Don’t ask how much you should pay in to a pension, ask how much you want back

Adrian Boulding | Supplied

There are some good tools available to help gauge how much income different people may need in retirement.

The Pensions and Lifetime Savings Association (PLSA) has its Retirement Living Standards, which detail three different levels of comfort you might wish for. Probably more important, they show different values for single people and couples, which brings home the fact that this is really a household planning activity and not an individual exercise. The Joseph Rowntree Foundation produces similar material too.

This stage of thinking about how much income you will need in retirement can be done at three levels of complexity.

Recent research from Nucleus found only 34 per cent of respondents are confident they would have enough money to live comfortably for the rest of their lives, based on the PLSA’s definition of comfortable.

You can take a much simpler approach than the PLSA’s shopping basket exercise by using the Government’s MoneyHelper website, which advocates targeting a percentage of current earnings, and it suggests that those on lower earnings will need a higher replacement percentage than those on higher earnings. Or a more detailed approach can involve personalising the standard shopping baskets, as some of us prefer to spend more than the average on clothes, cars or footie tickets. But of course, you have to project how your interests may change over time.

A mistake that many people make in preparing for retirement is to assume that their expenditure will drop off, at least in real terms, when they stop working. That’s a fallacy that makes annuities seem more affordable and is perhaps what leads most annuity buyers to choose a level of income with no increases over the course of retirement. A report by the Institute for Fiscal Studies in 2022 debunked that. It showed that total household spending per person remains relatively constant throughout retirement, perhaps increasing slightly more than inflation up to age 80 and still increasing but slightly less than inflation into the later years beyond that.

Only once that spending target has been properly evaluated should you move onto comparing it against current pension savings. Gather together the latest annual benefit statements from any defined contribution (DC) plans, add in any projected final salary pensions and get a state pension forecast from the gov.uk website.

It was Charles Dicken’s character Mr Micawber in David Copperfield who equated happiness with an income slightly higher than expenditure and misery with income that failed to meet expenditure. There are a number of strategies that can be deployed to convert projected pensions misery into projected happiness:

1. Save more. Perhaps the most difficult, as that probably means something has to be foregone out of today’s already hard-pressed household budget.
2. Work longer. A sensible option for those who really enjoy their job, but for anyone else this might just be kicking the can down the road and losing valuable time while doing so.
3. Invest in higher growth assets. While this could look like a free route to a higher pension, those higher investment returns come with higher risk, which should only be taken on if you can live with the potential downsides, which could be even less income in retirement or having to work even longer.
4. Move to a more efficient pension. With a DC pension that could mean finding a lower cost platform or amalgamating old pots together. In time it may also entail converting from DC to collective defined contribution schemes (CDC) which Actuaries suggest will offer a significant upside.

If the projected expenditure and income comparisons already project the state of happiness, then you might be one of the one in six people that are over-saving for retirement. But rather than reducing contributions you might be able to retire a little earlier, or move to safer, lower risk assets that can lock in your favourable situation.