simple assumption that that'll mean the money was invested for on average 14 years (some 28 years, some nil), and you get compound growth from your investments of 4.5% in excess of inflation in an equities-heavy portfolio.

So with the growth the £168k becomes £333k by age 68. You retire and keep the money invested, going in to drawdown taking out 4% each year. The starting figure would be £13.3k. Add to that your £8.2k state pension, and you have annual income of £21.5k which is comfortably 70% of the £30k salary except now you don't have to work for it.

Compare to someone age 52 working in middle-to-senior management expecting to average £35k over the last 16 years of his working life.

That person would be told by the rule of thumb to do 26% into pension which is £9.1k annually and £145.6k by age 68. The 16 year timeframe gives average investment period of only 8 years at the 4.5% real return, turning the £145.6k into £207k. Then retire and from that pot you can draw 4% a year, that's £8.3k, again add £8.2k for state pension and you're looking at £16.5k annual income.

For that person who started later, of course he won't get to the same "70% of the income I was earning while contributing", because there simply wasn't enough time for a few extra percent to make up twelve years of not bothering to contribute from age 40 to 52. Still, his/her total annual income is getting on for half of the £35k he used to earn when he had a job and it's double the poverty-spec state pension. So all is not lost.

For the person starting at 52 it was still worth contributing rather than just giving up. And a more realistic thing to aim for, than trying to contribute 50% of your salary in a desperate and difficult quest to build £300-400k before the day you can quit work. Few could manage that without extreme discipline.

For a lower earner, the state pension would be a higher proportion of total income, so the "retiring on x% of final salary or y% of average salary" would reach a higher percentage. Or for a higher earner, the total pot built would be a bigger number anyway. So, its nearly always worth starting rather than giving up because of the enormity of the task.. The key is making it sound somewhat achievable while not being unrealistic that you're going to get the rewards of what five decades of contributions could have brought.